Small Bets for Big Wins? Could NWD and GLP Perps Be Super High-yield Strategy in Crisis?

• The current yields of some perpetual bonds of New World Development (NWD) and Global Logistics Properties (GLP) reached over 11%. If NWD and GLP pass through this crisis, the credit spreads could be narrowed. We expect that their perpetual bonds could potentially reach an internal rate of return (IRR) of over 20% in around five years. Aggressive investors could consider them.

• As long as the company can continue to pay the coupon, the potential for the bond price to increase/rebound is promising. Even if the bond price does not rebound as expected, or even plummets, investors will still be able to achieve a positive return through the coupons received.

• As both perpetual bonds have their own unique features, and both companies have different risk factors in terms of fundamentals, investors could invest both of them to diversify their portfolios.

• Investors have to pay attention to the biggest risks, the suspension of coupon payments on the perpetual bonds and the company’s debt defaults.

As shown in Table 1, the current yields of some perpetual bonds of New World Development (NWD) and Global Logistics Properties (GLP) reached over 11% (see the first four bonds in Table 1).

(For the knowledge of perpetual bonds, investors could refer to the article - How to Measure The Yield of A Perpetual Bond?.)

Table 1: Perpetual Bonds of New World Development (NWD) and Global Logistics Properties (GLP)

This article will mainly focus on the first four bonds in Table 1, of which current yields are more meaningful.

As for the other three NWD perpetual bonds, since the market already priced in the probability of calling the bonds in the next reset date, their bond prices are higher, with lower current yields. Therefore, these three bonds are not discussed in this article.

Meanwhile, the following part of this article will talk about a more complicated trading strategy, which is based on investors’ understanding and confidence in these two companies. Thus, investors could read the related articles for your reference:

New World Development (NWD)

New World Development – After the Rumour, What are the Implications on its FY23 Result?

Were NWD’s Bonds Miss-sold?

Global Logistics Properties (GLP)

Global Logistics Properties (GLP) – With Resilient Fundamentals, Is this an Opportunity?

Global Logistics Properties (GLP)—Golden Investment Opportunity? Over 50% Return

If NWD and GLP pass through the Chinese real estate crisis, we believe that their perpetual bonds could potentially reach internal rate of return (IRR) over 20% (for NWD, it only applies to two fixed-for-life perpetual bonds) in around five years. Aggressive investors could consider them.

It is worth noting that for perpetual bonds, this internal rate of return (IRR) is not equal to the current yield. This is unlike fixed maturity bonds where the yield is equal to the IRR.

Taking “NWDEVL 4.800% Perpetual Corp (USD)” as an example, the bond price is around $40, implying a current yield of 12% (=4.8/40). This 12% can be further interpreted as the long-term risk-free rate (around 4%) + the credit spread (around 8%). The credit spread is considered as the indicator of default risks and corporate bond pricing. The higher the default risk, the larger the credit spread, vice versa.

If the industry sentiment or the credit profiles of these two companies improve, resulting in lower default risks, the bond credit spreads will be narrowed, driving a rebound in the bond prices.

Assume the credit spread of NWD perps bonds falls gradually from 8% to 4% over the next five years, which we extrapolate on the basis of NWD’s historical credit spreads.

In addition, if long-term treasury yield (e.g. 10-year US Treasury yield) falls slightly to 3%, after five years, NWD's perpetual bonds should be priced at a current yield of 7%, implying that this "NWDEVL 4.800% Perpetual Corp (USD)" bond would rise to $69.

(We believe that the economic downward pressure on Mainland China and Hong Kong should continue for at least two years. It also takes a longer time to tackle the debt issue in the Chinese real estate sector. Thus, it would be a reasonable expectation for it to return to normal in five years. Whether these assumptions are reasonable and how long it will take the property sector to be normalised are two things that investors have to think about.)

Under this circumstance, the capital appreciation of the perpetual bond would be $29 (=$69-$40), and this does not include the coupons received during the five-year period. Taking into account both the coupon and the capital appreciation, the IRR and total investment return over the five-year period of holding the bond would be 22% and 129% respectively (Note that this is 22% compounded over five years, see Table 2). The IRR is much higher than that of NWD’s fixed-tenor bonds which yield around 9% to 11%. Therefore, the perpetual bond could be a very attractive investment.

