capitaland strengthens balance sheet, page-6

Hi Watford,

Have been doing a lot more digging around in ALZ including interogating management for the state of play. Share prices of both ALZ and AAZPB looks ugly alright, sympotomatic of the market crash we find ourselves in. No buyers brave enough to stand in the way, prices always cheaper next day/week so why would you bother when nothing seems on the horizon to turn sentiment around.

For what it's worth I think both ALZ and AAZPB are undervalued. I am extremely confident that the AAZPB will continue to have interest payments made qurterly and that ALZ will not default on the Hybrids or go under based on low gearing, capital recylcling underway even in this environment, strong and steady Trust income earnings, Capitaland 60% investment and support etc. Asset values will come down and business is tuff no question but ALZ and AAZPB will be one of the survivors there is no doubt in my mind.

AAZPB is suffering from fear and illiquidity as all hybrids are getting sold off. The major reason is that with interest rates tipped to fall to 4.25% or lower within 6 months the market is treating all hybrids as perpetual and marking them down in concert with dropping interest rates. It seems that the going rate for a "second tier" perpetual hybrid (AAZPB anyway) is around 15% given that quality high yield stocks such as banks etc are paying >10% on a grossed up basis. The hybrid discount reflects liquidity risk, perpetuity risk (never redeemed), business solvency risk and dropping interest rate risk etc. Simply, the hybrids trade at a discount to a very cheap market which makes them very cheap indeed. A great situation if you have cash but of course not many have cash for quality shares or hybrids during this great deleveraging.

I have plotted the AAZPB price verses the BBSW rate over the last 3 months and it has stayed around 15% yield as the cash rate has fallen. At $57 the yield next year would be 15.5% assuming the BBSW drops to 4% for 2009, a figure the economists are talking as the target low point in the recession. So at $54 the share price has either overshot this relationship or some people are expecting even lower interest rates to come than 4%? Either way I believe they are great value and oversold based on lack of buyers rather than any well thought out market clearing price. Trouble is market has so many bargins but so little money.

The upside is of course redemption at $100 for an almost 100% capital gain. When or if that hapens is the question to calculate AAZPB's true ivestment value. I think it is a given that it will not happen next year or 2010 given how entrenched the credit crisis is. Will it be 2011, a little later or never? IMO the Step-up Rate of 4.8% above BBSW is prohibitively expensive for the long term, where a credit premium of between 1-2% above BBSW is predicted. Before ALZ re-set there syndicated bank fascility ($950M) they were paying a premium of 0.6% above BBSW but that jumped to 1.2% in 2008. It will be higher now and into 2009 but I think it reasonable that the premium will not exceed 2% over the longer term, especially if the reference rate is very low (at circa 4% as this would indicate a 50% profit margin above the BBSW cost of funds).

Bottom line I am guessing (betting...lol) that AAZPB will begin to be redeemded from 2011 onwards depending upon when the economy has bottomed and begins to rise out of the slump. That would be the time to lock in cheap credit to replace expensive hybrid debt before interest rates start to rise into the next cycle. Looks good on my spread sheet but I can understand that it seems all too far out for most when money is tight and so many other sexy options to make a killing inbetween are being presented.

goodluck.