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Bond of the Week: 13 June 2013

Helical Bar joins the retail bond market....

    

Helical Bar 6% 2020

Numis Securities is in the process of bringing a retail bond for Helical Bar. For those with a quixotic interest in the development of financial markets it might be of interest to know that Helical Bar and Engineering Company Ltd was incorporated in 1919 to make and sell reinforcing steel for the construction company. But they are no longer an engineering company. In 1986 as the long downward march of British manufacturing gathered speed, Helical, in accordance with the prevailing mood and received wisdom of the age, divested itself of any engineering activity, hired Mike Slade and turned to property. I suspect it was a good call. The company continued and continues to trade on the London Stock Exchange. We now, therefore, have not an engineering but another property issue in the retail bond market. I should note here, however, for those who are wont to complain that there is a never ending stream of real estate companies coming to market, that it is in fact six months since the last property company issue.

As serendipitous fate took Mr Slade to Helical in 1986, so it was most kind in blowing him, the Director of Investments and the CFO into our office as part of the bond road show. Before passing on their explanation of what they do and how they do it, let us look at the terms of the issue.

Issuer:                        Helical Bar
Maturity:                    June 2020 (7 years)
Coupon:                     6%
Rating:                        Unrated
Settlement date:       24th June 2013
ISIN:                            XS0942129957
Listing:                       LSE/ ORB
Denominations:        £100
Status:                       Senior unsecured


Helical Bar’s approach is straight forward. It has an investment portfolio with a book value of £407 million, the income from which is enough to pay for the running costs (including interest) of the entire company. The investment income is also enough to cover the dividend. Secondly there is a development portfolio with a book value of £169 million which aims to produce the more juicy returns sought by equity investors. It is difficult to criticise this, in a sense, rather conservative plan, as in our own modest way that is what we at City and Continental do. Instead of property providing the income, we rely instead on higher yielding bonds.  Should the good fairy from sleeping beauty arrive scattering her magic dust so that all were to fall asleep for a year; awaking from inactivity the plan is we could dust down our phones, fire up our computers and still be in business. I have to say that there are moments on a somnolent Thursday or Friday afternoon when that fate does not seem so far-fetched.  The intermittent ripple of red light on the phone consoles has ceased, bosoms gently heave and sigh in post prandial contentment and the only discordant notes are those emanating from our snoring colleagues on the B desk.

However, I do not wish to suggest Helical Bar is a place that lets grass grow under its feet! Mike Slade the Chief Executive, for one, is a man of activity. He has just returned from the 1,500 yacht Round the Island Race, captaining yet again the winning mono-hulled yacht across the finishing line and in the process breaking his own course record. I, with the former writer of Bond of the Week Mr Glowrey, am also making my way round the Isle of Wight but in my sea kayak. We have paddled a sixth of the way round in the last year and a half. Mike, see you on the finishing line in about 2018.

Anyway enough of all that; here are some more detailed figures and facts for the company. With a market cap of £313 million Helical Bar is at the low end of market size compared with other property companies that have come to the ORB. [Other market caps are as follows: PHP £240 million, CLS £420m, Unite £553 m, Work Space £581m and St Modwen £614 m]. In having a split between investment income and development earnings they are most similar to St. Modwen’s. St. Modwen’s business plan, however, is rather different in that they tend to buy and develop large, mostly post-industrial sites and then part let out existing buildings to gain rental income while gradually developing the rest of the site. You could therefore argue that in terms of secure running income Helical Bar is a better company from a bondholder’s perspective as the investment side is entirely separate from the development side. I asked whether they ever kept any of their developments as investments. I was told definitely not; to do so would invite lack of discipline whereby bad developments would become unwanted investments. I think Mr. Slade’s response was quite right.

Helical’s loan to value for the investment portfolio is a very respectable 46% (it has not been above 50% in the last four years). I asked whether there was an upper LTV level beyond which they would not go. The answer from Mr. Murphy the Finance Director was no but he would start to get uncomfortable with a LTV of 55% or above unless there was a very good reason for it. The weighted average maturity for the debt is (a somewhat short) 4 years and the cost is 4.2% (compared to the 6% on the unsecured bond). Interest cover is 2.7 times. The passing rental income is £28.7 million with a theoretical potential to increase this (upon rental review) to £32.4 million.

