When it comes to interest rates, many investors think in terms of dividends.
'Will company XYZ pay more in dividends than I could get in a term deposit?'
This is all well and good – who doesn't love a good dividend? – but there's another way to benefit from low interest rates:
Bonds.
Not as an owner (you'll be lucky to get more than your term deposit!), but as the owner of an issuer.
A whole pile of companies like Scentre Group Ltd (ASX: SCG) have been taking advantage of generationally low interest rates to issue debt with super low coupons, paying down higher cost liabilities and using cheap cash to fund development.
Scentre Group recently issued US$1 billion in debt (in addition to other bonds issued last year) at a cost of between 2.375% and 3.2% per annum.
Used to pay down debt at higher rates, the benefits won't immediately be apparent to shareholders, but the decision to issue seems a good one. Scentre's bonds are also used to fund 'general corporate purposes', which refers to the high-level objectives of the business, i.e. in Scentre's case, shopping centre development.
Or in the case of Wesfarmers Ltd (ASX: WES), husbanding a conglomerate of businesses in the eternal competition with Woolworths Limited (ASX: WOW).
Wesfarmers announced just yesterday it has issued A$500 million in 'medium term notes' at a premium of 0.9% above the 90-day Bank Bill Swap Rate; which as of today works out to be a cost of around 3% per annum.
Used for 'general corporate purposes', the purpose of the notes is a little obscure, but with Woolworths investing $500 million into store refurbishments and other business improvements, Wesfarmers could be set to follow a similar course.
Wesfarmers recently grew same store sales by 3.8%, which shows how even a mature business can get ahead with 3% debt.
If spent well, Wesfarmers and Scentre Group can potentially get a lot of bang for their buck with low-cost debt, but beware: Debt can catch up with you.
Just take Fortescue Metals Group Limited (ASX: FMG), whose aggressive debt issues of past times have caught up, forcing the group to issue bonds at a staggering 9.75%p.a. in order to attract investors.
That's like making your home loan repayments with your credit card!
Used to pay down existing debt, the bonds bought FMG more time to fine-tune the business and hope for improvements in the value of iron ore, but little more.
Shares dutifully soared on the news, which alleviated the risk of a default, but I'm not sure that Fortescue shareholders are really getting a good deal.
Pay attention to company debt issues and learn how to differentiate good debt from bad; it will help you better protect your wealth during tough economic times.
