Views at a Glance / Income Report; MXT raising money – worth a look

By Market Matters 28 February 18

Income Report; MXT raising money – worth a look

Market Matters Income Update 28th February 2018

The final day of local reporting season and the end of a fairly hectic month for markets generally. Some key stats in terms of market performance for the shortest month of the year below with some obvious takeaways. Overall, the Australian market has outperformed the US in absolute terms and importantly, has been significantly less volatile than our friends across the Pacific. Before today’s trade, the ASX 200 was actually higher for the month (0.32%) however if we include the benefit of dividends shown through the accumulation index we see a +0.97% gain for the month overall – an unlikely outcome it would seem following the blip at the start of the month.

Volatility has certainly raised its head and looking at the move relative to other major events post the GFC, clearly it was a significant one – bigger than BREXIT and a number of other major catalysts that sparked a sell off in equities.

The Volatility Index (VIX) Chart

The rise of US interest rates on the back of improving economic metrics has seen US bond yields track higher and overall equities traded lower in the US, but less so here. As we covered this morning the new Fed Reserve Chair Jerome Powell has essentially opened the door to 4 interest rate hikes this year in the US as he acknowledged a strengthening economy and rising inflation may force policy makers to move from the 3 forecasted hikes to 4. Following Powell’s first testimony the market has increased its likelihood of a 4th rate hike in Q4 of 2018 to 50% i.e. toss a coin time however continuing strength in economic data (as has been the case since December) will feed into higher rate expectations – as it should!

This is incredibly important for stock selection generally however as regular readers would know, extremely important when considering income investments. As Charlie Aitken wrote recently, the simple fact is the direction of the “risk-free rate”, and the rate of change of the risk-free rate is crucial to overall equity market pricing and stock and sector selection.

We’ve written on a number of occasions about this thematic given it has formed the key to our market outlook in recent times, so we won’t re-hash today other than to say rates are rising, fixed rate income will lag, and any perceived ‘bond like’ investment will struggle, particularly those assets that are expensive as you get the double whammy or rising rates putting pressure on valuations + rising rates putting pressure on yields. To view a recent income report on the topic, click here.

In terms of the MM Income Portfolio over the week,  the portfolio was up by  0.77% in a market that was also strong. Since inception (5/7/18) the portfolio has gained 7.18% tracking nicely above the market and above the portfolios benchmark. As always, to view all recent activity on both MM Portfolios - click here – or navigate to the RECENT ACTIVITY screen on the website.   

Sniffing around for Income Opportunities!

Metrics Income Trust (MXT); We allocated 5% of the MM income Portfolio into the Metrics Income IPO in October last year. The is a deal that Shaw and Partners (20% shareholder in MM) was involved in. Metrics are now launching a rights issue to raise an additional $300-380m at $2.00 per share, which is the same level as the original IPO – however they have paid income along the way. This is not a fund that is designed for capital growth, simply income and they have been true to label – even after rallying to a high of $2.12 which was well above the value of their assets.

We met with management today and it simply reinforced our thoughts from last year. These guys are exceptional operators, pursuing a strategy that has such a high probability of meeting its objectives (a return of the RBA cash +3.25%). Thus far they are running above that level, however importantly, they are incredibly well diversified fund, with the new money simply enhancing that level of diversification. Also worthy of note is their level of disclosure, with a daily NAV figure being released to the ASX.

Anyway, the deal is open for existing shareholders however there will be a short fall facility for ‘new money’ which we will be able to provide access to (through Shaw and Partners).

Here was our original rationale for adding the fund to the portfolio;

1.    It will be listed & traded on the ASX and there is already ~ $200m of demand which augers well for liquidity.  The Listed Investment Trust will pay a monthly distribution.

2.    They are focussing on Corporate Loans - not bank debt and this provides good diversification. The hybrid market in Australia is dominated by Bank securities and the MM Income Portfolio is reflective of that. Diversification into the corporate loan space is attractive

3.    Interest rates are floating, rather than fixed, giving protection (and higher income) as interest rates rise – the target return is +3.25% over the RBA cash rate which sits at 1.50%. Upon listing, the Trust is expected to yield 4.75%, rising in-line with the RBA cash rate.

