Australian Income Securities Research Monthly Review August 2013

Transcription

1 Australian Income Securities Research Monthly Review August 2013 Rate Sheet at 28 August Changes Since Last Month 3 Australia Securities and Investment Commission (ASIC) Report New Issues, Maturities and Resets 3 Outlook - Official Cash Rate 4 Bank Capital Securities 4 Non-Financial Corporates 6 Glossary 7 1

2 Rate Sheet at 28 August 2013 Code Recommendation Price (AUD) Issuer Issue Size (AUD m) Years To Maturity Trading Margin Running Yield Yield to Reset Dist inc Fr ex Fr inc Fr ex Fr (AUD) AGKHA HOLD AGK % 6.54% 6.54% 6.20% 6.20% /08/2013 ANZHA HOLD ANZ % 5.43% 5.43% 4.78% 4.78% /09/2013 ANZPA ACCUMULATE ANZ % 5.90% 4.13% 5.62% 3.85% /08/2013 ANZPB ACCUMULATE ANZ % 5.31% 3.72% 4.92% 3.41% /08/2013 ANZPC ACCUMULATE ANZ % 5.85% 4.10% 5.73% 3.97% /08/2013 AQHHA ACCUMULATE APA % 7.04% 7.04% 6.07% 6.07% /09/2013 CBAHA ACCUMULATE CBA % 3.84% 3.84% 4.02% 4.02% /09/2013 CBAPA ACCUMULATE CBA % 6.19% 4.33% 5.11% 3.10% /10/2013 CBAPC HOLD CBA % 6.41% 4.49% 5.70% 3.64% /09/2013 CNGHA ACCUMULATE CNG % 5.93% 5.93% 5.14% 5.14% /09/2013 CTXHA HOLD CTX % 7.03% 7.03% 5.87% 5.87% /09/2013 CWNHA ACCUMULATE CWN % 7.61% 7.61% 6.83% 6.83% /09/2013 GMPPA ACCUMULATE GMG % 6.94% 6.94% 7.42% 7.42% /09/2013 IAGPC HOLD IAG % 6.69% 4.68% 6.24% 4.00% /10/2013 IANG ACCUMULATE IAG % 6.73% 4.71% 6.40% 4.25% /09/2013 MBLHB ACCUMULATE MQG % 6.09% 6.09% /09/2013 MQGPA HOLD MQG % 6.87% 4.81% 7.03% 4.84% /11/2013 NABHA ACCUMULATE NAB % 5.65% 5.65% /10/2013 NABHB HOLD NAB % 5.43% 5.43% 4.76% 4.76% /09/2013 NABPA ACCUMULATE NAB % 6.09% 4.26% 6.12% 4.20% /08/2013 ORGHA HOLD ORG % 6.91% 6.91% 6.94% 6.94% /09/2013 PCAPA ACCUMULATE CBA % 4.05% 2.84% 6.31% 5.02% /09/2013 RHCPA HOLD RHC % 7.46% 5.23% /10/2013 SUNPC ACCUMULATE SUN % 7.26% 5.08% 6.36% 4.01% /09/2013 SUNPD HOLD SUN % 5.64% 5.64% 5.47% 5.47% /11/2013 SVWPA HOLD SVW % 9.03% 6.32% /11/2013 TAHHA ACCUMULATE TAH % 7.03% 7.03% 4.24% 4.24% /10/2013 TAHHB ACCUMULATE TAH % 6.82% 6.82% 6.52% 6.52% /09/2013 TTSHA ACCUMULATE TTS % 5.77% 5.77% 5.31% 5.31% /09/2013 WBCHA HOLD WBC % 5.43% 5.43% 4.77% 4.77% /11/2013 WBCPA ACCUMULATE WBC % 3.65% 0.39% 0.39% /09/2013 WBCPB ACCUMULATE WBC % 6.57% 4.60% 4.99% 2.69% /09/2013 WBCPC ACCUMULATE WBC % 3.20% 6.02% 4.21% 5.97% 3.95% /09/2013 WBCPD ACCUMULATE WBC % 6.05% 4.23% 6.02% 4.19% /08/2013 WCTPA ACCUMULATE WBC % 4.05% 2.83% 6.47% 5.19% /09/2013 WOWHC HOLD WOW % 5.84% 5.84% 4.61% 4.61% /11/2013 Source: Morningstar (yields) and ASX (prices and ex-dates) - yields and trading margins above 30% are not displayed. Ex-dates and distributions are the latest reported by the ASX at 28 August Ex Date 2