Table 2: IRR and Total Investment Return under different scenarios (Assume an investor buys "NWDEVL 4.800% Perpetual Corp (USD)" at $40 and successfully sells it at the specified price five years later)

However, investors should be aware that the biggest risk is the suspension of coupon payments on the perpetual bonds. If the company is under some liquidity pressure, it can suspend coupon payments, which does not constitute a debt default. Alternatively, the company might not be able to pass through the down cycle as expected and might not be able to repay its debt on time, which would constitute a debt default. In both cases, the price of the perpetual bonds could fall further to the level of the expected recovery value of the perpetual bonds.

The other risk is that if credit spreads continue to rise and there is no room for them to recover in the foreseeable future, the price of the bond will continue to fall. Investors might have to accept a permanent loss. Since the perpetual bond does not have a maturity date, it does not guarantee that investors can sell it at a specified price level.

Even so, we believe that investors do not need to be too worried about this risk, as long as the company is able to pay the coupon, the credit spreads will not keep increasing. This implies that the perpetual bond prices will be supported at a certain level.

These perpetual bonds are volatile. Investors might get some unrealized losses after they purchase the bonds. However, in the worst-case scenario (as long as the company can pay the coupon), investors could recover their principal through the coupon received over the next nine years, given that the current yield reaches 11%.

Referring to Table 2, even if investors sell the bonds at a lower price compared to the purchase price, it is still highly likely that they could still make a positive return in five years. In addition, if the company continues to pay the coupon, it is unlikely that the bond credit spread could be maintained at a very high level for the next nine years.

Hence, as long as the company can continue to pay the coupon, the potential for the bond price to increase/rebound is promising. Even if the bond price does not rebound as expected, or even plummets, investors will still be able to achieve a positive return through the coupons received.

The advantages of NWD’s perpetual bonds include (relative to GLP’s perpetual bonds):

• For the company, the coupon of perpetual bonds has a higher priority than the dividend payment to shareholders. If a company does not pay the coupon of perpetual bonds, it cannot pay dividends. NWD paid cash dividends every year since 1986, with a record of 37 consecutive years of dividend payment.

• The NWD’s perpetual bonds are senior unsecured bonds. If the company unfortunately defaults on its debt, under the scenarios of debt restructuring or forced liquidation, the repayment seniority of the perpetual bonds is same as that of fixed-tenor bonds.

The advantages of GLP’s perpetual bonds include (relative to NWD’s perpetual bonds):

• GLP’s perpetual bonds have a reset clause. The expected current yield after the 2026 / 2027 next reset could be reached to 20% or higher (based on the current price). It has a strong potential either from the coupon perspective or from the capital gain perspective.

• The reset clause of the perpetual bonds could result in an exercise of call option by GLP in 2026 or in 2027, meaning that the issuer redeems the bonds at the par value ($100). We think that the market does not price in this event. If GLP has significant improvement going forward and it chooses to call the bond, then the capital gain of investors will be as high as $60 (equivalent to the bond price’s 160%).

As both perpetual bonds have their own unique features, and both companies have different risk factors in terms of fundamentals, investors could invest in both of them to diversify their portfolios.

Nevertheless, we reiterate that the biggest risk is the suspension of coupon payments on the perpetual bonds. If the company is under some liquidity pressure, it can suspend coupon payments, which does not constitute a debt default, meaning that investors could not claim the bond principal and accumulated coupons against the company in a legal way.

Alternatively, the company might not be able to pass through the down cycle as expected and might not be able to repay its debt on time, which would constitute a debt default. In both cases, the price of the perpetual bonds could fall further to the level of the expected recovery value of the perpetual bonds.

Conclusion

The current yields of some perpetual bonds of New World Development (NWD) and Global Logistics Properties (GLP) reached over 11%. If NWD and GLP pass through this crisis, the credit spreads could be narrowed. We expect that their perpetual bonds could potentially reach the internal rate of return (IRR) of over 20% in around five years. Aggressive investors could consider them.

As long as the company can continue to pay the coupon, the potential for the bond price to increase/rebound is promising. Even if the bond price does not rebound as expected, or even plummets, investors will still be able to achieve a positive return through the coupons received.

As both perpetual bonds have their own unique features, and both companies have different risk factors in terms of fundamentals, investors could invest in both of them to diversify their portfolios.

Investors have to pay attention to the biggest risks, the suspension of coupon payments on the perpetual bonds and the company’s debt defaults.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report holds positions in GLPSP 4.500% Perpetual Corp (USD).

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