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Bond of the Week: 6 September 2011

Enterprise Inns bonds follow the share price south.............


We last featured the Enterprise Inns 6.5% 2018 (ISINXS0163019143) as our Bond of the Week in August 2010. Since then, government bonds have headed higher, lifted by the prospects of low interest rates for some time to come. The upward move in gilts has dragged the high-quality end of the corporate bonds along with it. However, the more speculative end of the bond market is typically equity-correlated, and prices in these sections have headed lower as risk-averse investors avoid bonds with perceived risk of default.

When I last looked at the Enterprise Inns bond, it was trading at a price of 84, equivalent to a YTM of 9%. My view at the time was:

"With a non-investment grade rating of BB-, the Enterprise Inns bond is not a candidate for risk-adverse investors - and I note that Moody’s placed the bond on "credit watch negative" in the spring, suggesting the risk is increasing. However, in the fixed income investor model portfolio we aim to have a spread of different types of credits, and I am tempted by the combination of yield of over 9% and a claim on some real assets to help secure our capital.

With more speculative positions, I generally take a smaller position size and with this in mind I have added £6,000 nominal of the bond to the portfolio, a total consideration of just over £5,000.

Moving back to the present, recent developments have knocked back the bond below my entry price. A fairly flat set of results saw the share price continue its decline, recently dropping through the 40p level (the shares were trading at over £1 when we purchased the bond last summer).

The bond has followed suit, dropping down from the 90’s in the summer to a recent level of 74.45. At that level, the YTM is now 11.8%. Clearly, given the high yield and the recent negative price action, investors are wary of the risk associated with holdings this asset. So, what to do with my holding? 

My view: The management of Enterprise Inns, along with many pub operators, have got their work cut out. The company is continuing to dispose of assets and shrink its balance sheet, But, revenue is also falling, a commercial situation that is always hard to deal with.

I will continue to hold my position in the Enterprise Inns 6.5% 2018. Operating profit continues to cover interest payments, albeit by a low multiple (1.7x), and, importantly, bondholders have the security of a charge on over 500 pubs. Whilst this is no great help in terms of servicing the debt, this debenture-like feature will help recovery in the event of the company folding.

On balance, I am happy to hold the security, but I am aware that over the medium-term, lower prices may well be seen. This theory is supported both by the volatile market conditions and observations of value/yield in other assets in the sector. Thus, speculative investors looking to pick up cheap bonds may do well to keep their powder dry for the moment.    

Mark Glowrey

PS - New Index Linked issue for National Grid.  Yesterday I attended the roadshow for a new retail-targeted index linked bond from National Grid PLC. The company is looking to issue a bond in the 10yr maturity area, with a structure that mirrors index-linked gilts (RPI-linked coupon plus RPI-linked repayment of capital).

Previous retail targeted issues have gone well, with significant initial premiums. My initial impression suggests that demand will be strong for this "linker" - the first in its field. The full terms of the issue are likely to be out next week and I will be covering the issue in detail.  

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