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Income Investor: to the pub for a 6.5% bond
Our income-hunting columnist has found a high-yielding, but risky investment.
Excitement! Danger! And romance?
Well maybe not romance, after all, this isn’t about Bond the secret agent, but corporate bonds. But they can have the excitement of the higher risk that their often-juicy returns imply. I put corporate bonds at the top of my Income Pyramid because frequently you must buy a big chunk at a time (sometimes £10k or more), making it more difficult to diversify and you can lose your money pretty comprehensively if the issuing company or bank hits the buffers.
Most commercial bonds have a redemption date, when you will be repaid ‘at par’ (the face value of the security) and until then you will receive the ‘coupon’, usually paid annually. So the price you pay is important: it defines whether you are likely to receive a capital gain or loss at redemption.
There are therefore two yields to consider: the income yield when you buy (which is the coupon divided by the purchase price) and the redemption yield, or the annual yield you will receive if you hold the bond until the redemption date. Usually these are calculated for you (eg, at Bondscape).
You obviously want to make sure that the return you will get is likely to exceed inflation. You also don’t want to pay too much above ‘par’ for the security because then you would be just getting your own money back in the form of the coupon.
As a case in point, one of my highest yielding corporate bonds is Enterprise Inns 6.5% 2018, so called because it pays a 6.5% coupon and maturing in 2018. It currently has a price of around 88p, giving it an income yield of 7.3% and a gross redemption yield of just under 8.6%. (The redemption yield is higher than the income yield because of the potential capital gain.) Not too long ago, because of concerns about banking covenants, the redemption yield was up at 13%.
Enterprise Inns (ETI.L) is the largest pub landlord in Britain. However, it does not pay any dividends and a look at the share price shows that it is not highly regarded by the market, with a forecast p/e (price to earnings ratio) of just over three. The market is clearly sceptical. This is a 'non-investment grade' BB+ security and is inherently risky.
However, this bond is a ‘007’ of its class: rather than being a simple loan to the company it is a debenture, secured against a portfolio of pubs. If you check out the covenants on this bond issue in the 'deed of trust' the property is valued at ‘fair value’ as opposed to ‘going concern’ and is ring-fenced in a special legal vehicle that must equal 1 and 2/3rds of the total value of the bond issue plus two years’ worth of coupon. This property is re-valued regularly.
ETI's report and accounts noted that they 'expect to refinance the GBP600 million 2018 bond on maturity, bearing in mind that it will always be secured on a portfolio of pubs with an up-to-date valuation of GBP1 billion and interest cover of two times.' What is more, these pubs are currently generating revenue that covers the bond coupon payments twice over!
So, risk, excitement…and pubs!
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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