Bonds and shares are often seen as opposites by many investors. This is not exactly true, though. While debt and equity are to a certain extent opposite, as investments they are more like two sides of the same coin. This is why I think its latest bond issues have a lot to tell us about the Rolls-Royce (LSE: RR) share price.
What moves a share price moves a bond yield
So we are all on the same page, a quick explanation about bonds. A bond is simply a securitised loan. Rather than borrowing from a bank, a company (or government) allows people to ‘buy’ its debt – loaning it money – for a guaranteed interest rate (called a yield).
As with a personal loan, a company’s ability to borrow money is subject to a credit score (for bonds, this is a credit rating set by three main ratings agencies). The higher the chances of not being able to pay back its debt, the higher yield a company is forced to offer to entice people to buy its bonds.
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The similarity with shares, then, is easy to see. The same prospects that determine a share price are mostly the same factors that influence the yield a firm must offer in its bonds. Things like earnings, broader market trends and the global economy impact both. Good prospects mean a high share price and a low yield, and vice-versa.
The Rolls-Royce yield vs. the Rolls-Royce share price
In the case of Rolls-Royce, we can see this quite clearly in its latest bond issue. Last month the company issued £2bn worth of bonds in the European markets. Across three countries, these six-year bonds had yields ranging from 4.625% to 5.75%. The European benchmark for the six-year bond is currently just 3.73%.
For those of us who look more often at the Rolls-Royce share price, this did not come as a surprise. The risks are obvious: the UK is now in a second lockdown; coronavirus looks set to dominate the global markets well into 2021; a vaccine, meanwhile, still seems to have a lot of questions surrounding it.
Would you feel secure lending Rolls-Royce money right now?
The Rolls-Royce share price is almost a quarter of the value it was at the start of this year. The company makes most of its money from the maintenance of its engines, in addition to selling them in the first place. If planes are not flying, they don’t need their engines maintained.
Even worse, it seems like the airline industry may be suffering a once-in-a-generation catastrophe. Who knows how long it take to will recover? A global economic recession is a real possibility. If this happens, airlines will be going from the frying pan into the fire.
Rolls-Royce needs money
The bond issue does not just reinforce what we already know, however. It could also have an impact itself. The company needs money. Last month it announced a £2bn rights issue (a more direct hit to the Rolls-Royce share price) as well as the bonds.
With these yields being so high, the company has committed itself to large loan repayments. This could be a drain on cash flow at a time when it can’t afford it. Its bond may not just have things in common with the Rolls-Royce share price, but may even be a driver of it in the future. As such, I’m unlikely to buy the shares for my own portfolio any time soon.
