12.25% Very Short Sinking Yankee Bonds from Transener, Average Life of 15 Months!

Argentina Bond
Emerging Markets Bond
South American Bond
Short Term High Yielding Bond
Sinking Bond
US Dollar Bond

Each week, we scour the globe to identify corporate bonds for investors needing or seeking higher yields with the least amount of risk possible relative to its projected return. By focusing more on an issuer’s core operations and its vitality to the economy it operates within, we have repeatedly been able to find an issuer that we see as being soundly positioned and reasonably capable of servicing its debt when comparing it to a number of much higher rated (even some investment grade) corporations. This week we look deeper into Argentina, where Transener, the owner and operator of 95% of the country’s high voltage electricity lines, has a sinking bond issued at 8.875% and a final 25% payment date of 12/15/2016. Transener has a natural monopoly of the transmission service in Argentina, holding a concession agreement with the government of Argentina that grants Transener the exclusive right to provide the public service of high voltage electricity transmission throughout their networks for a period of 95 years, which began in July 1993. Politically, Argentina has fallen out of favor with many countries. However, the county’s infrastructure continues to grow, in spite of the government’s challenges. Argentina’s electrical rates for consumers have long been fixed at artificially low levels by the government after the Argentine default of 2002, but in May of this year, the government granted higher electricity rates to power generators. This will provide much needed capital to build the infrastructure necessary to increase capacity to meet increasing demand.

Transener currently has $143 million in total debt, with a majority (around 70%) of the balance due in 2021. With over 11,000 miles of transmission lines, this breaks down to a debt per mile of about $13,000. The value of the hard assets owned by Transener (lines, pole support structures, transformers, substations, right of ways, etc) appears to easily exceed the current amount of debt, especially when one considers the cost of constructing another network from scratch (which could easily cost $1M USD per mile according to Black and Veatch). Transener has already made its first principal payment on these sinking bonds of 25% in December 2013, with equal principal payments of 25% to be paid in December 2014, 2015 and 2016. With 70% of Transener’s debt coming due in 2021, there appears to be more than adequate cash and revenues to cover interest and principal payments for this much shorter bond issue. Electricity is crucial to Argentina’s continued growth and recovery, and Transener provides this vital resource to Argentina’s citizens. In light of this, we feel these bonds are significantly undervalued, as they offer superior cash flow and very high 12.25% yields for the average life maturity of about 15 months, and see them as a strong addition to our high yielding managed global income portfolios, Fixed-Income1.com and Fixed-Income2.com.

About the Issuer:

Founded in 1993, Transener owns, operates and maintains 95% of the high voltage transmission system in Argentina under an exclusive 95-year concession agreement with the government. Prior to 1992, almost all of the Argentine electricity industry was owned and managed by the government. In the early 1990’s, a privatization program was initiated with the ultimate objective to protect consumer rights, encourage competition and investment and improve the quality of service. Currently, Transener has over 11,000 miles of transmission lines within Argentina. Pampa Energia, the largest integrated energy company in Argentina, has a co-controlling stake in Transener, and has traded on the NYSE in form of ADRs since October 2009 (ticker PAM).

Transener’s revenue streams are largely determined by the government via the Secretariat of Energy, who approves wholesale electricity prices. Transener receives monthly revenue for transmission, capacity charges and connection charges from CAMMESA, a national organization responsible for managing operations in the wholesale electricity market. Tariffs (what they can charge for electricity) have been kept artificially low since the 2001 / 2002 Argentine economic crisis, when Transener’s original concession agreement was renegotiated and tariffs of electricity distributors and transmission companies were frozen for several years.

As a result, the monies collected from electric customers and consumers did not cover their cost of operations. This rolling deficit was continually covered by federal subsidies paid to CAMMESA. After years of petitioning the government to adjust payments from CAMMESA to reflect actual production costs, Transener received some financial relief in 2013. The Renewal Agreement compensates the company for cost variations (the cost of operations not covered by tariffs and subsidies) retroactive to December 2010 and continues to December 2015. The execution of this agreement resulted in recognized revenues and interest income in the amount of AR$ 367.2 and AR$ 213.8 million respectively, for the year-end December 31st, 2013. In May of this year, the Argentine government granted higher electricity rates to power generators, allowing them to increase rates 25 – 110% above previous levels. Transener’s net sales revenue and EBITDA jumped considerably in 2013, most likely a reflection of the Renewal Agreement revenue.

