Does SIA's 3.03% Bond Have Sufficient Margin of Safety?

Following up from last week's blog post on Will Temasek Bail Out SIA Bondholders In Event of Default?, here is the analysis on SIA's 5-year 3.03% bond based on Benjamin Graham's criteria as described in The Lost Art of Bond Investment. Surprisingly, the bond is not as strong as I initially thought based on a simple Debt-to-Equity ratio check. Below are the computation of the earnings coverage and stock value ratio based on SIA's latest financial statements for Financial Year 18/19 ending in Mar 2019.

Earnings Coverage

 

Profit before tax	= $868.6M
Adjusted for:
- Deduct: Share of profits from joint ventures	= $23.2M
- Add: Share of losses from associates	= $97.4M
- Add: Rental on leased aircraft	= $679.7M
- Add: Finance cost	= $116.1M
Total earnings available for covering fixed charges	= $1,738.6M
Current finance cost	= $116.1M
Adjusted for:
- Add: Rental on leased aircraft	= $679.7M
- Add: Interest for $600M @ 3.16% MTN 007 series	= 3.16% x $600M
	= $19.0M
- Add: Interest for $750M @ 3.03% MTN 001 series	= 3.03% x $750M
	= $22.7M
Total finance cost	= $837.5M
Earning Coverage	= $1,738.6M / $837.5M
	= 2.08

Several adjustments were made to compute the total earnings available for covering fixed charges and total finance cost. The more unusual adjustment in SIA's case involves adding the rental of leased aircraft to both figures. This is because SIA leases aircraft in addition to buying them. The leases range from 6 to 12 years and cannot be cancelled, although there are options for early termination for up to 2 years before the original lease expiry. The leased aircraft do not appear on the balance sheet.

On the other hand, for aircraft that SIA owns by borrowing money from the banks, the aircraft appear as a asset and the loan appears as a liability on the balance sheet. On the income statement, there is no rental required, but SIA incurs depreciation and interest on the loan.

Hence, for the leased aircraft, even though SIA does not incur a finance cost, the rental is effectively a fixed charge that SIA has to cover, as the leases cannot be cancelled and SIA needs the aircraft to continue its operations. A similar adjustment needs to be made for the balance sheet, as discussed in the section later.

The current finance cost is also adjusted for interest on a $600M 3.16% Medium Term Note (MTN) issued on 26 Oct 2018 and the $750M 3.03% bond issued on 29 Mar 2019 which is the subject of this blog post. Although both bonds already appear on the balance sheet as at 31 Mar 2019, their first interest payments will only be made in FY19/20, Hence, their interest payments need to be added to compute the actual finance cost.

Based on the above adjusted figures, the earnings coverage is computed to be 2.08 times, which is below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares	= 1,199.9M
Share price	= $9.62
Market value of shares	= $11,542.6M
Current borrowings	= $6,654.4M
Adjusted for:
- Add: Liability for rental aircraft	= $2,200.0M
Total borrowings	= $8,854.4M
Stock value ratio	= $11,542.6M / $8,854.4M
	= 1.30

As mentioned above, adjustments need to be made to the balance sheet for the rental aircraft. The rental aircraft is effectively an asset for SIA. Correspondingly, there should be a liability to account for the loan that SIA would have borrowed to purchase the aircraft outright. In fact, International Financial Reporting Standard (IFRS) 16 on Leases came into effective starting from Jan 2019 that requires companies like SIA to account for leased assets on their balance sheets. SIA has disclosed in its Annual Report that the assets will be increased by $1.7B while liabilities will be increased by $2.2B.

Considering the $2.2B increase in total borrowings, the stock value ratio is computed to be 1.30, which is higher than the minimum stock value ratio of 1.0 for industrial companies.

Quantitative Assessment

Thus, based on the above figures, SIA's 5-year 3.03% bond does not meet the earnings coverage criterion but meets the stock value ratio criterion. Based on Benjamin Graham's criteria, the bond does not have sufficient margin of safety.

Other Considerations

As mention in my blog post on Will Temasek Bail Out SIA Bondholders In Event of Default? last week, I believe Temasek will come to the rescue of SIA bondholders in the event that SIA could not pay interest and/or redeem the bond.

P.S. I am vested in SIA's 3.03% bond.


See related blog posts:

• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?
• Will Temasek Bail Out SIA Bondholders In Event of Default?

Will Temasek Bail Out SIA Bondholders In Event of Default?

As regular readers would know, I stopped blogging for a year. I did not just stopped blogging; I also stopped monitoring performance of my portfolio and analysing shares and bonds in detail. So when SIA launched its retail 3.03% bond in Mar this year, I did not analyse it in detail as I would typically do using Benjamin Graham's method (see The Lost Art of Bond Investment for details) and simply bought it. I took a glance at its financial statements, carried out a simple Debt-to-Equity check and concluded that its debt obligations were not too excessive. Most importantly, I relied upon the assumption that SIA's parent, Temasek, would bail out bondholders in full in event of a default. This was not the only time that I relied on similar assumptions when buying bonds. I did the same when I bought Fraser Property's 3.65% bond (see Does FCL's 3.65% Bond Have Sufficient Margin of Safety? for more info).

Now that I am back to blogging (and thinking about financial issues), it is worth diving deeper to examine whether the assumption is rock solid and could be relied upon. Do note that this is not entirely a hypothetical question, as the airlines industry is a highly competitive one. Bankruptcies are not uncommon. Past examples include American Airlines, Delta Airways, Northwest Airlines, etc. going into Chapter 11 protection.

So, will Temasek come to the rescue of bondholders in the event SIA defaults on the bond? To answer this question, we need to first understand the background of SIA and Temasek. So, the first question is: will Temasek rescue SIA? The answer must be a resounding yes. SIA is the national airline and the pride of the nation. When our political leaders go overseas for conferences, they fly with SIA. It is difficult to imagine our political leaders flying on some other countries' national airlines. Thus, yes, Temasek will come to the rescue of SIA.

