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Bond of the Week: 25 November 2015
Bond of the Week : 25 November 2015
REA Holdings Pref and bonds
On 29th September I covered the REA 9% pref share as the Bond of the Week. I did not make a recommendation to purchase and said that I would not be surprised if there was further weakness in the price (and there was). However, I did make the point that I could change my mind if one (or more than one) of three things were to happen. “The palm oil price could show a sustained turn around, the company could pay down some debt via an equity placing or the price of the pref could get substantially cheaper.”
I have decided to write up on REA again for three reasons; a) I attended a company presentation, b) to write up on how underlying conditions have changed and c) because I have come across an alternative bond which represents a safer investment with the same yield.
The price had showed some encouraging signs of stabilizing at between $525 to $550, after bouncing off the 28th August low of $450. This new level would not be good but should have been enough to avert potential disaster. However, since the beginning of November there has been renewed weakness, although it would be unfair to say disaster threatens.
The price of the pref share was 96% when I last wrote. It then steadily traded (encouragingly for potential buyers) all the way down to 83%, a yield of 10.84%. This was while the Palm Oil price was holding up and it started to look as though the trade could be interesting. However, since the beginning of November the price of the pref share has recovered back to 93% on the offer side while the palm oil priced declined. Below you can see the price of the pref tracked against the Palm Oil price (top graph). The palm oil and pref prices are back at levels where I think there is the possibility of further drift (in both) and I wouldn’t currently make a purchase.
At REA’s presentation at their London offices I met Mark Perry who is taking over as CEO and is based in Singapore. He made a number of positive comments about the future prospects of palm prices and the competitive position of REA. What he said may be true but it is what you would expect to hear at a presentation and I don’t think was anything particularly new. There was also talk of how they are generating their only electricity with an anaerobic digestion plant and may now be in the position of selling some of it to the grid. However, I took this all as “noise” compared to the crucial issue of 1) The Palm Oil price and 2) REA’s debt burden and their breakeven cost of production.
- EBITDA breakeven is approximately $375 (when production levels are higher that can fall towards $350). [Not all the difference between $500 and $375 is accounted for by interest.
As a back of an envelope calculation and using their half year figures of an interest bill of $8.4mil while producing 95 tonnes of oil (CPO, Palm Kernels, CPKO), I make it an interest cost of $90 a tonne. This does not include the dividend on the pref share, which accounts for another $45 per tonne].
- They are still working on selling a minority stake in the operating companies to a trade buyer.
It is difficult to know how much progress, if any, has been made but I was told the stake might be worth in the region of 20% of the equity which would equate to $60 million.
- An analyst made a very good point that post the retirement of Richard Robinow as chairman REA really needed to put in place a CFO to face their investors and oversee their financing. Mark Perry certainly seemed more comfortable when discussing the plantations, palm trees and local conditions than the nitty gritty of the accounts. The point was registered and we were told that the appointment of a CFO was already under consideration.
- Historically the price increases in palm oil following an El Nino event always more than made up for the fall in production. This time it was different. They were still hoping for a reversion to norm. [It occurred to me that El Nino might have had the normal effect on palm oil prices but this time it had been via preventing an even more precipitate decline in price rather than an actual rally].
Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.
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