3 Changes Since Last Month On 12 August 2013, we updated our view on ANZ CPS (ASX code: ANZPB), CPS II (ASX code: ANZPA) and CPS III (ASX code: ANZPC). Our opinion of ANZ Bank (ASX code: ANZ) as an issuer was confirmed with the issuance of ANZ Capital Notes. Capital initiatives have commenced across the banking sector, suggesting tier 1 ratios have peaked. We continue to monitor ANZ Bank's Asian growth strategy but, based on the current balance sheet, we remain comfortable with a low-risk issuer rating. We maintain our recommendation of accumulate on all securities. On 21 August 2013, PaperlinX (ASX code: PPX) announced its full-year results as well as an update on PaperlinX Step Up Preference Securities (PXUPA). Holders of PXUPA have no voting rights on the listed company (except in special circumstances) nor do they have any rights on the assets, primarily because they are issued by a separate entity (the trust). The end of August 2013 was supposed to be the first remarketing date and when the distribution step-up comes into effect. However, it is our understanding that holders have not been sent a remarketing notice and hence PaperlinX is happy to let the ''step-up'' happen automatically. This is not really meaningful to holders, as PaperlinX has not paid a distribution since 2012 and this is unlikely to change any time in the near future. What is interesting is that hedge fund Coastal Capital fund has appeared as a substantial holder and is in discussions with management about potential conversion options. Morningstar does not cover this security. On 28 August 2013, Westpac (ASX code: WBC) announced it was redeeming the 2003 U.S. dollar Trust Preferred Securities (wholesale tier 1 securities). The redemption was not unexpected due to the security not being eligible as regulatory capital under Basel III requirements. The redemption will reduce the tier 1 ratio by approximately 37 basis points which brings it more in line with other major banks. Australia Securities and Investment Commission (ASIC) Report 365 On 20 August 2013, ASIC released a new report into the Australian hybrid market. This is the third release following two consumer warnings on 24 November 2011 and 27 August ASIC is concerned that hybrid securities promise 'high yields' and are issued by well-known companies with trusted brands, but investors do not necessarily understand the risks. During the past year ASIC has engaged with hybrid issuers and the brokers that sell hybrid securities so that these features and risks are clearly disclosed and the products are not being mis-sold. Morningstar continues to develop its research methodology and reporting suite with a focus on valuation and structural features which differentiates these products from traditional fixed income products. ASIC's conclusion to the report found that "no further regulatory action was warranted in connection with the content of the offer summaries, or the way in which the pro-forma s and stand-alone summaries were used, although we encourage more balanced disclosure of benefits and risks". Although we do not totally agree with this statement, we recognise the importance of standardised report formats which improves the ability for readers to understand complex structures. ASIC also discussed naming conventions and whether tools could be developed so investors can check their understanding of hybrid securities before investing in them. Morningstar has proven capability in the development of investor screening tools and this will be explored further during 2013/2014. New Issues, Maturities and Resets None 3

