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Bond of the Week: 12 October 2012

Enterprise Inns 6.875% 2021 versus 6.5% 2018...

    

Enterprise Inns 6.875% 2021

The Enterprise Inns Plc (ETI) 6.875% 2021 bond is the best value amongst the ETI bonds. It has much better value than the more widely reported ETI 6.5% 2018 bond simply becuase the 2021s benefit from a 1.6% yield pick-up per annum over the 2018s while still retaining similar credit risk profile.

6.5% 2018

6.875% 2021

Price

88p

80p

Current yield

7.4%

8.6%

Yield to maturity

9.2%

10.8%

Equity multiple to redemption

1.59x

1.98x

Issue size

£600m

£125m

Minimum nominal trade

£1,000

£10,000

ETI has quite a precarious corporate debt position with unsecured corporate bank debt, a securitisation and 5 London Stock Exchange listed secured bonds providing net debt of about 8x EBITDA.  This significant debt position has lead to ETI acting as best as creditors would hope; nil dividends for ordinary shareholders, meeting all interest payments and selling pubs outright and via sale and leasebacks providing the required debt repayment cashflows.  Thankfully like-for-like sales have recently turned positive.

The long term solvency of ETI is not immediately obvious – but I think probable due to ETI’s relatively low nominal cost of borrowings which are comfortably covered 2x by EBITDA.  While survival is probable, it is finely balanced and credit investors should be well rewarded for taking this risk and clearly the ETI bonds’ YTMs reflect this uncertainty.  

Thankfully for credit investors, the 2018s and 2021s are first charge securities whereby each of these securities have ring fenced groups of pubs which are subject to first legal charges to the benefit of the bondholders -  like the mortgage on a residential property.   The 1.5x asset cover covenant for the 2021s requires assets equal in value to no less than £188m be charged to the benefit of the £125m outstanding 6.875% 2021 bonds.  With these bonds priced at 80% of nominal the bonds benefit from an implied asset cover of 1.88x. 

Furthermore, both of the bonds’ covenants include a negative pledge whereby none of the pubs within the security pool can have an equal or senior charge over them.   So, in the worst case scenario of ETI entering some form of administrative type process, the Trustees of the 2021 (and each of the other bonds’ respective Trustees) would take effective control over the pubs within that pool of charged assets and the right to all the income from them.

Unfortunately ETI last published its actual covenant performance in December 2009, which is included in the table below.  We know the bonds are currently covenant compliant – but not by how much.

Covenants

6.5% 2018

6.875% 2021

Income Cover Covenant

2.0x

1.5x

Income Cover Covenant post security withdrawal

2.0x

2.0x

Income Cover – Dec. 2009

2.0x

1.78x

Asset Cover Covenant

1.67x

1.50x

Asset Cover Covenant post security withdrawal

1.67x

1.75x

Asset Cover – Dec. 2009

1.73x

1.55x

While the asset cover covenant is higher on the 2018s – the higher nominal price of the 2018s negates this benefit as both bonds have roughly the same 1.9x implied asset cover.  And unfortunately for the 2018s – the assets within this security pool are subject to a 20% lotting premium while the 2021s have 15%.  Lotting premiums are fixed percentage uplifts added to the value of a group of assets ascribing a premium due to there being a collection of assets.   Perhaps this was appropriate in the noughties – but certainly less so now. 

Inclusion of the Dec. 2009 covenants is relevant when one looks at the requirement for the covenants to be at certain levels prior to the issuer being able to transfer assets out of the security pool.  The Dec ’09 covenants were below these thresholds for both bonds and therefore it’s highly unlikely that any assets were subsequently transferred out of their respective  security pools thereby leaving the 6.875% 2021s with a greater level of covenant compliance headroom. 

The market related differences between these bonds include;

1)      The 2018s are traded on the Order Book for Retail bonds (therefore Crest eligible) while the 2021s are traded over the counter.   A good broker should be able to source the 2021s.    

2)      The larger issue size of the 2018s may be quite relevant for the short term traders and institutional investors while perhaps less of a concern for the medium to longer term retail sized investors.  

3)       £1,000 minimum nominal trade size for the 2018s versus £10k for 2021. 

Conclusion

The 2021s are a worthy candidate for inclusion in the very well diversified portfolio of an adventurous investor and certainly worth a switch for those already holding the 2018s.

Stephen Ackerman

Stephen Ackerman is a Partner of Castellain Capital LLP, an award winning independent asset management firm specializing in high yield fixed income and special situation investing.  The author and or Castellain Capital LLP clients may hold a position or trade in any of the securities mentioned above.

Castellain Capital LLP has provided Stockcube Research Ltd this commentary on the basis that Stockcube, and Stockcube alone, accepts responsibility for any redistribution.

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