Telstra – A Comparison Of Its Bonds & Shares – ‘Survivability Versus Growth’
Telstra is one of Australia’s top ten companies by market capitalisation.
Even if you don’t have a Telstra mobile or internet association it’s likely your superannuation fund will own the shares or bonds, or both.
This week Telstra made headlines with a severe 7 per cent one day drop in its share price when it was announced TPG would become a fourth mobile provider to rival incumbents Optus, Telstra and Vodafone.
But there is more for the investors to consider than Telstra’s high yields and struggling shares: you might find it interesting to learn that Telstra raised $1 billion in the over-the-counter bond market earlier this month. That’s a large sum, and even more impressive was the fact that $2 billion in bids were received for the bonds.
The deal was broken down into three tranches: a $300 million four-year fixed rate bond paying 2.95 per cent per annum equivalent to 82 basis points over the benchmark swap rate, a $150 million floating rate bond with the same term and same margin, and a $550 million ten-year fixed rate bond with an issue yield of 4.06 per cent per annum.
The returns don’t look very appealing especially when you consider the dividend yield on the company’s shares is approaching 9 per cent per annum following recent falls.
While any serious investor naturally compares the two asset classes, in reality they are complimentary as opposed to mutually exclusive. They have different features and purposes but both should have an allocation in your portfolio.
Lower risk bonds provide the consistency many investors crave while the shares provide the growth needed. Older investors, or those responsible for preserving capital, should have greater allocations to bonds while younger investors primarily driven by growth would have greater allocations to shares.
Reasons to invest in the bond over the share:
1. Bonds are safer investments than shares in the same company. They are a legal obligation.
Bonds are loans, you lend your money to a company or government and they promise to pay you interest in return and repay capital at maturity, so there is a lot of certainty with a bond that you don’t have with a share. In the event of a wind-up, Telstra bondholders are repaid before shareholders.
Telstra’s share price fell sharply this week – but the price of its existing 2020 maturity bond was unmoved.
2. Income is paid on set dates and cannot be foregone.
Telstra must pay interest quarterly for the floating rate bond and half yearly for the two fixed rate options, but it never has to pay a dividend. Shareholders invest expecting the company to grow and hope to see an increasing dividend. However, there is no legal obligation, unlike a bond.
3. Capital is repaid at a known future date.
Bonds have a maturity date, when the face value of the bond must be repaid. So no matter what happens to the price of a bond over its life – as they are tradable investments and prices can move up and down – investors have the certainty of knowing they will be repaid as long as the company continues to survive.
4. There is less volatility in the price of the bonds compared to the shares.
Bond prices are more stable than share prices, particularly in stressed markets. Because bonds will pay back $100 face value at maturity, investors have that capital certainty no matter what happens to the price in meantime.
A poor annual result will send the share price plummeting, but bondholders care less, as long as the company can make interest and principal payments as they come due.
Source: Bloomberg, FIIG Securities
Benefits of shares over bonds
A major difference between the two assets is franking. It increases returns and promotes investment in shares over bonds. However, as a share investor franking isn’t the primary driver, expected growth is typically the main goal.
Picking a high achieving growth stock could see you achieve very high returns which bonds can’t replicate. However, buying bonds when they are deeply discounted from their $100 face value can provide very high returns. I’ve seen some bonds return circa 40 per cent over short terms and double digit returns are not unusual.
Of course bonds in single companies can often require a relatively large investment but then again, I would feel confident in predicting the survivability of Telstra for the terms of issue of the bonds. I think it’s much more difficult to anticipate growth, along with an improving share price and dividend.