4 Outlook - Official Cash Rate The decision by the Reserve Bank of Australia (RBA) board to cut the official cash rate by 0.25% at its August meeting was widely expected. Our comments in last month's outlook about waiting for further data trends on housing were probably unwarranted given the weak inflation outlook. Overall, our view of the past 12 months that official real rates would approach zero before improving remains broadly intact with futures markets suggesting a low 2.25% for the official cash rate. What we had not expected is the effect from tapering of the U.S. stimulus. This has caused an almighty steepening of the U.S. yield curve (10-year treasury yields have risen from a low of 1.55% in May 2013 to touch a recent high of 2.94% in August 2013). In bond markets, this is a sharp correction and has in turn have dragged higher the Australian 10-year government bond yields (peaking at 4.03%, compared with a low of 2.80% in July 2013). As the U.S. 10-year yield approaches 3%, we think the pace at which interest rates are rising will moderate. One of the reasons we believe this is that the U.S. Federal Reserve has committed to keep short-term rates near zero until unemployment decreases to 6.5% or inflation increases over 2.5%. Current U.S. unemployment is 7.7% and inflation is 2.0%. The steepening Australian yield curve indicates we are starting to see the end of this easing cycle. It also makes the yield differential on short duration instruments (floating rate notes) look less attractive than long duration instruments. Unfortunately, for domestic investors, there is not a lot of fixed rate issuance in the Australian listed interest rate securities market and hence investors are stuck with short duration exposures. Figure 1.0 Australian Dollar Swap Rates Annualised Bank Capital Securities Commonwealth Bank of Australia (ASX code: CBA) reported fiscal 2013 cash earnings of AUD 7.82 billion, broadly in line with our estimates. Revenue growth was driven by stronger net interest income, supported by a mix of continued asset growth and a lift in net interest margin to 217 basis points in the second half (from 210 basis points in the first half, together with a continued strong asset quality performance which saw second-half impairment costs at post-global financial crisis lows. Trading income was positive, while the wealth business saw strong fund flows and market gains. Commonwealth Bank announced a final dividend of AUD 2.00 per share, which was in line with our estimates and the target band of 70% to 80%. Commonwealth Bank's capital position is broadly in line with peers, having 8.2% common equity tier 1 ratio. Australia & New Zealand Banking Group, or ANZ Bank, reported a year-to-date cash profit of AUD 4.8 billion (up 11%) as a result of a 5% lift in revenue, 5% decline in expenses and 2% lower impairment charges. Asset quality was satisfactory with ANZ Bank recording an impairment charge of AUD 277 million for the third quarter (AUD 876 million year-to-date) and now expects fullyear impairments to be lower than fiscal The individual provision charges of AUD 238 million were the lowest since

5 and new impaired loans were down 20%. ANZ Bank reported a common equity tier 1 ratio of 7.97% and has now issued AUD 22 billion of term wholesale funding in 2013 (up from AUD 12 billion in May). Customer deposits (+12%) continuing to outstrip lending growth (+8%) supporting the funding outcome, albeit at a cost. National Australia Bank's (ASX code: NAB) trading update was solid with stable asset quality, slightly lower capital ratios and a net profit of AUD 1.7 billion. The bad and doubtful debt charge for the quarter was AUD 489 million (down 10%) due to lower charges in business banking and U.K. businesses. National Australia Bank issued AUD 23 billion of term wholesale funding in the nine months to June, including AUD 7 billion of secured funding. As with other banks, all loan growth was funded with customer deposits. The common equity tier 1 capital ratio fell 0.25% to 7.97% and the ratio of group 90-plus day past due and gross impaired assets to gross loans and acceptances was 1.78%. Figure 2.0 Bank Capital Securities Trading Margins (change on month) Source: Morningstar 5