However, rescuing SIA the company is not the same as rescuing SIA bondholders. While SIA the company is a strategic national asset, SIA bondholders (and shareholders) are not. Furthermore, the ultimate shareholders of Temasek are Singaporeans. Bailing out SIA and its bondholders with Temasek's money is akin to using taxpayers' money to do so. It will be politically difficult to use taxpayers' money to bail out bondholders in full. The most likely scenario is that the settlement with bondholders will be at arm's length basis on normal commercial terms, i.e. the outcome would be similar to another company that is not owned by Temasek. In other words, bondholders will suffer some capital losses. This is not unlike the case of Hyflux preference shares and perpetual capital securities. Thus, from this perspective, SIA bondholders should not expect Temasek to bail them out in full.

On the other hand, SIA is not the only company that Temasek owns. Temasek owns a lot of companies in its portfolio. Temasek has triple-A ratings from both Moody's and S&P. Not all the companies in its portfolio has similar ratings based on their own merits. When companies with lower ratings borrow money, lenders take into consideration the fact that the company is majority owned by Temasek and offer a lower interest rate compared to a company that does not have Temasek as its backing. In the event that Temasek does not step in to bail out bondholders in full, credit markets will take note and will not offer lower interest rates to Temasek-owned companies in future. Each company has to pay an interest rate that is commensurate with its own credit rating. In other words, Temasek will have to bear higher interest payments across most of its subsidiaries. This long-term economic cost might outweigh the short-term political cost and prompt Temasek to bail out bondholders in its subsidiaries in full.

Finally, we should also note that Temasek, although it does not play an active role in day-to-day management of the subsidiaries' operations, is not a sleeping partner either. Long before trouble happens and hits the headlines, Temasek would have done something to avert it. For example, Tiger Airways, SIA's budget airline, had been losing money for 4 out of 6 years since its listing on SGX in Jan 2010. It carried out 3 rights issues over the same period. It also issued a 2% perpetual capital convertible securities (PCCS) in Apr 2013. If the trend were to continue, Tiger Airways would probably have failed and defaulted on the PCCS. In Nov 2015, SIA announced that it would take over Tiger Airways. It also redeemed all outstanding PCCS upon successful takeover of the company.

In conclusion, I had been lazy in analysing the SIA 3.03% bond when I bought it. But I guess I still can rely on the assumption that Temasek would step in and bail bondholders out in the event of default by SIA. Nevertheless, I should do my homework and analyse whether the SIA bond has sufficient margin of safety according to Benjamin Graham's method.

See related blog posts:

• The Lost Art of Bond Investment
• Does SIA's 3.03% Bond Have Sufficient Margin of Safety?
• Does FCL's 3.65% Bond Have Sufficient Margin of Safety?

Are Private Equity Bonds Better Than Corporate Bonds?

When Astrea V 3.85% bond was launched, some investors remarked that it is better than some of the recently issued corporate bonds, such as SIA 3.03% bonds. What are the differences between Private Equity (PE) bonds and corporate bonds, and are PE bonds really better than corporate bonds?

It is difficult to compare Astrea bonds with, say, SIA bonds, since their nature of business are different. To make the comparison between PE bonds and corporate bonds more meaningful, let us consider a hypothetical bond issued by Azalea Asset Management, which is the sponsor of the Astrea III/IV/V bonds. Fig. 1 below shows the corporate structure of Azalea.

Fig. 1: Azalea Corporate Structure

The assets of Azalea are the 3 Astrea companies issuing the Astrea III/IV/V bonds and owning the underlying portfolios of PE funds. Azalea probably has some other income-generating assets, such as the investment management company shown in Fig. 1 above, plus some other unlisted PE funds. Thus, the nature of business of Azalea and Astrea III/IV/V companies are similar. What would be the differences between the hypothetical Azalea corporate bond and Astrea III/IV/V PE bonds? Note that the PE bonds are not limited to the Class A-1 bonds which are open to retail investors. There are also Class A-2, B and C bonds.

The first key difference would be the security of the bonds over the assets. Astrea PE bonds are secured against the PE funds in the respective Astrea companies, whereas Azalea corporate bond would be unsecured. In the hypothetical scenario where the Astrea PE bonds default, Astrea bondholders could force the respective Astrea companies to liquidate their PE funds and return money to the bondholders. However, in the event that the liquidation proceeds are insufficient to redeem the bonds, bondholders have no recourse to Azalea, or to the other Astrea companies. For example, if Astrea III bonds were to default, Astrea III bondholders have no rights to the assets of Azalea, Astrea IV and Astrea V companies. The assets of each company are ring-fenced and could only be used to service the bonds issued by the respective company.

Similarly, in the hypothetical scenario where the Azalea corporate bond defaults, Azalea bondholders have no claims over the PE funds held in the 3 Astrea companies. Nevertheless, they could force Azalea to sell off the Astrea companies together with their portfolio of PE funds and PE bonds. However, they could not force Azalea to break up the Astrea companies, sell off their PE funds, redeem the Astrea PE bonds, and return excess cash to Azalea to pay off the corporate bondholders (Note: it might be possible to do so for other project/ asset-level bonds, but the terms of Astrea PE bonds do not allow for early liquidation of assets and redemption of bonds). In other words, regardless of what happens to Azalea, Astrea PE bondholders will not be affected. 

So does it mean that Astrea PE bonds, which are secured against the PE funds of the respective Astrea companies, are better than Azalea corporate bonds which are unsecured? Not necessarily. The key factor is the quality of the assets that are securing the bonds. If the assets are of high quality, the PE bonds have good collaterals. Conversely, if the assets are of low quality, the collaterals would be useless. Remember, Astrea PE bondholders have no recourse to Azalea and the other Astrea companies. They can only count on the assets in their respective Astrea companies to pay interest and redeem the bonds. 

