Income Report / Income Note: Hybrids, Fortescue & updated thoughts on Smart Group (FMG, SIQ, NBI)

By Market Matters 15 January 20

Income Note: Hybrids, Fortescue & updated thoughts on Smart Group (FMG, SIQ, NBI)

Market Matters Income Report 15th January 2020

The market has opened marginally higher this morning with utility stocks leading the charge, perhaps a sign that the market is gradually losing some steam after a very optimistic start to the year. As we suggested this morning the ASX 200 has already surged 278-points / +4.2% from the monthly low to be knocking on the door of 7000, a pause at least should now play out.  

Not a lot across the ticker in the first hour of trade this morning although gold stocks are finding some form after a weak period, Evolution (EVN) up +3.43% while Newcrest is trading 1.8% higher. Perpetual (PPT) released Funds Under Management (FUM) for the quarter this morning with outflows in equities offset by inflows into fixed income products, all in all total FUM ended the month at $26.3b, an increase of $200m. Shares are trading up 8c at $42.65. We hold PPT in the Income Portfolio.  

Overall, the ASX 200 is currently trading up +15 points / 0.22% at 6977

ASX 200 Chart

The Income Portfolio performed well over the break, adding +0.71% since the last report on 18 December. This was a touch behind the ASX200 accumulation index which pushed to all-time highs yesterday, up 1.8% in the same period with the Income Portfolio coming in behind due to the allocation to the lower volatility income securities. Only a handful of positions performed negatively during the period, with no single holding falling more than 3% -Spark Infrastructure (SKI) the worst performer, but falling just -2.76%. Ive Group (IGL) was the standout, adding 7.3% while Stockland (SGP) was up 4.71% after rebounding from a softer period. Five holdings paid dividends – ABP, MXT, NBI, SGP and XARO. The portfolio continues to track above the benchmarks, currently up +4.64% financial year to date, versus its absolute return benchmark of +2.63%. Since inception the portfolio is up +22.19% vs the benchmark of +13.55%.

A mixed bag to cover in our income note today, however we’re addressing questions / queries / comments raised over the break with an income tilt.

Questions on Hybrids: A number of mixed questions on hybrids over the break which is understandable as spending ticks up and investors become concerned about sustaining lifestyles on dwindling term deposit rates, which are likely to go lower. Higher returns generally = higher risk and that’s the case when we think about hybrids, however the old adage of risk v reward, or in other words, are we getting paid enough ‘return’ for the imbedded ‘risk’ we’re taking on. For those looking for a good overview on hybrids, Morningstar put out a Hybrid Handback a few years ago (click here), I’m not sure if there is an updated version however this one provides a good generic backdrop of the sector. They are reasonably complicated however on face value however acceptance of the asset class is growing, with more institutional money finding a home in the hybrid market.  

Firstly, when thinking about a hybrid understand the drivers of returns. 1. The issuer, how secure are they? Most investors stay in the bigger bank hybrids which are much the same, and that security issue is less relevant. 2. Type of security. There are generally two types, a tier 1 security or a tier 2 security. Tier 2 is safer, more debt like with less convertibility so they pay lower rates while Tier 1’s are what the banks have generally been issuing given higher capital requirements. To keep things simple, tier 1 securities are the most common, so comparing these is probably most relevant & 3. Duration, the longer the time to first call date, the higher the yield should be, more time for things to go wrong.

Here’s the most attractive hybrids as of today with mixed durations. Shorter dated, all things being equal mean safer, less volatility.

Short Term (1.9 years): WBCPG $104.49, yield to first call date of 3.43%

Medium Term (4.3 years): CBAPH $103.78, yield to first call date of 3.82%

Long Term (~6-7 years): AMPPB $100.50, yield to first call date of 5.54%, MQGPD $106.96, yield to first call date of 4.17%, CBAPI $101.38, yield to first call date of 4.11%

For a full hybrid pricing sheet thanks to the Shaw & Partners Income Team – click here 

How big could the Fortescue (FMG) dividend be? This is a question more from the institutional guys we deal with who are pricing up derivatives around the upcoming FMG dividend however it’s obviously also important from a share price perspective in the lead up to FMG’s 1H20 dividend at the end of February. Before then, FMG provide production numbers on the 30th January then report 1H earnings on the 19th February and barring any major issues, the FMG dividend should be a very big one. If we assume the payout ratio inline of guidance at 50-80% (more recently FMG has paid out closer to the 80% end) and with the Iron ore price in the 1H averaging US$95.66 minus a 12.5% average discount applied to FMG lower grade Ore then 1H20 profit should be around US$2bn give or take. Full year consensus is at $US3.9b.

In short, at a 50% payout ratio, the dividend would be ~57cps while at an 80% payout it would be ~92cps in AUD terms. That’s somewhere between 5.2% & 8.4% for the half. FY20 consensus is for 90cps for the full year so if they pay at the top end of the guided range, they could exceed the full year expectations at the first half drop.

While insiders are selling a few shares into recent highs, it’s hard to see any meaningful sell off in the stock before the results & massive dividend that seems likely.

Fortescue Metals (FMG) Chart

Are we still looking at Smart Group (SIQ)? Our last income note for 2019 looked at salary packaging business Smart Group (SIQ) after shares essentially halved (click here). The conclusion in that note being…technically, 2 aggressive days of selling has played out and the stock should find some support on day 3 which is today. MM now has SIQ on our radar as an income stock to buy, looking for selling pressure to subside.

The stock was $6.96 at that time and yesterday it closed at $7.01, selling has subsided but there’s been a lack of any real buying into the weakness despite the market’s overall strength rallying to new highs. SIQ now trades on an estimated P/E of 11.27x based on downgraded numbers while its Est yield is 6.28% fully franked with the stock going ex-dividend in April after they report on the 17th February. SIG have beaten expectations 4 times from their last 5 results implying that some upside could start to be baked in.

MM still has SIQ on our radar as an income opportunity

Smart Group (SIQ) Chart

Is Neuberger Berman (NBI) doing a new issue? This is an international bond fund we hold in the income portfolio and on the 22nd November last year they put out an announcement saying they were looking to raise more money in the new year. From what I understand, this is still happening, and new units would be offered to existing holders at NTA backing which currently sits at $2.07. In these types of deals there’s also a short fall facility that we can generally tap into where non-unit holders can buy in. For now, we think the issue will go ahead however we’ll update when more information comes out. The trust closed yesterday at $2.09, 2c above NTA.

Neuberger Berman (NBI) Chart

Conclusion

We prefer the longer dated hybrids with AMPPB our number 1 pick in the space

The FMG dividend will likely surprise on the upside relative to consensus
SIQ remains on our radar

Have a great day!

James, Harry & 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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