AGL Energy’s new hybrid notes: how they stack up

Co-founder of the Switzer Report
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Joining the flood of new hybrid issues looking for ‘end investors’ is a $650 million issue from AGL Energy Limited. This issue takes the current primary market supply to $3.9 billion – more than enough to whet most appetites. So, how does it stack up?

Firstly, let’s look at the company. AGL is an integrated energy company, with operations covering retail and merchant energy businesses, electricity generation and an upstream gas portfolio. It is the second largest energy retailer, and the largest private owner, operator and developer of renewable electricity generation assets. It’s in the ASX ‘top 50’ and has a market capitalisation around $6.4 billion.

Why AGL is issuing the notes

AGL is raising $650 million through the issue of ‘AGL Energy Subordinated Notes’ to help fund the acquisition of the Loy Yang A power station and adjacent coal mine. On 24 February, AGL announced that it had agreed to increase its interest in GEAC (the company that owns Loy Yang A) from 32.54% to 100%, for a total consideration of $448 million.

Through this issue and a later equity offer of $850 million, AGL will raise around $1.5 billion to purchase the outstanding shares in GEAC and partially repay GEAC’s bank loans. The balance of GEAC’s loans will come onto the AGL balance sheet.

The details

The Notes will pay interest at a rate of between 3.8% and 4.0% over the 90-day bank bill rate. AGL raised this margin from between 3.4% and 3.8% this morning, suggesting the market is weak due to the growing supply in this type of security. Details of the issue are as follows:

The institutional book build on Wednesday will set the final margin. If it comes in at the lower end of 3.8%, this implies an interest rate of around 8.25% for the first quarter – at the higher end near 4.0%, the rate would be 8.45%.

Although the Notes have a term of 27 years, AGL can (at its option) redeem the notes after seven years, or at any later interest payment date. If they don’t redeem the notes at the first available date, the interest margin is increased (or stepped up) by 0.25%.

Things to think about

An important consideration is that AGL Energy must mandatorily defer the payment of interest if its interest cover ratio is less than three-times, or its leverage ratio exceeds four-times. These features allow the ratings agency to classify the Notes as ‘high-equity content’, which effectively means they treat the Notes as equity rather than debt when evaluating AGL.

For the leverage ratio, AGL defines this as the number of years it would take AGL to pay off its existing debt (excluding these Notes) if its earnings (EBITDA) and net debt were held constant. To get a sense of these numbers, the following table shows AGL’s ratios as at 31 December, and on a pro-forma basis assuming that the acquisition of Loy Yang A is completed on the terms above:

Should you buy?

Bottom line – this issue looks relatively attractive on a margin basis compared with the ANZ, Westpac and Colonial issues, although not quite as good as Tabcorp’s (read, No hybrid bargains as new issues flood the market).

Importantly for SMSF hybrid investors, it is not another bank or bank subsidiary issue; industry credit risk diversification should be an objective of a fixed-interest portfolio. As a utility competing in a regulated market, AGL has a relatively stable earnings profile and despite assuming extra debt, should be able to stay within the key leverage ratios. I think this issue will be keenly sought.

NABHA

With the sell-off in the secondary hybrid market, we have had several questions about National Income Securities (NABHA) following my comment in New bank covered bonds weigh on hybrid market that at around $75, they would be in ‘buy’ territory. They closed on Friday at $73.65 (I wasn’t expecting so much supply to hit at once!).

Firstly, will NAB redeem them? Unlikely, as we understand that they are ‘grandfathered’ (that is, it is required to prepare a financial report but is exempt from lodging it with the Australian Securities and Investment Commission if it meets certain conditions) and will continue to be recognised as Tier One capital by the Australian Prudential Regulation Authority. If the price deteriorates such that it becomes economic for NAB to purchase the securities on market and replace the debt, or they become too much of an embarrassment, perhaps there might be a change of heart.

And am I buying at $73.65? Adjusting for the accrued interest of $0.30, NAB Income Securities are trading at a running yield of 7.63%, or a margin of 3.28%. While cheaper than the primary market issues, after transaction costs and other market considerations, they are fairly priced.

Nibble territory – no real hurry.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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