Although Azalea corporate bond is unsecured, if the Astrea companies are generating good cashflows for Azalea, it does not matter whether the bond is secured or not. In a hypothetical scenario where one of the Astrea companies have poor assets whereas the other Astrea companies have good assets, it might be better to hold the unsecured Azalea corporate bond than the secured but troubled Astrea PE bond. So, quality of assets is key in determining whether secured or unsecured bonds are better.

The second difference is that Azalea could have other income-generating assets and businesses besides the 3 Astrea companies. In Fig. 1 above, it has an investment management subsidiary to manage the investments in PE funds for the Astrea companies in return for a fee. It could also have other PE funds that are outside the Astrea companies. So, for Azalea corporate bonds, there could be other sources of operating cashflows, whereas for Astrea PE bonds, the only source of cashflows is the PE funds in the respective Astrea companies.

The third difference is that besides receiving cashflows from the Astrea companies to redeem the Azalea corporate bond, Azalea could refinance the bond through bank borrowings, new corporate bonds, shareholder loans from Temasek, or even private share placements and IPO! Being a corporate bond, there are many avenues to refinance it. Astrea PE bonds do not have such avenues. To reiterate, Astrea PE bondholders can only count on the assets in the respective Astrea companies. If the assets are good, PE bondholders will get the promised returns. If the assets are poor, they will suffer some losses.

Having said the above, being able to borrow money is a double-edged sword. While borrowings could help to refinance the Azalea corporate bond, Azalea could also run the risk of borrowing too much money and jeopardise its ability to pay interest to and/or redeem the Azalea corporate bond if banks decide that Azalea's credit risk is too high. For the Astrea PE bonds, such risks have been mitigated. The terms of Astrea PE bonds prohibit the Astrea companies to borrow money other than to issue the different classes of bonds at inception, as well as to meet capital calls and cover bond interest payment shortfalls. The last 2 conditions are actually safeguards for the PE bondholders (see Understanding the Safeguards of Astrea IV 4.35% Bonds for more info).

In conclusion, PE bonds are not necessarily better or worse than corporate bonds. The key words are: quality of assets securing the PE bonds. This is unlike preference shares and perpetual capital securities, which are inherently inferior to stocks and bonds (see Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form for more info).

See related blog posts:

• Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form
• Understanding the Safeguards of Astrea IV 4.35% Bonds 
• Astrea V 3.85% Bonds – Understanding What You Are Buying Into

Watch Out for Hyflux's Omission of Ordinary Dividends

Hyflux announced its half year financial results last month. For holders of Hyflux preference shares and perpetual capital securities (perps), perhaps the most noteworthy point is that it did not declare an interim dividend on its ordinary shares. Why is this important? It is because the payment of a preference dividend or perps distribution is discretionary. If certain conditions are met, the company can choose not to pay or only pay partially any preference dividend or perps distribution. One of these conditions is that a dividend on the ordinary shares is not paid out. The conditions for preference shares and perps are different, so let's discuss these separately.

Preference Shares

There are 2 conditions upon which Hyflux can choose not to pay or only pay partially its preference dividends. The 2 conditions are:

1. If it does not have sufficient Distributable Reserves; or
2. If it does not pay its next dividend on its ordinary shares.

See Figs. 1 and 2 below for extracts of the Offer Information Statement (OIS) for the preference shares.

Fig. 1: Conditions for No/Partial Preference Dividend (Extract)

Fig. 2: Definition of Distributable Reserves

For Condition 1, if Hyflux does not have sufficient Distributable Reserves, it will not be able to pay its preference dividends in full. The definition of Distributable Reserves is shown in Fig. 2 above. I interpret it to mean that Hyflux must have sufficient retained earnings to pay dividends, regardless of whether they are ordinary dividends or preference dividends. As at Jun 2017, the retained earnings are $146.9M. The retained earnings have been dropping recently. In Dec 2015 and Dec 2016, the corresponding figures are $284.2M and $210.3M. See Did Hyflux Make Money for its Ordinary Shareholders? for more information.

For Condition 2, if Hyflux does not pay its next dividend on ordinary shares, then it can choose not to pay or only pay partially the preference dividend. Nevertheless, this does not mean that Hyflux will definitely not pay its next preference dividend in full. It only means that Hyflux can choose not to if it wishes.

In addition, the preference dividends are cumulative. If a preference dividend is skipped, it will continue to accumulate until it is fully paid out or the preference shares are redeemed.

Perpetual Capital Securities

For perps, the condition upon which Hyflux can choose not to pay or only pay partially its perps distribution is if it does not pay a dividend on, redeem or buy back any of its Junior Obligations in the preceding 6 months. The ordinary shares are considered as Junior Obligations. In addition, Hyflux can defer part of the perps distribution if it pays a dividend on, redeem or buy back its Parity Obligations on a pro-rata basis with the perps in the preceding 6 months. The preference shares are considered as Parity Obligations. See Figs. 3 and 4 below for extracts of the OIS for the perps.

Fig. 3: Conditions for No/Partial Payment of Perps Distribution (Extracts)

Fig. 4: Ranking of Hyflux Preference Shares and Perps

The last ordinary dividend was paid on 25 May 2017 and the last preference dividend was paid on 25 Apr 2017. As Hyflux did not declare an interim dividend on its ordinary shares in its latest financial results, if Hyflux chooses not to pay the next preference dividend scheduled on 25 Oct 2017 in full, Hyflux can defer part of the next perps distribution scheduled on 27 Nov 2017.

And like the preference dividends, the perps distributions are cumulative. If a distribution is skipped, it will continue to accumulate until it is fully paid out or the perps are redeemed.

