Saturday 21 January 2012

Portfolio Buy: 13% Redemption Yield!

My latest portfolio buy must rank as the riskiest yet - riskier even than my recent Santander bond purchase. This security, with a redemption yield of almost 13% offers the tantalising possibility of an over-70% return by 2018.

If you do not already have a well diversified portfolio (along the lines of the DIY Income Investor Income Pyramid) do not read any further!

The security in question is the Enterprise Inns corporate bond paying a 6.5% coupon and maturing in 2018. It currently has an income yield of over 9% and a gross redemption yield of just under 13%. These are one of the highest yielding fixed income instruments available to private investors.

Enterprise Inns (ETI) is the largest pub landlord in Britain. However, it does not pay any dividends and a look at the share price shows that it is not highly regarded by the market. On a forecast p/e of less than two, the market is clearly sceptical.  However, with a corporate bond, as well as getting your coupon payments, you get your money back at maturity. (Hopefully.)

There have been some question marks about loan covenants in the past. TD Waterhouse carried an article about this security in August 2010, noting that it is 'non-investment grade' BB+ and recognising its inherent riskiness. Another article in Investor's Chronicle noted in relation to this security that:

It is always tempting to look through a list of bonds and select the highest yielding member. As a method of selecting assets, I would not recommend this – you'll just end up with a portfolio of high-risk bonds. Nevertheless, a few high-yielders can liven up a safe-but-dull portfolio, and such a role could be fulfilled by this issue. [...] It is worth noting that the bond is a debenture, with the assets secured against a portfolio of 503 pubs. So with the benefit of at least some kind of hold on the underlying assets, and [...] makes for a tempting prospect for risk-positive investors.

If you check out the covenants on this bond issue in the 'deed of trust' (which is a senior secured bond) they are most definitely reassuring, as follows: property (valued at fair value as opposed to going concern) is ring-fenced in a special vehicle that must equal 1 and 2/3rds of the total value of the bond issue (at issue 225millions) + 2 years worth of coupon. This property is revalued regularly when more property is added / removed from the vehicle as appropriate.

Moneyweek has also recommended the bond in a recent article, quoting the following from ETI's latest report and accounts:

"[We] expect to refinance the GBP600 million 2018 bond on maturity, bearing in mind that it will always be secured on a portfolio of pubs with an up-to-date valuation of GBP1 billion and interest cover of two times."

On the basis of a recent valuation, the pubs that the bond is secured against are worth £1bn compared with the total bond issue of £600m. What is more, these pubs are currently generating revenue that covers the bond coupon payments twice over!

But a bet against the market is always risky. Here's hoping it is a decision I will not regret!

Purchase price: £7.14.

Update - the company continues to sell is properties to reduce its debts. (3/2/12 company announcement): Enterprise Inns plc sells fifteen pubs to Fuller Smith & Turner plc for a consideration of £22.9m. "This sale is in line with Enterprise Inns' objective to use disposal proceeds and other surplus cash to reduce debts through repayment of bank debt or to purchase notes or corporate bonds."

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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