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Bond of the Week: 25 November 2015
REA Holdings Pref and bonds

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.

Below is the price of Crude Palm Oil since the beginning of September.

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.

Nevertheless there were some interesting points to take away from the presentation and I set them out below in bullet points.

   -  Breakeven cost of production is somewhere in the region of $500 (i.e. exactly where the crude palm oil price is today).

   -  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].

I mentioned last time I wrote that I was sure that REA wanted to pay the dividend on the pref share and that anyway it is cumulative so not paying it did not make much sense. I think that is still the case. But it need to be pointed out that in extremis they might feel they were not able to pay – after all to pay or not pay $45 per tonne in non-obligatory pref share dividends, were for instance the palm oil price to get to and stay at $400 or $450,  might make all the difference between survival or non-survival. Therefore with the current pricing I remain cautious on the pref.

Since my last article I have, however, made a purchase in a bond issue for REA. Here are the terms:

Issuer:                 REA Finance
Type:                  Senior 1st lien
ISIN:                  GB00B1FWDD12
Denominations: 1,000
Maturity:            31st Dec 2017
Coupon:             9.5%
Issued amount:  £37 million
Outstanding:     £9 million (approximately)
Price:                 98.25%
Yield:                 10.47%

N.B. There is a sink on this bond but it will not come into effect as bonds that have already been repurchased by the company will be used to fill in the sink.

This bond is senior debt, so coupons cannot be suspended without the company going into default. It is also secured on the underlying operating companies so in the event of the worst happening there is a good chance of at least some recovery. The bond ranks pari passu with Indonesian bank debt. It yields slightly more than the pref (10.07% today). The majority of this bond was switched into the REA 8.75% 2020 only about 3 months ago. The holders of the £9 million rump decided not to go into the deal (looks like a wise decision now). Finally this bond matures before the majority of their other debt; (they do have an unsecured USD34 million bond maturing in June 2017).

The caveats on this bond (other than the general credit risk which is still there) would be as follows. 1) With a short dated bond you do not have the price upside potential that you have with an irredeemable perpetual if there is a large turn around in fortune. 2) Although this bond is a QCB and the pref is not, you do not get a tax credit on the income as with a pref. Also the QCB benefit of this bond is limited, as the price is not far from par and you are likely to end up keeping it until maturity. 3) It is not very liquid and offers can be scarce (not much outstanding).

As of today I know there are £80-90,000 available and I was going to give the name of the seller. Owing to compliance worries, however, they have asked me to not to mention their name. Should you be interested maybe your stockbroker/ wealth manager may be able to find them on their own. If you decide you want to make a purchase and all else fails I can point your stockbroker/ wealth manager in the right direction. Don’t forget, though, that this is not an investment without risk.


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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