Income Report / Income Note: CBA Trading Update (CBA, CSR, MQGPD, SUNPE, SUN)

By Market Matters 13 May 20

Income Note: CBA Trading Update (CBA, CSR, MQGPD, SUNPE, SUN)

Market Matters Income Report 13th May 2020

The ASX has opened lower this morning thanks mostly to comments overnight from US central bankers about the economic impact of re-opening too quickly. Risk is back off with buyers focussing on the defensive areas like gold while real estate, retailers and the like are back on the nose, Solomon Lew’s approach to rents yesterday clearly not helping things.

CBA was out this morning with a trading update, the stock trading marginally higher, more on that below, while we also look at the new Macquarie Hybrid, the redemption of a Suncorp Hybrid and provide our view on CSR post yesterday’s earnings update, a stock we did well out of last year.  

The ASX 200 is currently trading  down -83pts /-1.54% to 5319

ASX 200 Chart

The Income Portfolio fell by -0.31% for the week weighed by a 6% decline from Westpac (WBC), while Super Retail Group (SUL) added +7.43%.  Financial year to date the portfolio has declined by -9.37% versus its absolute benchmark (RBA cash +4%) of +4.09%. Since inception, the portfolio has added +4.49% vs. the benchmark of +15.01%.  

Commonwealth Bank (CBA) trading update

CBA has this morning showed (again) why it’s the No 1 pick of local banks delivering a decent trading update in a very difficult period. They announced 3Q20 profit of $1.3B which included a bad debt charge of $1.6B, $1.5B of that is a forward-looking estimate on impacts from COVID-19.

In terms of the underlying result, they had no change in income from 1H20 quarterly average to 3Q20 with a small increase in lending being offset by a similarly small reduction in margins thanks to a lower cash rate. They had a bigger remediation provision ($135m) however excluding that, expenses were down a touch.

Capital for CBA is strong at 10.7% after paying the 1H20 dividend plus they announced the sale of 55% of Colonial First State, the total unit being valued at $3.3b. This and other announced sales should add 70 bps to CET1 capital which takes it well above the level of unquestionably strong.

All in all, a reasonable performance in a tough market with few surprises. CBA trading marginally higher at time of writing, outperforming both the market and the other banks.  

MM is bullish CBA

Commonwealth Bank (CBA) Chart

CSR Limited $3.72

We held CSR in the income portfolio last year, buying in May at $3.37 & selling in November at $4.59, including dividends it was a 46% gain. Yesterday the stock closed at $3.72 after reporting a ~30% decline in profits for the year, suspending its dividend, pulling a share buyback and offering no guidance for FY21. That all seems fairly negative however it wasn’t surprising and importantly, a better outcome that the market had feared.

CSR is primarily a building products company however they also have an Aluminium business. While the Aluminium business is not the reason to buy CSR, it was the main reason for the beat versus low expectations yesterday, although building products were also a tad ahead.

While there is likely to be more pain ahead for building product sales and the low in revenue is still ahead of CSR, markets price the future and will look through this if / when we see a recovery in construction data. CSR has net cash on their balance sheet and a very proactive management team.  

MM is again bullish CSR

CSR chart

New Macquarie Hybrid

Macquarie launched a hybrid security on Monday and the broker bookbuild opened and closed within the day due to strong demand. They were raising $400m in a longer dated tier 1 security, with first call in 8.5 years. Compensating for that was a solid 4.70% rate over bank bills landing the security at around 5% pa. Macquarie is a slightly higher risk issuer than a big 4 bank, and the note is longer duration hence the higher yield than many of the existing hybrids.

If you cast your mind back to early March this year, both Macquarie and NAB had new hybrids in the pipeline that were rightly pulled as credit markets went into meltdown. That security was being offered at a margin of 2.90% over bank bills meaning that the new security is costing MQG an additional 1.80% pa.

In terms of existing Macquarie Securities, they have 3 on issue:

MQGPB $101.70: 0.8 years to run paying 3.49% over bank bills  
MQGPC $98.20: 4.6 years to run paying 4.62% over bank bills
MQGPD $98.00: 6.3 years to run paying 4.67% over bank bills (we hold in the Income Portfolio)  

As a very general rule of thumb, we view hybrids offered with a margin of 4% as cheap and below 3% as expensive.

MM are positive the new MQG Hybrid however we already hold the MQGPD

MQGPD Chart

Suncorp Hybrid (SUNPE) repayment

This week Suncorp issued an exchange notice for the SUNPE. What this essentially means is that holders will get their $100 face value repaid in cash plus any accrued interest however Suncorp fund this through shares, not cash. This is becoming a more popular way for some hybrid issuers to pay back hybrid holders without reducing capital levels, here’s how. SUN enters into an agreement with an investment bank to buy all SUNPE’s on issue at $100 (plus accrued interest), holders get their capital back in cash. The buyer then converts the hybrids into ordinary shares at a prescribed conversion rate (slight discount to prevailing market price) and presumably has already on sold that stock to institutional investors through blocks.

Hybrid holders get paid back in cash, Suncorp pays it back by issuing shares, equity investors are able to get liquidity in the stock off market, and of course, the investment bank would charge a fee and / or earn brokerage on the sale of the stock to institutions.  Based on the size of the SUN issue $193m (which is small) assume a fee of 0.3% equates to nearly ~600k fee (I’m guestimating this) on one of the smallest hybrid issues on the market.  

SUNPE Chart

Staying on Suncorp, this week they released a quarterly trading update which brings into doubt whether or not they’ll pay a 2H20 dividend. While the stock rallied on the day the update was on the weaker side and this led to earnings downgrades from analysts, however the interesting aspect from my perspective was around tier 1 capital.

SUN said that they had excess tier 1 capital on their balance sheet to the tune of $682m as at the end of March, however it seems unusual if that was actually the case they would also issue stock to pay back the $193m hybrid security as outlined above. Shaw’s analyst Brett Le Mesurier has removed expectations for a 2H dividend taking the view that the fact that they elected to convert the hybrids suggests that the excess capital may not be excess at all.

MM has no interest in SUN

Suncorp (SUN) Chart

Conclusion (s)

The CBA trading update was solid, and asset sales will improve capital

We like the new MQG Hybrid

We are bullish CSR

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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