Income Asset Management: Here’s how to play the ‘reopening trade’ in Australia’s corporate bond market
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Some particularly attractive yields are on offer for investors who know where to look.
As post-COVID activity ramps up, investors are turning their attention to sectors positioned to benefit from the ‘reopening’ trade.
While the upside opportunities for industries such as tourism are fairly clear, the market is still recalibrating value for many companies that felt the impact of COVID-19.
For Matthew Macreadie – Director of Credit Strategy at Income Asset Management (ASX:INY) – it also creates some unique opportunities for bond investors looking to construct a risk-adjusted portfolio with attractive yields.
“I put some research together indicating that like equity investors, bond investors should consider bonds in sectors that have been hit hard by lockdowns,” Macreadie said.
“A number of bonds are trading relatively cheaply, and as the Australian economy normalises, those bonds can provide good opportunities to generate alpha.”
Speaking with Stockhead recently, Macreadie offered insights on four such investments – two in the high-yield (HY) space, and two investment-grade (IG) opportunities.
In terms of investment-grade debt opportunities, one company on Macreadie’s radar is Scentre Group (ASX:SCG) – owner of the national shopping centre assets developed by Westfield billionaire Frank Lowy.
“I think shopping centres are going to be a big part of how people and households reconnect post-COVID,” Macreadie said.
“It’s a good place for people to meet up which will accelerate food and shopping activity, lifting consumer demand. This will translate into higher retail rents, especially as restrictions are lifted.”
But because retail property faced such high disruption from the pandemic, Scentre’s USD-denominated hybrid notes are pricing cheap with a yield of more than 4%.
That’s a strong yield for a blue-chip Australian company issuing debt backed by a high-grade retail asset portfolio.
In that context, Scentre is a great example of corporate debt trading “very cheaply” relative to the industry standard, Macreadie said.
His other pick in the IG space is GPT Group (ASX:GPT), one of the largest diversified property owners on the ASX.
“The key point to note with GPT is that I think the work-from-home dynamic, and the negative consequences of lower office occupancy levels has probably been overplayed,” Macreadie says.
“People are going back to the city and companies are still keeping a large portion of their leased space. So those lower (property) valuations haven’t really played out as the market and many have expected.”
Concurrently, GPT just issued 10-year bonds for its new Wholesale Office Fund at a healthy yield of 3.25%
“If you package these ideas together, you can get a blended 3-4% investment-grade return which should outperform over next 6-12 months,” Macreadie said.
“Investors should be looking for opportunities in sectors that have underperformed, and pivot away from sectors like consumer staples and telco companies that did really well in the pandemic.”
Using the same strategy, Macreadie said there are also some great opportunities on offer in the high-yield space – starting with Crown Resorts (ASX:CWN).
The embattled casino operator briefly faced the prospect of losing its domestic licence, before being given a two-year window to fix its regulatory issues under government oversight.
“As restrictions are lifted in Sydney and Melbourne, we see Crown venues competing strongly for the entertainment dollar,” Macreadie said.
In addition, Crown has now cleared the steepest of its regulatory hurdles while its main competitor, Star Entertainment, is coming in for increased oversight.
Considering all that, Crown’s hybrid notes are currently trading at a significant discount to their par value, and it currently pays a coupon of 4% above the bank bill swap rate.
Combined together, “the yield to maturity on those bonds is close to 10%, for a large company with a two-year grace period to fix up its regulatory issues”, Macreadie said.
“That yield figure looks very attractive, particularly given Crown’s senior unsecured debt still has a BBB- rating and the company is well positioned for the reopening thematic.”
Macreadie’s other pick in the high yield space is listed distressed debt specialist Pioneer Credit (ASX:PNC).
PNC’s core business model involves buying high-risk debt portfolios of the major banks and getting loans in arrears back on payment arrangement terms, and subsequently liquidating them.
During the pandemic, banks didn’t release those portfolios in their efforts to provide goodwill to customers facing financial difficulties.
As a result, Pioneer’s business dried up.
“We think PNC is well positioned to acquire these assets now once they start coming to market,” Macreadie said.
“And as employment conditions improve, it will also drive up recovery values in those underlying portfolios.”
In the wash-up, Pioneer is an established business issuing high-yield bonds that are still paying a 9% yield.
Macreadie added that until recently, the company was struggling to refinance its own operations at a reasonable rate
“They’ve gone through that process and refinanced at lower rate, and now they’re also leveraged to the COVID-19 exit,” Macreadie said.
“We think the market’s overlooked that, and it’s the main reason why the yield-to-maturity on those bonds is so attractive.
Factoring in each of his four bond picks, Macreadie said its emblematic for bond investors to construct a balanced portfolio with attractive yields across IG and HY debt in the current market environment.
And it’s taking place where corporate debt can still provide a particularly attractive return, relative to government bonds.
While the RBA indicated earlier this week that its timeline for rate increases will come forward from 2024, rock-bottom rates are most likely here to stay for the short-to-medium term.
“The aim is to look at those sectors that are still mispriced but will benefit from the reopening trade,” Macreadie said.
“That kind of risk/return profile can complement investors’ diversified portfolios. Even if rates do rise they’ll most probably rise at a slower rate, so there are still lots of good opportunities in that high-yield environment.”
Income Asset Management (ASX:INY) delivers unparalleled access to a complete income investment service. We aim to provide investors and portfolio managers with the most trustworthy and capable platform to research, execute, and manage their income investments. Our businesses across deposits, bonds, treasury management and asset management are all there to enable investors to compare, choose, and execute, in the most efficient, transparent, and cost-effective way.
This article was developed in collaboration with Income Asset Management, a Stockhead advertiser at the time of publishing.
This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.