Income Report / Income Report; Why we’d sell WAM, new Westpac hybrid

By Market Matters 14 November 18

Income Report; Why we’d sell WAM, new Westpac hybrid

Market Matters Income Report 14th November 2018

An early Income Report today as it’s likely to be another fairly busy one on the desk with a number of companies out with results, and a few other bits and pieces. This morning alone we’ve seen a downgrade for Pact Group (ASX:PGH) with the stock getting hit hard (-12%), an inline full year result and guidance from Dulux (ASX:DLX) while Seven West Media (ASX:SVW) had their AGM this morning and reiterated guidance. We’re also seeing Ramsay Healthcare (ASX:RHC) CEO speaking now at their AGM suggesting that core earnings will be up 2% on FY18, which is in line with current market expectations.  

At time of writing, the market is trading down -7pts points at 5826

ASX 200 Chart

For the week, the MM Income portfolio added +0.25% against a backdrop of the ASX which fell  -0.70%. For the financial year to date, the portfolio is down -0.75%  versus its benchmark of RBA cash rate +4% which sits at +2.03% while the ASX 200 accumulation (including dividends) is down by -4%. Since inception (5th July 2017) the portfolio has added 5.43% versus its benchmark of +7.47%. The biggest drag on the week came from Alumina (AWC) while Super Retail Group (SUL) bounced (lethargically).

Wilson Asset Management (WAM) – has Chris Stott called the top of the market?

The main Listed Investment Company under the Wilsons banner is ASX:WAM and its clearly popular with income investors, delivering a current dividend yield of around 6.5% fully franked. Chris Stott, the Chief Investment Officer for the group has recently resigned to spend more time with family. Chris was at WAM for 12 years and oversaw significant growth in funds under management. Of course it was the well-known founder Geoff Wilson (who was originally a stockbroker) who set up Wilson Asset Management back in 1997 and the WAM portfolio kicked off in 1999.  Between 1999 and 2006 they had some great returns as outlined below;

In 2006 when Chris joined they managed around $100m. Now that particular LIC has around $1.4bn in it while they’ve built out a number of other funds - today they manage around $3.5bn collectively. 

Chris was a young CIO at WAM, he’s around the same age as I am and he’s has had a great track record of success, although as funds grew it became harder to replicate the earlier performance that Geoff delivered in the first 7 years or so. Clearly that early performance provided the foundation for what was to come. Over the past 10 years with Chris as CIO for the bulk of it,  WAM delivered 16.1% per annum versus their benchmark of 7.7% and that strong outperformance has allowed them to raise capital for other funds. 

10 year performance versus the benchmark – solid

 

Strong performance over a long period afforded them a platform to present their views to wide audiences and have a strong profile in the media. Their communications are on point and they articulate their approach exceptionally well – a lot to learn from them in that respect. This has led to WAMs share price typically trading at a significant premium to the value of its assets (NTA). For example, at the last NTA report they had around $1.45bn is assets yet they have a market capitalisation of $1.66b, a ~$200m premium or around 14%. Why buy something for more than the value of the underlying assets?  Clearly you’re paying a premium for the people running those assets, the systems in place and the ability for those people and systems to deliver strong results which Wilsons have delivered in the past, however it gets harder from here!

Focussing on results over the short term becomes less appealing for WAM.

1 year performance v index

2 year performance v index

The current composition of the portfolio is also interesting, with a big skew towards Consumer Discretionary.

WAM Portfolio Composition (Bloomberg)

 

The average Australian focussed listed investment company currently trades at a pre-tax discount to NTA of 6.95% according to the latest data from Independent Research while on a 3 year view, that number is a discount of 5.95% at the end of October. WAM has often enjoyed periods of 20%+ premiums to NTA and currently trades around a 14% premium, or around a 20% premium to the LIC market generally. That’s not a criticism - kudos to them, however the simple fact that a major contributor to WAMs growth and importantly performance over the past 10 years (Chris Stott)  has effectively left  at a time when performance relative to their own standards has struggled should be a concern. (Chris is staying on at board level but is out of the day to day)

As we’ve written at length, we believe the market gets harder from here, a fact not lost on WAM  (hence the 30% cash weighting in the portfolio), however a change of leadership at a precarious time means that we simply wouldn’t be paying a premium for WAM , and if we held, we’d sell it

WAM Chart

 

Investment Opportunity – Westpac (WBCPI) **Book build closing at 4pm today**

Earlier in the week we met with Westpac regarding a new Hybrid security being issued in part to refinance an existing security (WBCPD). The existing security has $1.4b on issue and WBC say they’ll issue a new security worth $750m with the ability to do more or less. From discussions, I think they’ll print somewhere between $1.2-$1.5b which probably means that bids in this hybrid will be scaled back which was the case with the recent CBA Hybrid issue.