Just a disclaimer, this post is not a recommendation for anyone to buy or sell Hyflux's preference shares or perps. It is also based on my interpretation of the terms in the OIS. You can find a copy of the OIS/ prospectus in Bondsupermart. Please read the OIS and do your own due diligence.

See related blog posts:

• Did Hyflux Make Money for its Ordinary Shareholders?
• If You Invest In Fixed Income, Read the Fine Print
• Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form

Prefs and Perps are Generally Inferior to Stocks and Bonds as an Investment Form

I have been investing in preference shares (prefs) for many years, so much so that I had forgotten that as an investment form, prefs are actually inferior to stocks and bonds. In fact, prefs have been the cornerstone of my equity-centric investment strategy, saving my equity portfolio during severe market crashes, as described in Behind Every Successful Bear Market Recovery is A Cash-Like Instrument. It was only last week when Hyflux launched its IPO of perpetual capital securities (perps) that I looked into the features of perps and remembered that prefs and perps are inferior to stocks and bonds as an investment form. 

Just to recap the characteristics of prefs and perps, they are perpetual securities with no redemption dates and hence are considered some form of equity. Unlike stocks, they have a pre-determined dividend/ distribution rate (distribution shall include to mean dividend for prefs and interest payment for bonds henceforth). However, the actual payout of the distribution for prefs and perps is discretionary, which means that the company can choose not to pay the full amount of distribution at the pre-determined payout date. For cumulative prefs and perps, any distribution not paid will accumulate and be paid out in the future (again, at the discretion of the company). Unlike bonds, this deferral of distribution is not considered a default event.

Compared to bonds, prefs and perps are inferior for several reasons. Firstly, payout of the stated distribution rate is not guaranteed and is not considered a default event. Secondly, if a company misses a bond interest payment and is unable to remedy it within a given period of time, the entire bond issue becomes redeemable immediately. If the company is unable to redeem its bonds, the company will go into default. Not only that, the company might have some loans with cross-default covenants stating that if the company defaults on some other loans or bonds, that particular loan will also become repayable immediately. In other words, when one creditor descends on the company, all other creditors will also quickly do so to safeguard their own interests. Thus, the company will be very careful not to default on any of its loans and bonds. For prefs and perps, there are no similar chain reactions since deferral of distribution is not considered a default event. Thirdly, in the event of claims, bonds rank higher than prefs and perps. Thus, bondholders have priority claim over pref and perp holders. 

Thus, for the above reasons, prefs and perps are inferior as an investment form to bonds. To compensate for the higher risks of prefs and perps, the margin of safety for investing in them needs to be higher. If you refer to The Lost Art of Bond Investment, you will see that the margin of safety required for Benjamin Graham's 2 criteria of minimum average earnings coverage and minimum current stock value ratio is higher for prefs than for bonds.

Compared to stocks, prefs and perps are also inferior for several reasons. Firstly, the upside is limited to the stated distribution rate for prefs and perps but unlimited for stocks. In my opinion, this makes for an unfavourable upside/ downside ratio for prefs and perps. Consider a pref with a stated distribution rate of 5%. If nothing goes wrong, you get a maximum of 5% in distribution every year. But if something goes terribly wrong, you can lose up to 100% of your capital. For stocks, it is also possible to lose 100% of your capital, but the capital gains (if any) for such high-risk stocks are usually more than 5%. Secondly, stocks have voting rights, but prefs and perps do not. If the current management is not doing a good job, stockholders can band together and vote out the current management. Pref and perp holders do not have such rights. Thirdly, the trading liquidity for stocks is much higher than that for prefs and perps. If you do not think the company is doing a good job, you can just sell and go away. However, for prefs and perps, there might be insufficient liquidity to sell at a reasonable price quickly. 

Thus, the worst possible scenario for prefs and perps is that the company defers some parts of the stated distribution and the price declines to reflect the uncertainty in timeline of the distribution, but you cannot get out because the company has no obligations to redeem the issue and the liquidity is too low for selling at a reasonable price.

In conclusion, as an investment form, prefs and perps are generally inferior to stocks and bonds. However, individual prefs and perps may have their own investment merits. Investors need to assess for themselves whether individual prefs and perps are good investments. 

See related blog posts:

• Watch Out for Hyflux's Omission of Ordinary Dividends
• If You Invest In Fixed Income, Read the Fine Print
• The Lost Art of Bond Investment

Do Hyflux's 6% Perps Have Sufficient Margin of Safety?

Hot on the heels of Aspial, Perennial and Oxley, Hyflux has launched an IPO for its retail 6% perpetual capital securities (perps). I used to own its existing 6% preference shares when it launched in 2011. However, that was before I calculated whether it had sufficient margin of safety based on Benjamin Graham's criteria. After I calculated the figures, I sold it off in Jan 2014. Hyflux's preference shares were the first bond / preference shares that I evaluated using Benjamin Graham's criteria of minimum average earnings coverage and minimum current stock value ratio as discussed in The Lost Art of Bond Investment. When I posted it in Jan 2014, I did not expect retail bonds to become so popular. The criteria have been very useful in assessing whether the various retail bonds launched since Aug last year have sufficient margin of safety.

Since the post 2 years ago, has Hyflux's financial strength improved and do its 6% perps have sufficient margin of safety? Based on Hyflux's latest financial statements, the computation of the earnings coverage and stock value ratio are as follow.

Earnings Coverage

 

Profit before tax	= $38.8M
Adjusted for:
- Add: Share of losses from associates	= $19.6M
- Add: Finance cost	= $42.8M
Total earnings available for covering fixed charges	= $101.2M
Current finance cost	= $42.8M
Add: Dividend for preference shares	= $24.0M
Add: Distribution for perpetual capital securities	= $25.7M
Add: Distribution for proposed perpetual capital securities	= 6.00% x $300M
	= $18.0M
Total finance cost	= $110.4M
Earning Coverage	= $101.2M / $110.4M
	= 0.92

The earnings coverage of 0.92 times is below the minimum average earnings coverage of 2 times for public utilities or 4 times for industrial companies.