6 Non-Financial Corporates Tabcorp Holdings' (ASX code: TAH) full-year earnings were in line with estimates (after adjusting for discontinued operations). Operating trends were fairly robust and hence our credit opinion remains stable, even in a cautious consumer spending environment. We remain positive on Tabcorp Bonds (ASX code: TAHHA) but more cautious on Tabcorp Subordinated Notes (ASX code: TAHHB) given the structural constraints. These structural constraints are a function of the terms of the notes which are linked to equity credit classification of Tabcorp's hybrid (this changed from 100% equity credit to 50% equity credit in April 2013). Wagering revenues and EBITDA fell 5% and 12% year-on-year respectively, which were largely expected following changes to the Victorian wagering license introduced in August These changes effectively granted the Victorian government a 50% interest in Victorian wagering income (versus 25% previously) and were part of the license renewal agreement between the parties in fiscal Leverage is in line with expectations with debt/ebitda of 2.5 times (versus 2.4 times as at first-half fiscal 2013). Funds from operations (FFO)/debt was 24% for second-half 2013, largely unchanged on the first half. Tabcorp has AUD 432 million of notes maturing in May 2014 (TAHHA and an institutional MTN of AUD 150 million) against committed undrawn bank facilities of AUD 460 million it is our understanding that the company is exploring a number of funding options to refinance these maturities. Goodman Group's (ASX code: GMG) fiscal 2013 result contained no major surprises with the highlight being a reduction in gearing. Goodman's credit profile is underpinned by the recurring operating cashflows from the property investment (around AUD 160 million per annum), funds management (around AUD 80 million) and fund investment businesses (annual dividends received of around AUD 170 million) which provides solid coverage of annual interest expenses (AUD 110 million). The credit remains underpinned by the property investment business (68% of look-through EBITDA) which maintained occupancy at 96%. The issuing subsidiary of Goodman PLUS II (ASX code: GMPPA) is the fund management business which provides12% of EBITDA and displayed strong momentum with assets under management growing to AUD 19.5 billion (up 12% from AUD 17.3 billion as at December 2012). Gearing dropped to 21% which remains comfortably below management's maximum level of 25%. FFO/debt of 13% improved from 8% in fiscal 2012 and debt/ebitda of 4.3 times is improved on 2012's 6.2 times. Together with cash, the company has AUD 1.8 billion in liquidity (cash plus undrawn bank lines) which covers all debt maturities until Management's outlook of 6% earnings growth in fiscal 2014 is unchanged. Crown (ASX code: CWN) reported normalised revenues of AUD 2.77 billion and EBITDA of AUD 788 million (+5.0%) off the back of a strong performance in Melbourne and growth in Perth. The company managed to deliver a 5.6% reduction in operating costs which led to a 30 basis point expansion of the Australian EBITDA margin to 28.4%. Management provided an update on its capital expenditure program (excluding Barangaroo) which will see capital expenditure at AUD 270 million in fiscal 2014 (AUD 250 million in fiscal 2013) and increasing to AUD 380 million in Leverage on a debt/ebitda basis improved to 1.8 times (from 2.1 times in fiscal 2012 and 2.5 times in first-half 2013). FFO/debt was 39% in 2013 which is also a moderate improvement on fiscal 2012 and first-half 2013 numbers. There are minimal debt maturities in fiscal 2014 (less than AUD 200 million). There was no major update provided on stage 3 of the New South Wales government's selection process for a VIP casino in Sydney. On 22 August 2013, Origin Energy (ASX code: ORG) announced its full-year results and a new syndicated debt facility to replace the current arrangement. The results show that its financial ratios are deteriorating as EBIT narrows and interest payments increase from the higher debt drawings to pay for the liquefied natural gas (LNG) projects. The recent changes to the terms of the notes is an obvious attempt to cover up the fact that even Origin now expect to breach the initial leverage triggers but the rating agencies have given them the benefit of the doubt due to the strong cashflow expected from APLNG. Interest cover will not be a problem for Origin as rates continue to come down and they now have more than sufficient facilities available. However, this all depends on how much debt they draw. It is possible, but in our view unlikely, under our modeling assumptions that Origin could breach the (unchanged) interest cover ratio in Post completion of Australia Pacific LNG (APLNG), we are confident of a very sharp increase in Origin Energy's free cash flow and a reduction in debt. If there had been any mandatory deferral of interest, subsequent back payments should be very easily accommodated from 2016 to

7 Insurance Australia Group (ASX code: IAG) reported cash net profit after tax of AUD 1,156 million, up 98% on fiscal The reported insurance margin came in at an impressive 17.2% versus 11.5% in fiscal 2012, at the top end of guidance. After several tough years, everything that could go right did. The huge profit increase reflects double-digit gross written premium growth, natural peril claims below allowance, higher-than-expected reserve releases, and a positive credit spread impact. Figure 3.0 Floating Rate Securities Trading Margins (change on month) Source: Morningstar Glossary BBSW Conversion Conversion Discount Conversion Number Convexity The Bank Bill Swap Rate (BBSW) is the average mid rate for Australian dollar bills of exchange accepted by an approved bank, having a tenor with a designated maturity that appears on an approved information vendor's service (e.g., Reuters Screen BBSW page). Under certain circumstances, the hybrid security may be converted into a number of ordinary shares of the underlying stock at a specified conversion number, subject to terms, conditions and corporate events, including conversion discount, conversion date and triggers. A discount in percentage applied to the underlying stock price into which the hybrid security may be converted. Also referred to as exchange discount. The number of ordinary shares of the underlying stock into which the hybrid security may be able to convert. For certain hybrid securities, there may be a minimum and/or a maximum conversion number applied. The conversion number is generally calculated based on a formula: Conversion Number = Face Value / [VWAP х (1 Conversion Discount)] A measure for bonds used in conjunction with modified duration in order to measure how the bond's price will 7

