When the preliminary numbers for 2013 began leaking in local newspapers last month, the 2014 bonds for Petroleos de Venezuela S.A. (PDVSA) began marching back towards par in anticipation of redemption this October. Considering that many of our clients purchased these (soon to be redeemed) bonds at a substantial discount, we believe the over 10½% yield now indicated in the discounted price of PDVSA’s slightly longer 2017 sinking notes is a superior investment opportunity. This slightly longer debt instrument, dated November 2017, bears an 8.5% coupon, but only has an average life of only 28 months because of its scheduled amortization of principle. Although this Yankee note may lack some appeal with many U.S. investors because of the unpopularity and geopolitical risk associated with the of Venezuela’s current socialistic government, it does represent the debt of the most highly prized and crucial state owned company within the country’s most valuable industry. Here at Durig Capital we have developed our own strict criteria for evaluating lessor rated high yield junk bonds, and as a result of our research as presented in more detail below and in anticipation of PDVSA’s 2014 bonds this October, we believe that the high cash flow and over 10% yields of this note merit a short term overweighting in both of our high-yielding managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
Venezuela remains highly dependent on oil revenues, which account for roughly 95% of export earnings, about 40% of federal budget revenues, and around 18% of GDP. Venezuela is the fifth largest member of OPEC, and is reported to have the world’s largest proven oil reserves, surpassing both Canada and Saudi Arabia. However, a lack of technology and limited drilling sees its output at only 31 percent of Saudi Arabia’s and its exports at only 22 percent that of Saudi. GDP growth rose to 6.8% in 2013, while government spending, minimum wage hikes, and improved access to domestic credit continues to cause high inflation – roughly 27% in 2013. The government tightly controls Venezuela’s currency, the bolivar. It was devalued in 2013 (officially trading at 6.3 bolivars to the dollar), pushing up prices for most products. Since oil is priced in dollars, a weaker bolivar increases the local value of oil revenues, giving the government more cash.
While Venezuela continues to wrestle with a housing crisis, higher inflation, an electricity crisis, and rolling food and goods shortages – all of which were fallout from the government’s unorthodox economic policies – a healthy Venezuela would quickly become one of the most attractive destinations for investment in South America. Its size, geographic position, resources and educated workforce would find it relatively easy to attract international investment as it did in the past. Closer relations with powerhouses, such as Brazil and Colombia, that have prospered without alienating the US, are a chance for Venezuela to reintegrate the international fold.
A handful of oil companies have stuck it out in Venezuela, especially Chevron (CVX), which takes the long view that by sticking with the country through difficult times it might end up in a favorable position when a more reasonable regime comes to power. Whether or not Venezuela contemplates a liberalization of its oil economy that would allow or encourage greater investment from giants like Chevron, currently involved in five important onshore and offshore projects in Venezuela through a partnership with Petróleos de Venezuela S.A., we prefer the similarly yielding debt of the state owned oil company PDVSA over any of Venezuela’s sovereign debt issues.
Petroleos de Venezuela S.A. (PDVSA)
Petróleos de Venezuela S.A., the state-owned corporation of the Bolivarian Republic of Venezuela, is responsible for the efficient, profitable, and dependable exploration, production, refining, transport and commerce of hydrocarbons. Its main objectives are to foster the harmonic development of the country, to guarantee sovereignty of national resources, to increase endogenous development and to serve and benefit the Venezuelan people, who correspond to their share of the country’s national wealth. PDVSA is constitutionally the owner of the country’s oil reserves. The State of Venezuela is PDVSA’s sole stockholder under the provisions of the Constitution of the Bolivian Republic of Venezuela and represents the economic and political sovereignty exerted by the Venezuelan people over oil, their major energy resource.
Therefore, PDVSA’s actions must follow the Ministry of Energy and Petroleum’s guidelines, plans and strategies, as well as the norms issued by the National Development Plans for the hydrocarbon sector. Transparency and clear control of accounts is stated as being a fundamental value for PDVSA, however, it is difficult at best to obtain either. In 2013, production and revenues declined versus 2012, and preliminary reports mention that revenues ($116.2bn) were down 7% year over year on the back of a 2% decline in average export prices (from $103.42/bl to $101.40/bl) and in volume exported (from 2.568mmbpd to 2.399mmbpd). Average production declined 0.7% from 2.91mmbpd in 2012 to 2.89mmbpd in 2013. However, operating income was higher due to the effect of the devaluation in the cost structure of the company. Social expenses declined 18%yoy in USD terms, but increased 20% in VEF terms. JP Morgan estimated the potential Earnings Before Interest and Taxes (before social expenses) increased from $28.8bn in 2012 to $40.4bn in 2013, while EBIT after social expenses increased from $11.5bn to $26.2bn.
It bears repeating (from our previous review) that PDVSA is using the lending in US dollars to bring in equipment and technology, while Asdrúbal Oliveros, an economist and director of economic research firm Ecoanalítica, commented that these bond issues are mainly made to maintain the exchange rate policy. “PDVSA is borrowing money at expensive rates to grant the private sector access to foreign currency,” he remarked.
Some of the metrics that we consider when reviewing this issue are cash flow, profitability, and the longevity of its proven reserves (which is estimated at 387 years.) While the investment spending by the company’s growth and expansion strategy are more concerning to from a long term perspective, the short to near term prospects for a return of capital appear to us to be favorable. According to an unnamed company official speaking to Bloomberg news, it was also reported today that PDVSA is looking to an international bank loan to help it refinance the $3 Billion October maturity of bonded debt. The report also states that once the company “receives the loan to pay off bonds that mature this year, PDVSA will work to refinance [$11.9bn of] debt due through 2017 to push out maturities to between 2021 and 2023”. Consequently, we think the higher yields associated with this relatively short term (28 month average life) PDVSA Yankee bonds represent a great opportunity to both increase and maintain good exposure to this debt instrument’s enduring high return potential.
The default risk is PDVSA’s ability to perform. Given the importance of the state-owned company’s oil export business to economy of Venezuela, we do not believe the performance risk differs significantly from slightly lower yielding sovereign debt of similar maturity. Therefore, we see higher yield of this bond is an intelligent reward opportunity relative to its performance risk.
These bonds do carry geopolitical risk associated with the policies and actions of the sovereign government of Venezuela.
We view these PDVSA Yankee bonds have similar risks and maturities to other Yankees bonds such as the 8% Ceagro Agricola, the 10.76% Mriya Agro, or the 9.85% Alto Palermo, which we have reviewed previously on our Bond-Yields.com blog.
Accessibility and Liquidity
PDVSA has numerous outstanding US dollar denominated bonds with maturities ranging out to 2037. We believe that acquiring and owning individual maturity definite bonds offer significant advantages over owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail. Even though many times broker/dealers require an institutional sized bond purchase, it is possible with a broker and advisor’s assistance for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as US $10,000.
Given the savvy high reward to risk opportunity we see these bonds represent, we are recommending these short term PDVSA Yankee bonds for our clients looking for both greater cash flow and diversification away from overweighted US economy based assets, and it is why we are adding it to high-yielding managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
Issuer: Petroleos de Venezuela S.A. (PDVSA)
Maturity: 11/2/2017, average life of this sinking bond is 10/17/2016
Yield to Maturity: ~10.5%
Disclosure: Some Durig Capital clients may currently own these 2017 PDVSA bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this PDVSA bond call our fixed income specialist at 971-327-8847
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