View the article online at http://citywire.co.uk/money/article/a649090
Income Investor: Enterprise Inns and the urge to grab a profit
Citywire's yield-hunting columnist considers whether now is the time to sell out of Enterprise Inns corporate bonds.
‘A bird in the hand is worth two in the bush’ the traditional adage tells us. Is this right or wrong for investment? Is this just a manifestation of one of our human behavioural biases – the urge to grab a profit?
I’m facing such a decision in the form of my holding of my corporate bond holding in Enterprise Inns paying a 6.5% coupon and maturing in 2018. These were viewed by the market as quite risky when I bought them and came with a hefty current yield of 9%. What was strange (to me at least, no doubt I was missing some other risk) was that these bonds were (unusually) backed by a dedicated pub property portfolio and the probability of an outright loss of my investment seemed quite remote.
Fast-forward to the present and I am showing a 35% capital gain, as the market has developed a taste for high-yield securities. What is a more relevant measure to me is that this gain is equivalent to four years’ income (from the coupon). My own metric for considering a sale is a capital gain of five years’ income, so this situation has me thinking
‘Bird in the hand’...
- It’s a nice profit
- Times are hard for pubs
- Pub property prices must be depressed - Lloyds recently sold its Admiral pub estate at a huge loss
- can re-invest the cash
Or ‘two in the bush’...
- If I hold on until maturity, I’ll get this price anyway (it’s nearly 98p in the £)
- There are potentially five more years of coupon to come
The current yield has fallen to around 6.6%, but this is not bad at all in the current yield climate. So what to do now?
There is a lot of evidence that we humans are not good at estimating probabilities. Logically, I can exclude most of the maturity value, so the difference comes down to the five years of a reasonably attractive coupon. Assuming that I could reinvest the sale capital at a fairly similar yield, the risk comes down to the risk of loss on the new security versus this one. So what is the probability of Enterprise Inns failing?
The 2012 Annual Accounts for Enterprise Inns puts a brave face on it, seeming to show in its headlines a recovery situation, with lower losses, reduced debts (still £2.7 billion, though!) and bank financing extended to 2016. However, there is a declining trend in profits before tax and exceptional items, cash flows and adjusted earnings per share. Looking at the cash flow, the company’s interest bill has nearly doubled since the previous year – equivalent to over half the operating cash flow. The company has been quietly buying back £52m worth of its own debt during the year as well as repaying £340m of other loans, but financed partially by taking out £160m of new loans – presumably at lower coupons.
So, it looks like the company is likely to limp forward for a few more years, although with some improvement. But is it likely to be ultimately a success story? This seems unlikely to me – a lot of corporate activity seems to revolve around financial re-engineering. My particular piece of debt is part of a chunk valued at £600m, coming due in 2018: that’s a lot of refinancing to handle.
I think I’m heading towards the exit soon. With my bird in my hand.
If you've enjoyed this article, why not visit DIY Income Investor's blog? The views in this article are the author's own, and do not constitute advice.
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by Gavin Lumsden on Oct 23, 2016 at 00:01