8 Cumulative Dividend Yield Duration Exchange Face Value Gross Margin Market Rate Mandatory Conversion Net Reference Rate Reset Running Yield Step-up Tax Deferred Time to Maturity/Reset Trading Margin VWAP Volatility Yield to Reset/Maturity (YTR/YTM) change as interest rates change. It is equal to the opposite of the second derivative of the bond's price relative to its yield, divided by its price. For example, since a non-callable bond's duration usually increases as interest rates decrease, its convexity is positive. Depending on the hybrid security, the dividend, distribution or coupon paid may or may not be cumulative. If the dividend, distribution or coupon is cumulative and if the issuer defers the payment of the dividend, distribution or coupon on any payment date, then additional dividend, distribution or coupon will accrue at the prevailing distribution rate. Expressed as a percentage, dividend yield is the company's annual dividend payments divided by its market cap, or the dividend per share divided by price per share. The change in the value of a fixed-income security that will result from a 1% change in interest rates. Duration is stated in years. For example, a five-year duration means the bond will decrease in value by 5% if interest rates rise 1% and will increase in value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the bond will pay out. Exchange means the conversion, redemption, buy-back or cancellation of the hybrid security. The face value of the security is the issue price typically being AUD 100 per security. Yield expressed, inclusive of any available franking credits or tax-deferred benefits. Expressed as a percentage per annum, the margin offered by the hybrid security over a reference rate. The initial margin is typically determined by a bidding process within a prescribed margin range known as bookbuild. For certain hybrid securities, the margin may be increased (refer to Step-up) at a predetermined date. See Reference Rate. Some securities include a mandatory conversion condition, which forces conversion if the underlying stock price is above some threshold level and the issuer chooses not to redeem the security for face value. Yield expressed, exclusive of any available franking credits or tax-deferred benefits. Typically a floating reference rate (e.g., 90-day BBSW) used to reference the periodic coupon payment of a hybrid security. The reference rate is generally applied at the beginning of a distribution period for the upcoming distribution. Also referred to as the market rate. For certain hybrid securities, on a reset date, the issuer may reset certain terms including the next reset date, the dividend/distribution rate, the conversion discount and the timing of frequency of dividend/distribution payments. Resets may mean significant change to the terms of the hybrid security and as a result investors may or may not accept such new terms. Further, the issuer may elect to redeem or to exchange the hybrid security. As such, Morningstar has a conservative approach to treating resets and considers it as a probable maturity. In tables and abbreviations, we use "Reset" to refer to any step-up, mandatory conversion, call or other pseudomaturity event. The hybrid's annual coupon payments expressed as a percentage of the market value of the security. For certain hybrid securities, the margin above the reference rate may be increased or stepped-up at a predetermined date upon the occurrence or non-occurrence of a certain event (e.g., non-conversion at a specified date). The distribution of certain hybrid securities may have a tax-deferred component (may be less than 100%), which allows the distributions to be tax deferred over a certain period. The tax-deferred distributions are not assessable to Australian income tax upon receipt for most investors, but instead reduce the cost base of the security for capital gains tax purposes and as a result defer tax until the disposal of the security. Securities offering a tax-deferred component may give rise to tax benefits. Changes to tax legislation may have the effect of reducing the taxdeferred component of distributions. Investors should seek professional taxation advice in relation to dealing in these securities and their individual situation. The time expressed in number of years from now to a reset date, conversion date, step-up date and/or maturity date, where on such date, either the terms of the security may change or the security may be repurchased, redeemed, exchanged or converted. In simple terms if an issuer already had securities on issue, they could expect any new securities with $100 face value to trade close to the trading margin. The Trading Margin of a security s is the effective margin at which s trades; it is the margin which a new security n with face value of AUD 100 would need so the sum of the discounted cash flows of n equal the discounted cash flows of s assuming redemption of both s and n at the pseudo-maturity date of s. The calculation is grossed up for franking where appropriate. The average of the daily volume weighted average sale price of ordinary shares sold on ASX during the relevant period subject to specific terms and adjustments of the relevant hybrid security offer. The degree to which the price of a security tends to fluctuate. The hybrid's internal rate of return to reset, step-up or other pseudo-maturity event. 8