Income Report / Income Report; Hybrids, Property & Fortescue Metals (FMG)

By Market Matters 12 September 18

Income Report; Hybrids, Property & Fortescue Metals (FMG)

Market Matters Income Report 12th September 2018

Early days, however the market has opened down this morning with most weight coming from the recently buoyant Telco sector which is off ~1% at time of writing. Sitting down last night thinking about the Income Report, there wasn’t really a lot to get excited about this week which has resulted in a bit of a flat outcome. We’ve looked at the hybrid market below while we’ve also reviewed the property sector post recent results, the key takeaway for both being that they remain in good shape, but not that exciting from a valuation perspective

Pretty much red across the board this morning with only a few pockets of buying playing out.

In terms of the MM portfolio for the week, it fell by -0.27% however that result shows the defensive qualities of the portfolio with the ASX 200 down by -1.81%. Weakness from Nick Scali (-5%) was offset by strength in Telstra (+4%). The portfolio is now up 2.11% this financial year, and +8.24% from inception vs the benchmark which is tracking at 1.08% & 6.53% respectively. The expected yield on the portfolio is ~7% inclusive of franking.

Hybrids – traded higher through recent volatility

As the equity markets have become more volatile in recent times, the credit markets have remained fairly uneventful and we actually saw credit spreads narrow over the month of August. Credit spreads are essentially a measure of perceived risk of corporate debt relative to a risk free rate, or in other words, how much risk premium the market is demanding to hold corporate debt over and above risk free government debt. That contraction lead to a narrowing in the median margin across financial hybrids during August down from ~ 3.27% to ~ 3.00%, which means prices ticked slightly higher through the period.

Putting that margin into context, the lowest margin a tier 1 financial hybrid has been issued on in the last 5 years was 2.8% over the bank bill swap rate, of course that was the CBAPD which had a large negative influence on the market at that time (we have seen lower margins of tier 2 notes). The highest margin offered  more recently was also from CBA at 5.20% over bank bills, and that was the CBAPE which now trades at ~$105.

CBA - PERLS VIII Capital Notes ** CBAPE  Chart

As a rule of thumb, hybrid spreads generally reside between 3% - 4% so margins near 3% are relatively expensive and margins near 4% are on the cheaper side. Right now the market is clearly on the ‘expensive side’ collectively.

As touched on above, credit spreads do play in to it. If the world becomes a riskier place as was the case through the GFC, investors will demand a higher rate of return to hold risk, and margins will increase (meaning prices will fall) – and vice versa.

There are some other factors that also come into play in the shorter term, the main one being supply and demand. New supply of bank hybrids is likely to be very low for the foreseeable future, with the banks still engaged in asset sales, with the divesting of residual holdings in Wealth Management arms imminent. Overlay that with slower credit growth over the past few months due in large part to tighter lending standards being applied plus of course lower auction clearance rates and falls in house prices then there is likely to be less pressure on bank capital. APRA’s 10.5% tier 1 capital requirement by January 2020 has already been surpassed by ANZ and NAB looks comfortable here as well, so any meaningful new supply of tier 1 bank hybrids is unlikely in the next few months.

The other interesting theme that’s been obvious in recent times is that tier 2 securities (subordinated notes) that are up for re-financing are being done in the wholesale market rather than the retail market. The latest example of this was Westpac’s $925m of Listed Tier 2 Security the WBCHB. Banks can clearly borrow cheaper now in the wholesale market than tapping retail investors which is a sign of underlying strength. So, although hybrids look expensive, we think they’ll remain well supported into 2019 at least.

We’re all about finding opportunity and as with any market, pricing anomalies do present themselves with some obvious ones currently playing out in shorter dated issues, with hybrids due to go ex-dividend offering relative value compared to those that have recently gone ex-dividend.

·         Screens Cheap (relatively)

o   MBLPA: 4.89% yield to 24 March 2020 Optional Call Date (ex div 13/9/18)

o   WBCPF: 5.07% yield to 22 March 2021 Optional Call Date (ex div 13/9/18)

·         Screens Expensive (relatively)

o   IANG: 3.73% yield to 15 December 2019 Call/Conversion Date (went ex 6/9/18)

o   SUNPE: 3.71% yield to 17 June 2020 Call Date (went ex 31/8/18)

o   MQGPB: 4.22% yield to 17 Mar 2021 (went ex 6/9/18)

A look at Real Estate Investment Trusts post reporting

Firstly, we’re negative overall on property given the backdrop of rising interest rates and tighter credit, as a consequence we don’t hold any direct property securities in the MM Income Portfolio at present (we’re exposed through the banks). We have held 2 property stocks in the portfolio since inception, one being Centuria (CNI), a foundation member of the portfolio we trimmed at $1.43 then sold outright at $1.46 booking a ~20% profit (now trades $1.36) while we also held Vicinity Centres  (VCX) for a period, although only made a few shillings on that one (sold $2.74, now $2.71).

With a greater chance of a Labor victory at the next election, the franking credit debate will likely build momentum, and  we may well see more demand for unfranked yield such as that offered by property stocks. The sector is in good shape and that was shown during this recent reporting season with gearing generally low and no material short term debt refinance risk across the sector. The sector yields around ~5% based on a 79% payout ratio which is fairly conservative and there are some property names that are in value territory (sort of).

Typically, a property REIT will trade around net tangible assets (NTA), however the large variance in some relate to the size of their funds management operation – a number below own / manage properties whist they also manage external funds – Goodman Group (GMG) is the obvious example of this.

·         Screens Cheap (relatively)

o   Stockland (SGP)

o   Scentre Group (SCG)

o   Vicinity (VCX)

o   Centuria Metro (CMA)

o   Folkestone (FET)

·         Screens Expensive (relatively)

o   Gateway (GTY)

o   Goodman Group (GMG)

o   BWP Trust (BWP)

Scentre Group (SCG) Chart

Averaging down on Fortescue Metals (FMG) – Not yet

A few weeks ago we discussed averaging our current 3% position in FMG, saying all in all, FMG looks a good risk v reward play below $4.00. however if we’re correct on BHP and see that trade sub $30, as we expected, FMG would be around ~$3.75, so patience is prudent just here.

We covered our views in the AM note this morning focussing on BHP with our buy level another 5% lower (below $30). FMG has moved below $3.75 however given the downside trend currently playing out in the Australian currency, and the negative influence that tends to have on resource stocks, we intend to remain patient FMG at current levels.

Fortescue Metals (FMG) Chart

Income Investment opportunity – International Bond Fund – ASX Listed

The Neuberger Berman International Bond Fund will be added to the Market Matters Income Portfolio with a 5% weighting. The fund does not commence trading on the ASX until Wednesday 26th September.  

Conclusion (s)

There are some opportunities in hybrids and property stocks, but nothing hugely compelling

We remain patient towards averaging our 3% position in FMG

We are adding an international bond fund to the MM Income Portfolio with a 5% weighting, reducing exposure to financial hybrids – watch for alerts

Have a great day

James / Harry &  the Market Matters Team


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.


All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 12/09/2018

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