Typically, although investment properties are not redevelopments, there will be substantial refurbishment subsequent to purchase. Of course we can ask when does a refurbishment become a development; I expect only when it is raised to the ground but maybe I am too cynical. Refurbishment is the way Helical can acquire buildings that ultimately have higher rental incomes (nearer eight than six percent yields I gather). But what type of property do they invest in and where? Regional retail (for instance a central Cardiff arcade and a shopping centre in Corby town centre) accounts for 56% of the portfolio and London offices for 36%. There is a very small amount of regional offices and industrial sites. One of the most interesting things to come out of the meeting was that their market strategy is a dash for London (office space). This re-balancing of the portfolio will not be achieved by any selling of existing retail space but by new London acquisitions as and when cash becomes available (from this issue for instance). While in the “provinces” away from London good rental yields are to be found, judicious refurbishments can be used to enhance yields and advantageous purchases struck with distressed sellers, the underlying rental tide is not coming in. Slack water threatens to continue on and on into the foreseeable future – in short, making money will be hard work. London is different.  The investment committee of Helical Bar is not alone in arriving at the conclusion that the location, location, location should be London, London, London. Workspace and CLS were very anxious to explain the preponderance of London property in their portfolios when issuing their own bonds. When I suggested London offices were not cheap, I was corrected by Mr Duncan Walker the investment director. He said this was not the case if on-going expected upward rental reviews was included. The rental tide is in flow not ebb. It might also be added that the solvency of the tenants is likely to be better in London.


I don’t think it necessary to dwell too long on the development side given the bond holders’ reliance on the security the investment portfolio provides (albeit that the bond is structurally subordinated). Cash investment in developments is minimised by the purchase of options, joint partnerships and selling prior to completion. Profits from developments are not smooth but arrive in chunky lumps.

The proceeds from the bond will be used to “bulk up” London office investments. This should not mean a significant increase in gearing as I understand it as they are on the point of having a lot of cash released as a number of projects are realised. They also have profit rolling in at something like £35 million per annum. The bond will therefore provide the funding that would otherwise have come from bank lending. Although the 6% rate Helical are paying is higher than secured bank borrowing would be, the longer maturity profile and lack of security being pledged makes it attractive. Diversification of funding sources is also a plus although I am told there was never any threat of their banks withdrawing support in the depths of the financial crisis.

Numis is keen to emphasise the strength of the covenants and tell me they are the strongest to date. Certainly the gradual re-emergence of bondholder protection through increasing covenants since the first property issue for PHP (which has no covenants at all) is to be welcomed. Maximum LTV, under Helical’s issue, is 75% (currently 46% as mentioned above).  Interest cover must be 1.5 X or better (currently 2.7) and minimum NAV of £150 million (£254 million today) is required.  There is no put in the event of a hostile takeover. Breach of a covenant is an event of default so the company will not want to sail too close to the wind.

Conclusion

The company has a strategy of safety (investment income) first which should appeal to a bond investor. Helical is well run and has a good reputation amongst those whom I have spoken to – both equity analysts and those directly in the property market. Mike Slade is still there after 27 years and he points out the management has a large, but not too large, stake in the company, thereby aligning management’s interest with that of bondholders. I would therefore have no problem under normal circumstances in recommending their bond. However, relative value cannot be forgotten as the other property companies with issued bonds are also mostly well run. At the time Helical Bar came to see me, as a very general guide, property bonds were yielding 5 ½% thereby making this issue a bit of a no-brainer. Switch and pick up 50 basis points or more. However, there has been a very large sell off in the retail bond market. A 6% yield is no longer special. So it is now a question of “you pays yer money and takes yer choice”. And here is your choice:

PHP             5.375%  2019     99    5.57%
Workspace  6%         2019    101   5.81%
CLS            5.5%       2019     98   5.87%
Unite          6.125%   2020    101   5.95%
St. Modwen 6.25%   2019     101   6.06%


Has the retail bond market found a new level? I suspect yes and if not now then I think it soon will have. Bar Severn Trent and its potential takeover, there has been no change in credit and no meaningful change in the outlook for interest rates to justify a continued sell off. It is also more than a distinct possibility that an end to price declines will be followed by a sharp bounce. Nevertheless we sail in tumultuous financial seas and you never know when and if a nasty squall from outside the sterling retail bond market might arrive to take ORB bonds into unchartered waters. Enough of the seafaring metaphors! I wish Mr Slade and his team at Helical and Mr. Dyson and his team at Numis every success.

 

Oliver Butt

Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income.

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