Purmo is planning a hybrid bond

Translation: Original comment published in Finnish on 2/14/2023 at 6:00 am.

Purmo announced that it is planning a EUR 50-75 million hybrid bond. Purmo’s gearing was at the upper limit of its target level (net debt/adj. EBITDA 3x) at the end of 2022. A hybrid bond that is considered equity in accounting is a way of lowering gearing and/or improving the company’s financial leeway. We expect that the interest rate for the hybrid bond will be quite high.

Purmo is planning a EUR 50-75 million hybrid bond

Purmo announced yesterday that it is planning a green hybrid bond of EUR 50-75 million. The proceeds from the bond will be used to finance the company in accordance with Purmo’s newly established Green Finance Framework. According to the company, the funds will not be used to pay existing debts, so with the bond the company apparently prepares for both near-term financing needs and possible acquisitions.

Gearing is rising above the target level in the first half of 2023

Purmo's net debt/adj. EBITDA was 3.0x at the end of 2022, while the target is to be at 3x or below it. In addition, working capital is seasonally committed early in the year and earnings are still expected to decline at the beginning of this year. Non-recurring costs of the company's efficiency program will also burden cash flow this year. Thus, without the hybrid bond, the company would probably have exceeded its target level during H1’23. As the company also wants to be active in acquisitions and pay good dividends, the hybrid bond appears to be the company's solution to strengthen its financial position. The hybrid bond is treated as equity in IFRS accounting. A hybrid of EUR 50 million would reduce reported net debt/adj. EBITDA to around 2.4x. We believe, however, that this is more technical, because a hybrid bond is still a loan by nature, even if it is considered equity in accounting. On the other hand, the hybrid bond allows investments/acquisitions without breaking the 3x target level or at least the potential overshoot is smaller.

We estimate that the interest rate on the hybrid bond will be close to 10%

We believe that the interest rate for the hybrid bond will be quite high. For example, YIT's hybrid bond, with a repayment option in 2026, is currently priced on the market at an interest rate of around 12%. However, YIT’s gearing is somewhat higher than Purmo’s, so a lower interest rate is justified for Purmo. One of the latest new hybrid bonds was Aspo’s bond in June 2022, with an interest rate of 8.75% at the time of issue. However, the market interest rate has risen by almost 2 percentage points since then. We feel that this interest rate level is high for Purmo considering that our return on capital estimate is only good 10% in the next few years. If the interest rate was 10 % and the bond was EUR 50 million, it would mean an annual interest expense of EUR 5 million. This is a considerable amount compared to the net operating profit of EUR 40-50 million that we expect in the next few years.