Australian Foundation Investment Company Ltd Convertibles Notes (AFIG)

In my previous role, I covered this stock in detail. For those interested in a stock with very low downside potential while having the potential for decent upside may wish to keep AFIG on their radars. 

AFIG is issued by the Australian Foundation Investment Company (AFI). AFI is a Listed Investment Company (LIC) and is considered a blue-chip Australian LIC. Their portfolio consists almost entirely of big name Australian companies such as BHP Billiton Ltd (BHP) and the major Australian banks. As at 31 December, AFI had $5.430bn in assets and $319m in debt. From a creditors perspective AFI is safe. 

AFIG is quite a novel structure that I quite like from a risk/return perspective. AFIG have a face value of $100 and pay a fixed rate of 6.25% or $6.25 per note p.a. The maturity date is 28 February 2017. The notes will mature for $100 OR note holders have the option to convert into ordinary AFI shares at a rate of $5.09 per share. When AFIG were issued, AFI shares were well less than that value, however given the excellent performance of the S&PASX200 over the last 12 months, AFI shares have moved up to $5.44; therefore the call option embedded into AFIG are now well in the money. 

AFIG are currently $115.90. Are they worth buying? 

Scenario a) Let's look at the downside first. The likely worst case is that AFI slump over the next four years and we simply get our $100 back in 2017. Under this scenario the yield to maturity is 2.1% p.a. Not exactly inspiring; however that's the worse scenario. I would love to have had a minimum positive return on some of my previous trades! Scenario b) For the next scenario, let's just assume we convert now. AFIG can be converted at the semi-annual interest dates of 28 February and 31 August each year. Assuming the AFI price is the same at the end of this month, for each AFIG share we would receive $100/$5.09 = 19.6 AFI shares = $106.9 in value at $5.44 per share. Add in the $3.13 interest payment and we still lose quite a bit of money (5.1%) in a short period of time. This scenario isn't particularly relevant as we have the option of converting; if it doesn't make sense to convert we won't. Scenario c) let's pluck a few numbers out of the sky: assume AFI closes at $6 or $8 or $10  in February 2017 and we convert into ordinary shares. Including interest, the respective pre-tax rate of returns are 5.8%, 12.6% and 18.3% p.a. There is no particular reason I chose those numbers other than to demonstrate the potential blue-sky should the markets continue to do well from current levels.

AFI have recently announced a share buy-back which I find a little surprising given the level of the share price and underyling NTA. However AFI has a good long term track record, so it is reasonable to say they think there is upside in the share price. AFIG isn't a get-rich-quick scheme. But as a security with excellent downside protection and upside exposure, its a solid bet. I don't currently own AFIG, but may consider buying some in the future.