Stock Value Ratio

No. of shares	= 785.3M
Share price	= $0.545
Market value of shares	= $428.0M
Current borrowings	= $1,423.9M
Current preference shares	= $400.0M
Current perpetual capital securities	= $475.0M
Proposed perpetual capital securities	= $300.0M
Total bond value	= $2,598.9M
Stock value ratio	= $428.0M / $2,598.9M
	= 0.16

The stock value ratio of 0.16 is lower than the minimum stock value ratio of 0.67 for public utilities or 1.5 for industrial companies.

Thus, based on the above figures, the proposed Hyflux's 6% perps do not pass both the earnings coverage and stock value ratio criteria. Hence, based on Benjamin Graham's criteria, the perps do not have sufficient margin of safety.

See related blog posts:

• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?
• Benchmarks for Retail Bond Pricing

Does Aspial's 5.30% Bond Have Sufficient Margin of Safety?

7 months ago, I blogged about whether Aspial's 5-year, 5.25% bond has sufficient margin of safety. 7 months later, Aspial has launched a new 4-year, 5.30% bond. Since the last blog post 7 months ago, has Aspial's financial strength improved based on the 2 criteria that Benjamin Graham used to analyse bonds, namely, the minimum average earnings coverage and the minimum current stock value ratio? Using Aspial's latest Financial Year's results, the computation of the 2 ratios are as follow.

Earnings Coverage

Profit before tax	= $13.0M
Adjusted for:
- Deduct: Share of results of associates	= $1.8M
- Add: Non-recurring forex loss	= $10.0M
- Add: Finance cost	= $20.4M
Total earnings available for covering fixed charges	= $41.5M
Current finance cost	= $20.4M
Add: Interest of proposed bond	= 5.30% x $75.0M
	= $4.0M
Total finance cost	= $24.3M
Earnings Coverage	= $41.5M / $24.3M
	= 1.71

The earnings coverage of 1.71 times is below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares	= 1,891.6M
Share price	= $0.275
Market value of shares	= $520.2M
Current amount of borrowings	= $1,305.2M
- Add: Proposed bond size	= $75.0M
Total bond value	= $1,380.2M
Stock value ratio	= $520.2M / $1,380.2M
	= 0.377

The stock value ratio of 0.377 is lower than the minimum stock value ratio of 1 for industrial companies.

Thus, based on the above figures, the proposed Aspial's 5.30% bond does not pass both the earnings coverage and stock value ratio criteria. Hence, based on Benjamin Graham's criteria, the bond does not have sufficient margin of safety.

Compared to the figures in the previous blog post (based on 2014 financial statements), both earnings coverage and stock value ratio has dropped. The earnings coverage has reduced from 2.50 times to 1.71 times while the stock value ratio has reduced from 0.548 to 0.377. In fact, all key measures for computing the above 2 figures have weakened.

	2014	2015
Earnings Coverage
Total available earnings	$52.6M	$41.5M
Total finance cost	$21.0M	$24.3M
Earnings Coverage	2.50	1.71
Stock Value Ratio
Market value of shares	$   651.9M	$   520.2M
Total bond value	$1,190.4M	$1,380.2M
Stock Value Ratio	0.548	0.377

This reduction in margin of safety affects not just the newer 5.30% bond, but also the older 5.25% bond.

In conclusion, Aspial's 5.30% bond does not have sufficient margin of safety. The margin of safety of Aspial's 2 retail bonds has reduced since the last blog post 7 months ago.

See related blog posts:

• Does Aspial's 5.25% Bond Have Sufficient Margin of Safety?
• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?

Do Retail Bond Investors Get the Poorer Deal?

When Frasers Centrepoint (FCL) announced the issue of its 7-year, 3.65% retail bond on 12 May 2015, it was preceded by another announcement just a day earlier regarding the issue of a perpetual securities that carry a coupon rate of 5.00%. In fact, the perpetual securities were not the only bonds issued by FCL since its listing on SGX in Jan 2014. There were 2 other bonds, namely a 4.88% perpetual securities and a 7-year, 3.95% Fixed Rate Notes, both issued in Sep 2014. Thus, among all the bonds issued by FCL within a short span of 8 months, the 7-year, 3.65% retail bond has the lowest coupon rate. All other wholesale (i.e. non-retail) bonds have higher coupon rates. It raises the question whether retail investors have the poorer deal when it comes to new bond offerings.

Shortly after FCL's retail bond issue, Aspial, Perennial and Oxley all issued their own retail bonds with coupons ranging from 4.65% to 5.25%. Like FCL, all 3 companies have issued wholesale bonds before the retail bond offering. Let us study whether it is true that retail investors have the poorer deal when it comes to new bond offerings. 

The figure below shows the Yield-to-Maturity (YTM) of the various bonds issued by the above-mentioned companies that are available on Bondsupermart. Each colour represents all bonds issued by a particular company. The retail bonds are identified by a label next to the points. As an example, Aspial have 5 existing bonds, shown in purple in the figure. Its retail bond has the highest YTM and longest maturity among all its bonds. Also shown in the figure are the 3 lines representing the YTM of the risk-free Singapore Government Securities (SGS), high investment-grade bonds rated A3 by Moody's and the lowest investment-grade bonds rated Baa3 by Moody's. These lines provide a reference to determine whether the bonds are fairly priced or not. Please see Benchmarks for Retail Bond Pricing for more details on how to price a bond.

