BBB rated, A+ returns
With exceptionally low yields across most developed markets and asset classes, investors are increasingly having to take more risk to achieve higher returns. Even beyond 12-month term deposits (paying ~1%), term bank senior yields and credit margins are now at their lowest levels since 2007 (refer Chart 1).
![](https://www.livewiremarkets.com/rails/active_storage/blobs/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBaTFwIiwiZXhwIjpudWxsLCJwdXIiOiJibG9iX2lkIn19--f540752680b46fbadf3d649dfaa9ab955c05e2c2/Screen%20Shot%202020-10-26%20at%209.49.15%20am.png)
Yields and credit margins on other investment grade (IG) corporate bonds, particularly in the BBB rating band, however, tell a different story.
There are ample opportunities for investors to construct attractive, low-risk portfolios yielding consistent returns of 3.5-4.0% p.a.
But is the lure of higher consistent returns in BBB corporate credit – margins are currently four times bank senior and double those prior to the onset of COVID-19 – both justifiable and sustainable?
Our proprietary credit analysis of Australia’s BBB universe is providing strong evidence in support of the strong risk-adjusted returns on offer. While there are some COVID-19 impacted outliers (e.g. QANTAS), we expect underlying credit quality among IG Australian corporates (38 Australian issuers) will remain relatively stable looking out to 2023 (refer Chart 2).
![](https://www.livewiremarkets.com/rails/active_storage/blobs/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBanBwIiwiZXhwIjpudWxsLCJwdXIiOiJibG9iX2lkIn19--8bc60f1b93e2f136a6f32e22c128d0e343312e94/Screen%20Shot%202020-10-26%20at%209.49.52%20am.png)
![](https://www.livewiremarkets.com/rails/active_storage/blobs/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBajFwIiwiZXhwIjpudWxsLCJwdXIiOiJibG9iX2lkIn19--e30ca486cae483608a1e7515a459aef2b17852f5/Screen%20Shot%202020-10-26%20at%209.50.13%20am.png)
![](https://www.livewiremarkets.com/rails/active_storage/blobs/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBajVwIiwiZXhwIjpudWxsLCJwdXIiOiJibG9iX2lkIn19--9c6e375c4bd8c52ecba841c851d49670d8f84992/Screen%20Shot%202020-10-26%20at%209.50.22%20am.png)
Our view is positively influenced by the levers increasingly being deployed to preserve IG credit ratings, including: (i) cutting shareholder dividends; (ii) shelving growth capital expenditure; and (iii) raising fresh equity capital (in some cases).
The BBB rated Incitec Pivot (IPL) provides a good case in point. Despite being less impacted by the pandemic than many Australian Industrials, IPL raised $600m of new equity in May 2020, significantly de-leveraging its balance sheet and removing any medium-term credit risk. The company’s pro-forma Net Debt to EBITDA now sits below two-times, with debt serviceability (EBITDA Interest Cover) forecast to increase significantly through to 2022 (refer Chart 3).
![](https://www.livewiremarkets.com/rails/active_storage/blobs/eyJfcmFpbHMiOnsibWVzc2FnZSI6IkJBaHBBakZwIiwiZXhwIjpudWxsLCJwdXIiOiJibG9iX2lkIn19--c9d045f43cef2b71b343ce22f1c9c31b9a44f1d8/Screen%20Shot%202020-10-26%20at%2010.06.41%20am.png)
Furthermore, with supportive agricultural conditions (positive for fertiliser volumes) and explosives demand stabilising, IPL’s 2026 bonds have performed strongly. During March/April sell-off, we purchased these bonds in secondary markets at a relatively distressed yield of ~5%. With a current credit margin of ~250 bps and outright yield of ~2.80%, these securities continue to offer compelling value.
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