By OH BOON PING

 

BABCOCK & Brown Structured Finance Fund (BBSFF) closed at 63 cents yesterday - a 40.6 per cent loss from its offer price of $1.06 in December 2006. A look at its stock chart also revealed that the price has been falling since its listing over a year ago.

 

This is, however, not surprising since BBSFF's complex structure - including exposure to securitised loans - is not easily understood here, and it is also not helped by the recent spate of bad news on the US sub-prime mortgage market.

But at its existing price, the fund could be undervalued even though it has no equivalent on the local bourse. This came as BBSFF delivered a strong set of FY07 results despite the challenging circumstances. For example, last year's cash economic income exceeded its IPO forecast by 29.5 per cent to reach $44.8 million, while full-year revenue was $96.3 million - 118 per cent over initial projections. Its net profit after tax of $68.7 million also exceeded guidance by 153 per cent.

Babcock & Brown also forecast a half-year dividend of 5.2 cents per share in H1 2008. Based on yesterday's close, this translates into a six-month yield of 8.25 per cent - attractive by any measure.

Plus, if one were to look beyond its present constraints, the fund's prospects appear promising.

Just consider its underlying assets. As at end-FY07, slightly less than a third of the fund consists of fixed assets like aircraft leasing, which could benefit from growing air passenger traffic worldwide.

For example, Airbus sees passenger traffic growing an average of 4.9 per cent per year, while Boeing expects passenger planes to account for the bulk of the global fleet in 2026.

Some observers note that aircraft leasing stocks promise a lot more cash flow visibility than airline stocks because of the leasing contracts in place.

At its FY07 results briefing, BBSFF said its alternative investments included a US property development loan and music copyright assets.

Both the completion and repayment risks for the property loan are mitigated by the substantial pre-sales with 20 per cent cash deposits, while music copyright investments are not strongly correlated with its aircraft leasing and rail segment. Therefore, the fund benefits from the diversification in its fund structure.

Perhaps the segment that merits the closest scrutiny is its securitisation portion - comprising stakes like collateralised loan obligations (CLOs) and notes secured against mortgages over Australian and UK residential property. This came as assets like CLOs and mortgage- backed securities are now deemed highly risky owing to the US sub-prime woes. But even then, the outlook for BBSFF's securitised segment isn't really bleak.

For one thing, its primary exposure is to the Australian property market, which is looking at accelerating returns.

In a report, ANZ Bank said the property market Down Under is driven by buoyant economic growth and tightening market fundamentals, and it thinks there will be a serious housing shortage by 2010. Plus, BBSFF said the performance of borrowers for its CLO investments remains strong and there were no defaults last year.

Therefore, the risk specific to this segment may not be as high as widely thought, even if one does not factor in the diversification benefits from the fund's structure.

In short, market sentiment on BBSFF may have been too negative, and investors would do well to give the stock a second look.