Fig. 1: Wholesale Bonds versus Retail Bonds

At first glance from Figure 1, the retail bonds appear to be priced fairly in line with their wholesale cousins after accounting for unique bond features that could introduce a premium or discount to the YTM, such as putable features (which results in lower YTM) and callable or step-up coupon features (which results in higher YTM). However, on closer look, there are differences in the yield spread between wholesale bonds and retail bonds. In bond pricing, every 0.01% in yield counts. 0.01% is so important that it has a special name – a basis point. If you compute the YTM spread between the bonds and Baa3-rated bonds, retail bonds have lower spreads compared to their wholesale cousins ranging from 0.11% to 0.30%. What it means is that retail bonds are actually more expensive.

The correctness of the above analysis is dependent on 2 assumptions, namely, (1) the spread is constant across all bond maturities and (2) the reference yields are correctly constructed. In view of these limitations, let us consider perpetual bonds which do not have such limitations. There are 3 perpetual bonds listed on SGX, namely, DBS 4.7%, Genting 5.125% and Hyflux 6%. Like the other companies mentioned above, they also have wholesale perpetual bonds. Let us look at each of them.

Fig. 2: DBS' Perpetual Bonds

Figure 2 shows the perpetual bonds issued by DBS. The first bond (DBSSP 4.700% Perpetual Pref) is a retail bond. As can be seen from the figure, it has the lowest YTM among all the bonds.

Fig. 3: Genting's Perpetual Bonds

Figure 3 shows the perpetual bonds issued by Genting. Both bonds have the same coupon, but the first one is the retail version. Again, it has a lower YTM compared to its wholesale cousin.

Fig. 4: Hyflux's Perpetual Bonds

Figure 4 shows the perpetual bonds issued by Hyflux. The first bond (HYFSP 6.000% Perpetual Pref) is the retail bond. Similarly, it has the lowest YTM among all the bonds.

Thus, it is fairly conclusive that retail bonds are priced more expensively compared to their wholesale cousins. This is to be expected, since wholesale bonds are traded in multiples of $250,000 and hence not accessible to most retail investors. Nevertheless, retail investors should be vigilant and not let ourselves be taken advantage of.

P.S. I am vested in FCL's 3.65% bond and CapitaMallsAsia's 3.8% bond.

See related blog posts:

• Benchmarks for Retail Bond Pricing
• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?

Benchmarks for Retail Bond Pricing

There are a couple of retail bonds listed on the SGX. How do you tell whether the 5.25% coupon offered by Aspial's 5-year bond is too high or the 3.65% coupon offered by Frasers Centrepoint's (FCL) 7-year bond is too low? To determine the right pricing for these bonds, you need to know what is the credit rating of the bond and the Yield-to-Maturity (YTM) for bonds with similar ratings. Unfortunately, the majority of retail bonds listed on SGX are not rated. On the other hand, thanks to Bondsupermart, we now have benchmarks to determine the YTM and pricing for bonds with various ratings. The blue line in the figure below shows the YTM for bonds rated A3 by Moody's (equivalent to A- by S&P / Fitch), which is the lowest of all A-grade bonds. The red line shows the YTM for bonds rated Baa3 by Moody's (equivalent to BBB- by S&P / Fitch), which is the lowest of all investment-grade bonds. Also shown in the figure in green is the YTM for the Singapore Government Securities (SGS), which provide a risk-free return for various bond maturities. This green line is also known as the Yield Curve. The difference between a bond's YTM and the yield curve at the same bond maturity is known as the spread and is commonly used to measure the pricing of a bond. Actually, you can construct a different line for each bond rating, but for ease of discussion, we will show only 3 lines in this figure.

YTM for A3/A- and Baa3/BBB- Bonds

The YTM of retail bonds listed on SGX are plotted as purple points in the figure above. The YTM has considered any step-up coupon feature in the bond, which is why CapitaMallsAsia 3.80% bond has a YTM of 4.064% even though its coupon is only 3.80% (this step-up will only apply if the bond does not get redeemed early). Among the 6 retail bonds with maturities of less than 10 years, only CapitaMallTrust's (CMT) 3.08% bond is rated A2 by Moody's. Let us use this as an example to explain how bonds are priced. CMT bond's rating of A2 is 1 grade higher than A3 which is represented by the blue line. As shown in the figure above, CMT bond's YTM is slightly below the blue line. Since CMT bond is less risky than A3-rated bonds, it should have a lower YTM than A3-rated bonds. Thus, CMT's 3.08% bond is correctly priced.

All the other retail bonds do not have any credit rating. We have to estimate a probable credit rating for the bond and from there, determine if it is overpriced or underpriced. Using FCL's 3.65% bond as an example, the YTM is closer to the blue line (A3 / A- bonds) compared to the red line (Baa3 / BBB- bonds) as shown in the figure above. If we think that FCL bond's rating is closer to Baa3 / BBB- than A3 / A-, then its YTM should increase to that of Baa3 / BBB- bonds (i.e. price should decrease). 

How do you compute the price of a bond from its YTM and vice versa? There are simple tools to do so. One such tool is posted on the SGS website. Just enter the maturity date, coupon rate and YTM and compute the price (or vice versa). As an example, the price of FCL's bond is currently $0.990, which translates to a YTM of 3.826%. If we think FCL's bond should have a Baa3 / BBB- rating, its rightful YTM should be 4.216% as shown in the figure above. Based on this YTM, the price for FCL's bond should be $0.968.

Finally, although we do not know the credit rating of Aspial's 5.25% bond, Oxley's 5.00% bond and Perennial's 4.65% bond, they are all priced above the red line, which means that the market thinks they are not investment-grade bonds. This is consistent with the analysis based on Benjamin Graham's criteria of earnings coverage and stock value ratio, which showed that all 3 bonds (together with FCL's 3.65% bond) do not have sufficient margin of safety. Readers will have to assess for themselves if the higher coupons offered by the bonds are sufficient to compensate for the risks in investing in them. 

P.S. I am vested in FCL's 3.65% bond and CapitaMallsAsia's 3.80% bond.