In terms of the CBAPH which was refinanced recently, the size of that deal was up scaled from $750m to $1.25bn. There was a reinvestment component to the offer from the CBAPC’s which was a large $2.0bn issue. Of that $2.0bn, ~$870m was rolled into the new security and they accepted ~$380m of new money. New money bids were scaled heavily, something to the tune of ~60%. The CBA issue was done at the same 3.7% margin as Westpac will do theirs. Interestingly enough, Westpac didn’t need to refinance this security until Mar 2019 so they’ve obviously seen the demand into the CBA notes and wanted a slice of the pie.

Looking ahead in terms of hybrid deals, there is unlikely to be a lot of opportunity in 2019. Given CBA and WBC have / are refinancing issues now, the only other major one I can see is the IANG which has $550m on issue and is due in December 2019. There is an AGL note due in June 2019 worth $650m  and a Tatts Bond due in July worth $192m however both are unlikely to offer rolls into new securities leaving very little on the horizon for 2019.  

In short, on a relative basis to both existing bank issuance and to existing Westpac notes this new WBC security looks attractive, particularly given the dearth of new issuance for the next 12 months  

Key details

Margin; The range is 3.70% to 3.90% over the 90 day bank bill rate. This means the indicative yield based on current interest rates are as follows;

  • Using a 5.5 year swap rate of 2.59% and using a margin of 3.70%, the indicative implied Yield to Call is 6.29% grossed for franking.
  • Using the current 1.94% 3 month BBSW, indicative Running Yield is 5.64% grossed for franking

Duration; 5.5 years

As suggested above, based on the 5.5 year swap rate of 2.59%, this security will pay a grossed up running yield of 6.29% - floating – with dividends paid quarterly.
Given the terms of these securities are fairly standard, the variables come in terms of the issuer (Westpac), the duration (time) and the rate (assume 3.70% over swap) relative to where the current market is at. Here’s a look at the current landscape for financial hybrids with 4 years or more to maturity;

Financial hybrids with more than 4 years to maturity

It’s also worthwhile looking at where bank hybrids typically trade in terms of margin over the bank bill rate as a group. This is essentially a function of investor demand for them, the higher the margin, the less demand and vice versa. Just like a stock that has consistent earnings - when the market is bullish they’ll pay 30x those earnings but when the market is bearish they’ll pay 20x. There has been a lot thrown at the hybrid market in 2018 however pricing has remained fairly resilient. Tier 1 bank hybrids on the market have traded from a low of 296 basis points while hitting a high of 395 basis points in terms of margin.

Since 2012, the average margin is 360 basis points according to Morningstar.

 

Our view; While these notes are not without risk, and individual investors should consider the prospectus, on a relative basis to both existing bank issuance and to existing Westpac Notes, the deal looks attractive.

Timetable;  If you would like to bid into the broker firm offer, you can email [email protected] or call (02) 9238 1561 – the broker firm offer is closing today at 4pm. The broker firm means that you bid an amount in dollars which is submitted into the ‘book’ and within a few days you know the amount you have been successful with. This may be 100% of your bid amount or it may be a portion of that, however the benefit of this process is an investor knows what they will get before having to send funds, however those looking to bid through James will ultimately need to set up a Shaw and Partners account. Alternatively, subscribers could bid through their existing broker which could be easier.

The notes are expected to start trading on the ASX on the 19th December 2018.

Qualitas Real Estate Investment Fund

I covered the above new listing in the Monday Question’s report this week (click here), and I’ve been pulled up on a few inaccuracies, which I’ll address.

Inaccuracy 1; The fund invests in loans only, not equity.  They were originally looking to do a version of the fund some months back that included debt and equity however as a consequence of feedback, they changed the fund to debt only.

Inaccuracy 2: I suggested they may have had a difficultly raising funds, I’m told that is not the case. They planned to raise between $150m & $500m, and have raised circa $220m…

All else stands…The fund lists end of November by the look under code ASX:QRI. We have not invested.

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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