It was seven months ago that I suggested you take a look at the Enterprise Inns 6.5% 2018 bond. In the quest for a decent return, this was a bond that offered a 12% yield (if you hold it until 2018). And it did rather nicely.
But recently it’s slipped back a little. Today the yield is about 11.55%.
And I think the market is missing something here.
So today I think it’s well worth re-examining this bond.
I’ll also show you a handy way of evaluating the risk associated with it. Let’s get started…
What’s driving the price action?
One of the biggest drivers of bond prices is interest rates. Basically, if rates go up, bond prices go down.
That’s because if you’ve got a bond, you’re tied into the bond’s coupon (the interest rate set when it was launched). If market interest rates go up, then because the coupon you’re getting is fixed, the bond has lost some of its appeal. The chances are its price will move down to reflect the fact that it’s not as good looking as it once was.
But, of course rates haven’t moved for over three years. I’ve been saying that low rates are here to stay for a long, long time. That’s why I wasn’t (and am not) concerned about rising rates knocking our bonds down. My concern has been in finding bonds with a decent yield to give us an income during these return-free days.
Oh, and in case you missed it, yesterday the Bank of England’s Monetary Policy Committee (MPC) told us rates are to remain at 0.5% for the next month. No great shock there.
Nonetheless, the Enterprise Inns bond price has been on the move...
Today it’s all about credit risk
Market interest rates aren’t the only thing that concern bond investors. In today’s markets it’s credit risk that pushes and pulls at bond yields. That is, the risk of the issuer (in this case pub group Enterprise Inns) going bust – and therefore the bonds not paying out.
So how do you determine the credit risk of a company?
Well, one way is to listen to the ‘rating agencies’ – you know the guys... Fitch, Moody’s, Standard & Poor’s.
These guys are supposed to diligently analyse the bond issuers and work out the risk associated with each of their bonds. They provide a grade accordingly.
The only thing is that these assessments always tend to lag the market. That is, by the time the agencies have changed their rating on a bond, the market price has already moved to reflect the new reality. I mean the first time we heard the agencies warn about sub-prime risk was after the stuff had well and truly exploded.
What I’m saying is you can’t really use the agencies to help you evaluate a bond. In most cases, the market price of the bond is probably a better barometer.
But there is another handy way of using the markets to help give you a clue. It’s also free and very easy for any private investor to get hold of...
An exclusive report from The Right Side
Using equity prices to evaluate bonds
Here’s an interesting chart.
Enterprise Inns 6.5% 2018 bond vs Enterprise Inns PLC
Source: Teleborsa (published by The London Stock Exchange)
It’s a chart of the Enterprise Inns bond (blue line) versus the price of Enterprise Inns' shares (red line) since I tipped the bonds on 4 November 2011.
As you can see, the bonds have been very stable relative to the price of the equity. It’s one of the nice things about bonds – they don’t tend to be as volatile. Holders that took my advice and bought in for a 12% redemption yield (ie, the annualised yield if you hold until redemption in 2018), will probably sit on their bonds – investors are more likely to be long-term guys. The only reason to dump would be if the credit risk on Enterprise soured. Why on earth else would you chuck out a 12% return in these markets? So the blue line has stayed pretty flat.
But what’s more interesting to me is the red line. The red line tells me things are looking better on the credit-worthiness side of things.
Let me explain...
A great opportunity to stock-up
When I first tipped the Enterprise bonds, they were trading at around 75p. Here’s an excerpt from that piece explaining why the yield was nearer 12% than the nominal 6.5% coupon:
It'll currently cost you 75p to buy. That means instead of getting just 6.5% on your money, it'll be nearer 8.7%. But it gets better yet...
At the end of 2018 you're promised £1 back for every 75p you shell out on a bond today. That gives you a capital profit of 25p for every 75p you put up. If you add that return to the running yield on the bond, you'll find that your annualised return is 12.1%. That's known as the gross redemption yield (GRY).
I’ve just done the maths and with the bonds standing at 78.5p to buy, the GRY has now fallen to 11.55%. Though it’s not as good as the 12.1% available when I first recommended them, in many ways it’s better.
And that’s all down to the red line – Enterprise Inns' share price.
Now bear in mind, not every bond issuer will have a quoted share price to use a comparison. But most do. I’ve used the charting tools available on the London Stock Exchange website. It’s free and very useful – here’s why...
Back in November, Enterprise Inns shares were in the doldrums, trading as they were around 31p. With a debt pile of around £3bn, it was (and still is) a great millstone round its neck. Basically no dividends for shareholders all the while Enterprise is battling to repay debt. And while there’s a risk of bankruptcy, the shares will stay in the doldrums. Unlike us bond-holders (who effectively hold a mortgage over a whole load of pubs), shareholders have no security in the event of bankruptcy.
But from a very low point for shareholders, things are looking slightly better now. The interim accounts (for the six months to 31 March 2012) reveal that not only is the company profitable, but it’s going great guns at paying down debt ahead of schedule. Enterprise has sold a host of pubs, achieving prices above book value.
And the shares have responded. They’re currently trading at around double the price they were in November.
Now that should be very encouraging for bondholders.
If Enterprise Inns is doing well (or should I say less badly), then arguably the bonds are less risky than they were. I maintain my buy recommendation for Enterprise Inns Plc 6.50% SEC BDS 2018 (LSE: 47VU).
If you’re considering buying, please be sure to take a look at my original recommendation – and the risk warnings attached. Any investment paying out 11.55% should, of course, be considered risky.
But I would say, the risk:reward profile stands up in this case – and to judge by the share price, may have actually got better.
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