See related blog posts:

• Do Retail Bond Investors Get the Poorer Deal?
• Does FCL's 3.65% Bond Have Sufficient Margin of Safety?
• Does Aspial's 5.25% Bond Have Sufficient Margin of Safety?
• Does Perennial's 4.65% Bond Have Sufficient Margin of Safety?
• Does Oxley's 5% Bond Have Sufficient Margin of Safety?

Is Benjamin Graham's Art of Bond Investment Outdated?

There were 4 retail bonds issued this year, yet all 4 were assessed not to have sufficient margin of safety according to Benjamin Graham's criteria of earnings coverage and stock value ratio. Despite so, all 4 bonds have hovered around the par value since listing. Is Benjamin Graham's art of bond analysis as described in The Lost Art of Bond Investment outdated?

To answer this question, let us go back to the first principles. The safety of a bond depends both on the issuer's ability to pay and willingness to pay. The ability to pay in turn depends on the issuer's recurring earning capability and/or adequacy of assets to extinguish the bonds. The willingness to pay depends largely on the management's integrity and is usually safeguarded by convenants in the bond agreement restricting management's rights, such as declaring excessive dividends to shareholders, or allowing bondholders to take over the company in the event of a default. Benjamin Graham's criteria measure the issuer's ability to pay and the 2 criteria of earnings coverage and stock value ratio measure the issuer's recurring earning capability and adequacy of its assets respectively. Although they were derived more than 80 years ago, the concepts are still relevant today and can be found in today's loans, including the housing mortgage loans that most people are familiar with. Interestingly, all the 4 retail bonds were issued by property developers. Let us visit each one of the criteria.

Earnings Coverage

The earnings coverage is more commonly known as interest coverage in today's age. It measures how much cushion the company's recurring earnings has to cover the total interest expense from all loans. The inverse of the earnings coverage would be equivalent to the Total Debt Servicing Ratio (TDSR) introduced by the Monetary Authority of Singapore (MAS) to determine how much of a person's salary could be used to service all the loans he has and hence how much loan he could obtain to purchase a property. Using industrial bonds as an example, Benjamin Graham recommended an earnings coverage of not less than 3 times fixed charges. This translates to a TDSR of 33%. Although this figure looks low compared to MAS' allowable TDSR of 60%, it has to be considered that individuals have mostly stable salaries, whereas companies' earnings are quite variable from year to year. The more variable the earnings are, the lower the TDSR should be. In fact, for bonds of public utilities which have more stable earnings, Benjamin Graham allowed a lower earnings coverage of 1.75 times fixed charges, which translates to a TDSR of 57%, which is quite close to MAS' allowable TSDR of 60%. Considering the variability of earnings of property companies, an earnings coverage of 3 times fixed charges is not excessively stringent. 

Stock Value Ratio

The stock value ratio measures how much cushion the company's equity could provide to the bonds in the event the company loses money. It is measured as the ratio of equity to total debt. In today's age, the related but more commonly used yardstick is the Loan-to-Value (LTV) ratio, which measures the ratio of debt to asset value. Using industrial bonds as the example, Benjamin Graham recommended a stock value ratio of not less than 1. This translates to a LTV of 50%. Again, although this figure looks low considering that individuals could borrow up to 80% of the property price, it has to be considered that individuals pay down their loans over time whereas companies mostly roll-over their loans when they mature. Thus, the LTV for individuals decline over time whereas the LTV for companies mostly stay constant. Moreover, individuals' mortgage loans are secured using the property as collateral, whereas companies' loans may either be secured or unsecured. A more appropriate benchmark would be the 45% leverage limit imposed by MAS on REITs. From this angle, the stock value ratio of 1 for property companies is not excessively stringent. For public utility bonds, Benjamin Graham allowed the stock value ratio to go up to 2 times, which translates to a LTV of 67%.

Other Considerations

Having too much debt does not necessarily means that a company will default on its bonds. It is akin to an individual with high cholesterol; while it places the individual at risk of a heart attack, it does not mean that one will definitely occur. The catalyst for a heart attack for companies would be a credit crunch or a sharp or prolonged industrial downturn in which the company is unable to find a bank willing to refinance its debts or a buyer willing to buy over its assets at reasonable prices. One of the biggest lessons REIT investors learnt from the Global Financial Crisis is that in times of crisis, having a strong parent helps. REITs with deep-pocket parents such as CapitaComm or A-REIT weathered the storm better than REITs without such parents. 

To conclude, Benjamin Graham's art of bond analysis is still as relevant today as it was formulated 80 years ago. 

Finally, you probably have heard the story that banks are famous for being fair-weather friends; they are nowhere to be found when you need the money but beg you to take the money when you do not need it. As bondholders, we should learn from the banks, i.e. lend money only to those who do not need it!

P.S. I am vested in Frasers Centrepoint's 3.65% bond (held as available-for-sale instead of held-to-maturity).

See related blog posts:

• The Lost Art of Bond Investment
• Does FCL's 3.65% Bond Have Sufficient Margin of Safety?
• Does Perennial's 4.65% Bond Have Sufficient Margin of Safety?
• Does Oxley's 5% Bond Have Sufficient Margin of Safety?
• Does Aspial's 5.30% Bond Have Sufficient Margin of Safety?
• Do Hyflux's 6% Perps Have Sufficient Margin of Safety?
• Does SIA's 3.03% Bond Have Sufficient Margin of Safety?

Does FCL's 3.65% Bond Have Sufficient Margin of Safety?

I realised I had omitted the analysis for Frasers Centrepoint's (FCL) 7-year, 3.65% retail bond when it launched its Initial Public Offering in May. Since FCL announced its latest full-year financial results a week ago, here is the analysis according to Benjamin Graham's criteria of average earnings coverage and stock value ratio.