4.    The Trust will be diversified, with no more than 5% of the Trust allocated to one loan + it will be Australian centric with greater than 80% of loans to Aussie corporates, with the Trust targeting 75-100 different exposures. Although default rates in Australia are extremely low, as we outline below, diversification in this space is really important.  

5.    Experience – the guys running the show have a very strong track record, they’re already managing $2bn in this space for Wholesale Investors, and the team has a very strong relationship with NAB (after being spun out of NAB a few years ago). NAB own 35% of MCP, and the MCP investment committee (comprised of 4 partners) own equal shares in the business – or in other words, the guys on the front line have skin in the game.

6.    And finally, a lot of investments like this are let down by their fee structure in a few different ways. Obviously the management fee is important, but that’s very transparent, there are often other fees, particularly listing fees that are worn straight up by the investor, which is wrong in our view.

All in all, this looks a strong candidate for the MM Income Portfolio – and a position will be taken.

For more details, please review our original note by clicking here – the rationale remains relevant. To enquire about investing; please email [email protected]

In terms of timings, see below.

Metrics Income Trust (MXT)

Hybrids; We hold 4 hybrids, all are floating and are well insulated against rising rates. Over the past week, the group of financial hybrids we track saw margins across all call dates widen ~ 5 bps compared to a week ago – which means prices have tracked lower (or yields are up a touch) which is to be expected with the new Westpac Hybrid deal being financialised and CBA now coming to market with another $1.25bn new money deal (we’ll send details when available). Overall, we’re comfortable here with our current exposures

Retail Sector; We bought into the ‘Amazon’ panic adding Harvey Norman simply because it was a clear value play that offered an exceptional yield, however the quality of the business is questionable. We bought well but sold as our reason for holding (value) became less attractive. We took a ~13% profit at $4.44 + the 0.17c dividend however the stock did reach ~$4.61 – showing we do sell early at times. Today the company reported and is trading down ~15%. We also hold Nick Scali (NCK) however the is a call on quality rather than the sector generally (or deep value for that matter). Overall though, we are negative the retail sector and have very little interest from a sector perspective at this juncture. 

Harvey Norman (HVN)

Property; We are negative property yet we hold Vicinity (VCX) - a retail landlord. This too is a value / yield play however it’s gotten cheaper since we bought - the position showing a ~5% paper loss. VCX reported an inline result mid-month with occupancy at 99.5% with a WALE of 5.2 years – which is the weighted average lease expiry. The retail sector is facing challenges (as shown through margin compression of our retailers) and Vicinity are getting hurt as a consequence. They are trading at a 13% discount to the value of their assets – which is cheap. The macro backdrop goes against this holding and at the moment that is winning out. This stock remains on our SELL radar and we have no interest in the property sector in a general sense.

Resources; We own FMG & BHP as income stocks, not your typical holdings however for now strong free cash flow is supporting good income from the sector. These will be shorter term holdings within the income portfolio, however we remain keen on the sector although conscious of a the $US

Energy; Woodside is our only holding here. We believe this value at current levels and assuming the stock is trading above $27 we will take up our rights. We retain a BUY on this stock

Woodside (WPL) Chart

Financials; We’re bullish the financial space and are happily long the sector. Perpetual (PPT) went ex-dividend today for $1.35 while our banking exposures are usually strong into the end of April. We retain BUY’s on our bank holdings into seasonal strength. Genworth is our weakest position however the stock trades ex-dividend tomorrow for 12cps fully franked, putting it on a current yield of ~9%.

Telcos; Telstra went ex-dividend today for 11cps fully franked which equates to 15.7cps, the stock trading down 12c today at $3.36. We would be keen buyers of TLS below $3.30.

Telstra (TLS) Chart

Conclusion (s)

- We will be increasing our allocation to the Metrics Income Trust in the announced 1 for 1.7 rights issue
- Vicinity and Genworth are two underperformers that are on the chopping block, but not yet.

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 Wednesday, or after the session when positions are traded.

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