Eureka Correspondence

Analysing CBA's hybrid issue, behind Tiger Resource's acquisition, whether to sell out of ToxFree and the closure of Abernethy's portfolios.

Analysing CBA’s PERLS VII

I conclude from Table 1 in Rosemary Steinfort’s article (August, 25, 2014) the PERLS VII offer is broadly on a par (yield to maturity, determined in the market) with other big four banks hybrids. This tells me that the CBA is offering the current market rate for this type of instrument. Presumably the Rosemary’s recommendation would apply to the purchase of most of these instruments?

My reading of the margin over the bill rate is that it has been decreasing for some years now. In fact some margins have been as low as 1% if you go back far enough. Is there any reason to believe that future hybrids will not be offered at lower margins?

You mention that the terms do not meet the risk-return expectations of wholesale investors. Could you elaborate? What have been the recent trends in margins and risk terms available to wholesale investors? How does one access these offers?

Let me also comment on your risk perspective and comment in regard to CBA shares. Today CBA is around $80, yet your target price is around $70. If you are right, an investor risks the loss of around $10 per share. Yet a decline in share price of this magnitude is unlikely to provoke a similar percentage decline in value of the PERLS VII. At the other extreme, should CBA be unable to make the payment on the hybrid, it would be precluded from paying a dividend. Imagine where your purchase of an $80 share would be in these circumstances!

My advice is that the strong demand may yet have the PERLS VII trading at a premium due to relative scarcity. I am advised that an unusually high percentage of holders of PERLS V will roll over, and bids for further script may well be scaled back by around 40%.

Douglas Taylor

Rosemary Steinfort’s response: Thanks for your questions, which I have endeavoured to address below:

  1. The demand for hybrids has compressed yields, so CBA PERLS VII are one of the highest yielding now. Most of the hybrids are trading below what would be considered good value – especially if bought now in the market on current yields. The yields when first issued were more attractive in most cases.
  2. The margin over the bank bill swap rate has been decreasing due to yields of all debt/hybrid instruments being compressed across the market. The low margins being offered now are in line with the market. Future hybrids may be offered at lower margins –although Challenger's recent offering is above PERLS VII.
  3. Hybrid securities are classified as neither bonds or equity generally due to their position in the capital structure.  Most wholesale investors prefer to invest directly in bonds and equity (rather than hybrids).  Wholesale investors can easily access the over-the-counter bond market for bonds because of the size of the minimum investment required, from about $100,000 - $500,000 (some wholesale bond issues may also be available for retail investors via bond brokers such as FIIG, who break the minimum investment down into smaller parcels).  Generally bonds provide more protection from volatility in the share market.  Hybrids are less volatile than shares (on average about as half as volatile) but bonds (investment grade) are about half as volatile as hybrids.  So you are right about if the price of CBA shares fell by $10 (about a 12% fall) then the hybrid would fall less than that.
  4. The demand for PERLS VII will be strong with indicative demand over $2.6 billion from the book build. They are likely to trade at a premium on listing.

Behind Tiger Resource’s acquisition

Hi team, would it be possible for you to publish a brief on the recent Tiger Resources acquisition and elaborate on what it means for shareholders with reference to the various entitlements/options etc?

I am not sure when TGS are scheduled to recommence trading and I suspect there is an element of timeliness associated with any publication you decide to make.

I also just wanted to say thanks for providing the Eureka Report and all its contents. I’ve been a subscriber just a few months and am really enjoying it – very satisfied.
Rod Worthington

Brendon Lau’s response: I will be writing up a detailed report this Monday. The share offer to retail investors opens on the same day. Stay tuned.

When to sell out of ToxFree

ToxFree Solutions (TOX) has been a Eureka buy recommendation since mid-February this year, but a few days ago it was changed to a hold. The stock hit a high in mid-May but has since declined by 28%. I have not bought the stock because it has been in downtrend for the past six months. Further, it’s been hammered by around 15% after its results announcement on August, 20. Now, it may recover … but I will only buy a stock once it reverses its downtrend and shows clear signs of sustaining an uptrend.

So, if I was to buy or hold this stock I would first want to know, specifically, the exit strategy. And I would not just want the answer to be: “Don’t worry, TOX is still a good company with a good story and good prospects, just hold on and it will be OK in the long term.” It might be a “hold”, backed up by rational economic and logical reasoning, however, I would still want to know at what point one exits the stock. We all have different risk profiles and tolerance levels, but to hold on to a stock without an exit strategy in place means you have to have “faith” in the company … but if I want to invest based on “faith” then I would go to church and pray to God!

So, what is the exit strategy for TOX please? At what stage or under what circumstances would you sell the stock?

Simon Dumaresq’s response: Thanks for the question. Waiting for the start of a new uptrend is a good idea to prevent the opportunity cost of waiting for "deep value" stocks to recover.

For any of my stocks I will move to a Sell recommendation if it is either over-valued or at the first sign of any change to the reasons I recommended the stock. I also use technical analysis in combination with fundamental analysis to assist with timing.

Whilst there were "technical" signs of weakness leading into the result, that alone wasn't enough for me to move to a Sell. TOX has a very robust business model, and is priced at a reasonable discount to valuation.

The risk from here on is more to do with the lack of a near-term catalyst, and the opportunity cost of waiting for a turnaround. For active investors there are likely to be better opportunities elsewhere.

Abernethy’s portfolios

I used to follow with great interest (and success!) John Abernethy's reports on hybrids/notes and high yielding stocks, especially his Clime income portfolio. Early this year he was big on NABHA and MBLHB. Can you please ask John to give us an update on his Clime Income Portfolio choices at this time?

Editor’s response: Thanks for your letter. While John Abernethy continued to provide his outlook on companies and markets for Eureka Report, he has closed his Clime growth and income portfolio. You can read about the closure of the growth portfolio here and about the closure of the income portfolio here.

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