SMSFundamentals | Aug 06 2012
SMSFundamentals is an ongoing feature series dedicated to providing SMSFs (smurfs) with valuable news, investment ideas and services, in line with SMSF requirements and obligations.
For an introduction and story archive please visit FNArena's SMSFundamentals website.
By Paul Rickard of the Switzer Super Report
Caltex ((CTX)) has been grabbing the news headlines lately on its decision to close the Kurnell Refinery in Sydney in 2014 and convert it to an import terminal. Now the company has announced details of a $300 million hybrid securities issue to raise capital.
The proceeds will be used to support the costs associated with converting the refinery, and to help strengthen its balance sheet.
The question for us is, should we buy it?
The details
Caltex expects the Notes to be classified as ‘intermediate equity content’ by Standard & Poor's, thereby improving the likelihood of it preserving its BBB+ rating (three notches above ‘investment grade’).
The ‘Intermediate equity’ classification means Standard & Poor’s will assess it as 50% debt and 50% equity. To qualify, this hybrid issue uses the standard structure – notes with a 25-year term, redeemable or callable at the issuer’s option after five years, and the ability for Caltex to defer the payment of interest.
The Notes will pay interest at a margin of between 4.5% and 4.75% over the 90-day bank bill rate.
The notes are subordinated and unsecured and rank behind all senior obligations and unsecured creditors, and ahead of Caltex ordinary shares. Interest payments can be deferred, however interest deferrals are cumulative, and a dividend ‘stopper’ applies to the payment of dividends on Caltex ordinary shares.
The institutional book build on Wednesday will set the final margin. At the lower end of 4.5%, this implies an interest rate of around 8.1% for the first quarter, while at the higher end of 4.75%, the rate would be 8.35%.
Pricing
Given the issuing costs and distribution risks, the issue of any listed hybrid security is opportunistic behaviour by the borrower, which makes commenting on whether the issue is fairly priced somewhat academic. The best guide is to look at adjacent secondary market issues.
The Origin Energy Notes (ASX code ORGHA) are currently trading at a margin of the bank-bill rate plus 3.90%. Origin is also rated BBB+, however it isn’t on a negative credit watch and the ORGHA issue was structured such that it is classified by S&P as 100% equity. This increases the chance it will be redeemed after five years (rather than the nominal term of 60 years).
Caltex faces a different set of industry challenges, so there are sound reasons why it needs to pay a higher margin than Origin. Is 4.5% enough of a premium? Our sense is that the Caltex issue is probably in the ballpark.
Our View
It is only a $300 million issue, which won’t be great for secondary market liquidity. Also, the incentives for Caltex to redeem the Notes after five years aren’t strong; the step up margin of 0.25% is miserable, and as the Notes are only 50% equity, there is not quite the same urgency for Caltex to redeem and replace with a new hybrid security. So there is some chance this security ends up running past its five-year call date.
Caltex also faces a challenging operating and industry environment.
These are the negatives.
The positives – it’s hard to argue with the interest rate margin and Caltex is not ‘junk’ – the Company has an ‘investment grade’ rating. Within a diversified portfolio of hybrid securities, this issue is probably worthy of a nibble.
There are more issues on the way (CBA is expected to announce a replacement issue for its PERLS IV issue, which is due for mandatory conversion on 31 October) – so keep most of your powder dry.
Paul Rickard is a contributor to the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