(In Millions of AR$ pesos)	2011	2012	2013
Annual Consolidated Net Sales	523 M	528.9 M	873.8 M
Consolidated Adjusted EBITDA	137 M	68.9 M	399.0 M

One final note – subsidized electricity rates in Argentina currently average 1.5 cents per kilowatt hour. In neighboring Peru, rates average 16.1 cents per kilowatt hour. As Argentina is forced to decrease subsidies to the electricity industry to reduce its fiscal deficit, prices can only increase. This will provide welcomed relief for the electricity companies who have suffered decreased profits for the last decade.

Argentina – Economic Growth

Argentina GDP has stalled recently, registering -0.8% in Q1 2014. However, forecasts predict modest GDP growth over the next few years, in the 2% to 3% range. Argentina has abundant natural resources, a well-educated population and an export-oriented agricultural sector. Indeed, shipments of agricultural products have been the motor of Argentina´s growth in recent years. In addition, Argentina has been diversifying its industrial base and it has been experiencing a record growth in the automobile, textile and power sectors.

Risks:

The default risk is Transener’s ability to perform. Considering the increased tariffs from the Renewal Agreement and the fact that they have already paid 25% of the principal on these bonds, we feel the default risk for this relatively short-term bond is minimal relative to its outstanding return potential. Also, the majority of Transener’s current outstanding debt (70%) comes due in 2021. Although rated at only CCC-, this issue is a relatively small part of the total debt and we feel Transener’s level of cash and increasing revenue streams are more than adequate to fulfill the interest and principal payments.

Geopolitical risk is also present. While the socialist Argentine government has historically closely controlled all public utilities, it appears to be relinquishing some of that control. It has made recent strides in cutting many of the federal subsidies to those same utilities that were privatized in the 1990’s, such as water, electricity and natural gas providers. The government has stopped short of finalizing a full tariff review for electricity companies, but we feel the negotiation and execution of the Renewal Agreement for Transener indicates their recognition of the vital importance of reliable electric power to ensure Argentina’s growth and economic viability.

Recent news from Argentina surrounds the country’s default – the second default in 12 years. This default is not the show-stopping default Argentina experienced in 2002; this is a selective default, mainly tied to the previously negotiated 2002 debt restructuring that a rather small group of investors, hedgefunds, and lawyers refused to accept. Unlike 2002, the Argentine government is solvent. Many investors and economists are hopeful that a solution to the default can be negotiated after a damaging repayment clause expires at the end of this year. Indeed, it would seem Argentina is anxious and willing to negotiate once the threat of larger losses is removed. The country’s economy is much healthier than in 2001, but the economic consequences of the default may still be felt. However, as international investor relations wane in light of this most recent default, China has signaled its support of Argentina by recently signing an $11 billion (USD) infrastructure-financing and currency swap deal with Argentina. This deal will provide much needed capital as well as provide relief to the country’s foreign currency reserves.

Transener’s business operates primarily in Argentina and as such, its revenues are received in Argentine pesos. This debt is issued in US Dollars so the company is exposed to risks in the fluctuations of the exchange rate. However, we feel the increased revenue from the Renewal Agreement as well as rising electricity rates due to the decreased federal subsidies will help offset currency risk.

We believe that these 12.25% Transener Sinking bonds have similar features and risks as other high yielding Yankees bonds from Latin America such as such as the 9.5% Autopistas Sinking Bonds, the 9.5% Alto Palermo SA (APSA), the 11.22% Aeropuertos Argentina 2000, and the 11% Transportadora de Gas del Sur (TGS) 11% bonds, which have been previously reviewed on our Bond-Yields.com blog.

Conclusion:

Considering that Transener has already paid 25% of the principal of this bond as well as the recent concessions granted via the Renewal Agreement, we believe this bond offers significant return in light of the risks that we can identify. Argentina lacks the resources to replicate or replace the valuable service Transener provides for the country, and Transener’s near monopoly in the electricity transmission sector means it is perfectly positioned to profit from increased tariffs (rates) as government subsidies decline. Furthermore, the value of the company’s hard assets (lines, pole support structures, transformers, substations, right of ways, etc) appears to easily exceed its total outstanding debt, and this bond issue reflects only a fraction of that debt. Therefore, we see the high 12.25% average annualized yield (for about 15 months) that this bond offers as a significant new addition to our FX-1 and FS-2 global high income portfolios.

Issuer: Compania de Transporte Energia (Transener)
Coupon: 8.875%
Maturity: sinks an additional ¼ on 12/15/14, another ¼ on 12/15/15, remainder on 12/15/2016. Average life 12/15/2015. Callable at par after 12/15/14.
Ratings: CCC-
Pays: Semi-anually
Price: 96.0
Yield to Average Life: ~12.25%

Disclosure: Durig Capital and certain clients may have positions in Transener 2016 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.