Earnings Coverage

Profit before tax, fair value changes & exceptionals	= $955.4M
Adjusted for:
- Deduct: Share of associates' & joint ventures' results	= $279.4M
- Add: Finance cost	= $186.2M
Total earnings available for covering fixed charges	= $862.1M
Finance cost	= $186.2M
Earnings Coverage	= $862.1M / $186.2M
	= 4.63

The earnings coverage of 4.63 times is above the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares	= 2,895.0M
Share price	= $1.63
Market value of shares	= $4,718.9M
Total borrowings	= $9,255.3M
Stock value ratio	= $4,718.9M / $9,255.3M
	= 0.510

The stock value ratio of 0.510 is lower than the minimum stock value ratio of 1 for industrial companies.

Quantitative Assessment

Thus, FCL's bond meets the earnings coverage criterion but not the stock value ratio criterion. Based on Benjamin Graham's criteria, FCL's 7-year, 3.65% bond does not have sufficient margin of safety.

Other Considerations

Although the focus of the financial assessment should be on the company issuing the bond, we could look towards the parent company if the issuer company does not have adequate financial resources. In the case of FCL, it is the subsidiary of F&N, which is in turn a subsidiary of TCC Assets. If we can be sure that F&N will not completely sell off FCL, then we can assume that F&N will come to the rescue of FCL should it encounter difficulties in paying interest and/or principal.

Thus, for the above reason, I am vested in FCL's 3.65% bond even though it does not meet all of Benjamin Graham's criteria (Note: it is held as an available-for-sale instead of held-to-maturity investment).

See related blog posts:

• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?
• Benchmarks for Retail Bond Pricing

Does Oxley's 5% Bond Have Sufficient Margin of Safety?

Bonds are typically boring investment with very little news. However, for the past week, it seems that the market could not get enough of news about bonds. First, there was the start of trading of Perennial's 4.65% bond on the SGX. Next, the second tranche of Singapore Savings Bonds closed with barely more than 20% of the total amount subscribed. Following that, OCBC announced that it would be redeeming its 4.2% preference shares listed on the SGX. Finally, we also have Oxley launching its 4-year, 5% bonds for subscription. Does Oxley's 5% bond have sufficient margin of safety according Benjamin Graham's criteria of minimum earnings coverage and minimum stock value ratio as described in The Lost Art of Bond Investment? Below are the ratios computed based on Oxley's latest financial statements in Jun 2015.

Earnings Coverage

Profit before tax	= $142.7M
Adjusted for:
- Add: Non-recurring loss (forex, revaluation, impairment)	= $23.3M
- Add: Finance cost	= $41.0M
Total earnings available for covering fixed charges	= $207.0M
Current finance cost	= $41.0M
Add: Interest of proposed bond	= 5.00% x $125.0M
	= $6.25M
Total finance cost	= $47.3M
Earnings Coverage	= $207.0M / $47.3M
	= 4.38

The earnings coverage of 4.38 times is above the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares	= 2,9448.2M
Share price	= $0.42
Market value of shares	= $1,238.3M
Current amount of borrowings	= $2,406.0M
- Add: Loan advances	= $81.9M
- Add: Proposed bond size	= $125.0M
Total bond value	= $2,612.9M
Stock value ratio	= $1,238.3M / $2,612.9M
	= 0.474

The stock value ratio of 0.474 is lower than the minimum stock value ratio of 1 for industrial companies.

Thus, Oxley's bond meets the earnings coverage criterion but does not meet the stock value ratio criterion. Based on Benjamin Graham's criteria, Oxley's 4-year, 5% bond does not have sufficient margin of safety. Having said that, this does not mean that Oxley will definitely default on this bond, it just means that the risk is higher.

See related blog posts:

• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?
• Benchmarks for Retail Bond Pricing

Does Perennial's 4.65% Bond Have Sufficient Margin of Safety?

It has been getting more interesting for retail bond investors recently, with the launch of Aspial's 5.25% bond in Aug, Singapore Savings Bonds in Sep and now Perennial's 4.65% bond. Does Perennial's 3-year, 4.65% bond have sufficient margin of safety according to Benjamin Graham's criteria of minimum earnings coverage and minimum stock value ratio as described in The Lost Art of Bond Investment?

Perennial was listed following the reverse takeover of St James Holdings in Oct 2014. Hence, it did not have financial statement for a full financial year. Based on Perennial's latest financial statement for the year ended Jun 2015, the minimum earnings coverage and minimum stock value ratio are computed as follow.

Earnings Coverage

Profit before tax	= $57.1M
Adjusted for:
- Deduct: Non-recurring fair value gain on investment properties	= $46.0M
- Deduct: Other non-recurring gains (earn-out, forex)	= $11.0M
- Deduct: Share of results of associates	= $13.8M
- Add: Finance cost	= $37.8M
Total earnings available for covering fixed charges	= $24.1M
Current finance cost	= $37.8M
Add: Interest of proposed bond	= 4.65% x $150.0M
	= $7.0M
Total finance cost	= $44.8M
Earnings Coverage	= $24.1M / $44.8M
	= 0.54

The earnings coverage of 0.54 times is way below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

No. of shares	= 1,652.5M
Share price	= $0.975
Market value of shares	= $1,611.2M
Current amount of borrowings	= $1,678.5M
- Add: Proposed bond size	= $150.0M
Total bond value	= $1,828.5M
Stock value ratio	= $1,611.2M / $1,828.5M
	= 0.881

The stock value ratio of 0.881 is lower than the minimum stock value ratio of 1 for industrial companies.

Thus, Perennial's bond does not meet both the earnings coverage criterion as well as the stock value ratio criterion. Based on Benjamin Graham's criteria, Perennial's 3-year, 4.65% bond does not have sufficient margin of safety. Having said that, this does not mean that Perennial will definitely default on this bond, it just means that the risk is higher.

See related blog posts:

• The Lost Art of Bond Investment
• Is Benjamin Graham's Art of Bond Investment Outdated?
• Benchmarks for Retail Bond Pricing