Weak results push more investors into bonds

An investor shift to the bonds markets is expected to continue following end year results of listed companies falling below market expectations.

Listed firms whose financial years end on December 31 have been reporting slow growth in profitability since 2009 was a difficult financial year but the levels of disappointment beat expectations.

Banks which have traditionally been able to weather turbulent years to record double-digit growths have seen a sluggish rise in profitability.

“We were expecting some disappointment but some results came lower than expected,” says Eric Musau, research analyst at Renaissance Capital.

Equity had set a 20 per cent target but it only managed to record a five per cent growth in pre-tax profit.

KCB also posted a five per cent growth rate while NIC was at three per cent.

The subdued performance was partly the result of less uncertainty in 2009 as compared to 2008 which meant that there was less money to be made on forex trading.

Activity in the capital markets was relatively dormant with no initial public offering (IPO) to prop up financial institutions.

Despite the disappointment, counters for KCB, Equity and Co-operative Bank have been trading in high volumes but the sales are being generated by foreigners as local investors favour infrastructure bonds.

An appetite for bonds, was seen by last Friday’s oversubscription of the government’s third infrastructure bond offer by 243 per cent, with the lion’s share of participation coming from commercial banks.

The Sh14.5 billion eight-year bond attracted 770 bids worth Sh35.3 billion and the effect of the oversubscription has been the correction of bonds with similar maturities by pushing down their yields.

Given the inverse relationship between yields and asset values, where lower yields result in higher bond values, the correction of the market may further push banks towards this side of the market at the expense of the private sector and short-term securities such as the T-bills.

Johnson Nderi, an analyst with Suntra Investment Bank, says that the declining yield arose from the Central Bank of Kenya’s actions of reducing interest rates on short-term maturities and thereby widening spreads of credits with larger maturities.

That will cause the yield curves for securities with the same maturities as the infrastructure bonds to decline and as a result the values of the assets should appreciate making it more attractive to invest in the debt-instruments.

But the Renaissance Capital analyst says the market had factored these elements and there is an upbeat feeling from local investors for 2010 after banks revealing their future plans.

KCB, for instance, plans to raise Sh15 billion for expansion but trading of its counter has been lukewarm.

Sales of the counter’s shares have taken a small dent since the announcement of the bank’s plans due to uncertainty over whether it will raise funds through a bond or a rights issue.

“Due to the size of the funds, KCB might opt to go for a mix of the two,” says Mr Musau.

Should KCB opt to raise the additional Sh15billion through a bond, the tricky part will be the issue of the coupon rate which analysts say is difficult to tell.

Premium coupon

Infrastructure bonds have a 15 per cent tax deduction and should KCB opt to raise a bond it will have to pay a premium coupon rate to compensate investors for the tax deduction loss.

But KCB has the advantage of more predictable cash flows than KenGen.

It also has less government ownership thus bolstering investor confidence in management.

These two factors could see it offer a lower coupon rate than the infrastructure bonds.

“Cash flows for KenGen looked uncertain because of the tariffs but KenGen is a very big and important utility company therefore government has to back it,” says Mr Musau.

This is the reason behind investor confidence in the power generator’s public infrastructure bond offer, he added.