What to look for in corporate bonds that are not real estate bonds?

As a large proportion of bond issues are typically structured for real estate projects, we have been talking a lot about what to keep in mind while deciding whether to invest in them. Meanwhile you have been asking us if we are going to have any bonds for other sectors. The answer is yes. Therefore we decided to talk more in depth about what to look for in bonds that are not related to real estate.

Business sector & model. What kind of sector the issuer belongs to, what is its business model (how does it make money) and what does that mean for the possible cash flows of the company? Always think about the cash flows as it is where your interest will come from if you decide to invest. Are the cash flows sustainable? Mind these factors: sales, profit margin, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of the last 3 years and possibilities for growth as well as trends and forecasts for the sector.

Is it a project-based business? If so, every year may be very different for the company in terms of its financial indicators, depending how much projects/orders the company managed to secure for that period of time. The examples of such businesses are construction, IT companies. Or is it a business that generates steady income throughout the year, every year, as its business model is either subscription-based (e.g. telecommunications) or relies on long-term contracts (e.g. manufacturing, wholesale companies).

Goal of bonds. Also, it is important to understand, where the money raised through bonds will be spent and why? The funds could be used for sustainable and growth-oriented goals, such as development or investment into gear/infrastructure that will contribute the issuer's EBITDA in the future, or to finance the working capital of the company, which should help increase sales. On the other hand, the funds could be used to refinance the existing loans (working capital/investment), which is also fine as corporates might seek for better financing conditions or existing loans mature (expire).

Financial factors. Even if you are not a number-person, you still need to look at some numbers. What is the leverage level of the company (i.e. how much of its own equity company uses in its activity vs external debt)? A ‘healthy’ equity ratio is considered to be at least 30%.

How much outstanding loans does the company already have for the banks/credit companies apart from the current bond issue? What is the ratio of those loans to EBITDA (debt-to-EBITDA), and what will it be after issuing the new bonds? Don't worry, there are guidelines for that.

Usually, a sustainable ratio is up to x3.5 (banks consider it normal), but in some cases the ratio can go up to x5, if it relies on a steady cashflow with pre-signed contracts (investment funds find it still ‘healthy’). To put it simple, this ratio reveals how many EBITDAs (or years) will it take for the company to fulfill all of its loan duties. For example, if the EBITDA of a company is usually around EUR 1 M, and company's loan duties are EUR 3 M, it will take 3 years for the company to return the loans (interests are not included).

Asset pledge (liet. įkeitimas). With real estate bonds it is common to secure them with a first or second-rank asset pledge, the assets being land plots and buildings in construction. When we are dealing with other types of companies, securing the bonds is a little less straight-forward, but nonetheless important for investors. First, the majority of companies do have some material assets such as stock of products, machinery/gear/infrastructure. The manufacturing companies usually own some real estate that can also be pledged. If the issuer belongs to a holding company, it is very important that the holding company extends guarantees (warranties) for it. This means that in case of worse luck of the issuer company, the ‘mother’ company will come in and help with the cashflow. Covenants are also important, for example you can look for the ones getting in the way of the company taking on any further loans.

Refinancing risk. Refinancing risk refers to the question of how the bond issue will be redeemed at maturity. Most businesses have some financial debt at all times (for working capital, investments), so the extension/refinancing of loans or bonds is a common practice and should not worry investors. Having said that, it is important to pay attention to the current financial ‘health’ of the issuer (based on the key criteria above) and what financial forecasts the company provides (i.e. equity, debt/EBITDA ratio at the bonds' maturity, what the loan will be used for). This will provide more clarity to you whether the company will be able to redeem all the bonds by itself (from its own capital), whether the projected financial indicators will be positive and it will allow the company to have more options when choosing future financial partners at the end of the bond term to refinance the issue.

If at first all this information looks a bit too much, don't worry! We will be here to answer your questions and guide you.