This week, we look to South America, where an Argentine utility monopoly continues to improve its profitability and ratios. This is our third look at Transener, which we first profiled in August 2014, then again in June 2015. After two solid, profitable years in 2013 and 2014, Transener has continued to improve its position with consolidated net income for first six months of 2015 of AR$ 117.5 M compared to a consolidated net loss of AR$ 4.0M for the same period in 2014. Interest coverage has also improved since our last review, going from 1.7x to its current level of 2.3x. At their current yield of 12.5%, these relatively short-term bonds exceed the current 5-year U.S. Treasury yield of 1.40% by nearly nine times. With Argentine elections being held at the end of the month, expectations are that the next ruling party will at last review and adjust the outdated tariff rates that have prevailed for over a decade. With investment interest in Argentina growing, these outstanding 12.5% yielding bonds present a perfect opportunity for investors to participate in Argentina’s recovery, and we have marked them for addition to our FX1 and FX2 portfolios.
Essential Services for Argentina
For any modern country and economy, electricity is absolutely essential for its citizens. Transener transports 90% of the electricity in Argentina. In spite of the tariff freezes imposed since the 2001/2002 economic crisis, Transener has continued providing this essential service, as it is virtually a monopoly. In addition, there is very little possibility for any competitor to enter this space, as the costs would be prohibitive (in excess of USD $1 M per mile according to a study by Black and Veatch). For the investor, a company with a virtual monopoly, providing an absolutely essential service in an industry with extremely high barriers to entry is a welcomed addition to any investment portfolio.
About the Issuer
Founded in 1993, Transener owns, operates and maintains 90% of the high voltage transmission system in Argentina. 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 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. As a result, the monies collected from electric customers and consumers did not cover Transener’s cost of operations. This rolling deficit has been 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.
At our last review of Transener in June 2015, we noted the excellent recent performance of Transener stock, which at that time had appreciated a whopping 210% over the previous 52-weeks. It is also worth noting that Transener stock was the top performer for 2014 in the Buenos Aires Merval Index with a gain of 206%. The stock is currently trading around AR$ 5.07, still well above its current 52-week low of AR$ 2.80.
Argentina’s Upcoming Elections
There has been a great deal of interest from the financial investment world in the upcoming Argentine elections scheduled to take place in late October. The prevailing opinion is that the new ruling government will take the much needed steps to remedy the policies set in place by current President Cristina Fernandez de Kirchner that have damaged the Argentine economy and made it difficult for the country to gain access to international lending and international investment. This election optimism was evidenced earlier this year, when Transener bonds were up 23% for 2015 on the speculation of a more market friendly government once the elections are held.
As stated in our last Transener review earlier this year, the company was able to register profits in 2013 and 2014 thanks in part to the revenues from the Renewal Agreement. The company’s financials for Q1 and Q2 of this year continue to show solid growth as well.
For Q1 2015, consolidated net sales increased 12.6% as compared to Q1 2014. Consolidated net profits showed even more impressive growth, with a profit of AR$18.2M compared to a net loss of AR$92.8 M for Q1 2014.
Transener’s last reported quarterly results (which include results from Q1 2015) should also encourage investors and bondholders.
Consolidated net revenues for six months ended 6/30/15 were 32.1% higher than same period for 2014. (AR$ 823.9 M vs. AR$ 623.7 M)
Consolidated net income for first six months of 2015 was AR$ 117.5 M compared to a consolidated net loss of AR$ 4.0M for the same period in 2014.
Operating income increased for six months ended 6/30/15 – registering at AR$136.1 M compared to AR$ 71.9M for the same period in 2014.
Transener’s interest coverage ratio has also improved. At our last review, the company had an interest coverage ratio of 1.7x for 2014. For the six months ended June 30, 2015, Transener had operating income of AR$ 136.1 M and finance expenses of AR$ 58.8M for an interest coverage ratio of 2.3x. Transener also had cash and cash equivalents as of June 30, 2015 of $44.9 million (in US dollars).
The default risk is Transener’s ability to perform. It is encouraging that the company has produced two profitable years, and continues to improve even in the wake of tariff rates that are still in need of adjustment to reflect market rates for the cost of electricity. With the election set for the end of this month and the expected tariff reviews that many expect will follow, Transener margins should continue to benefit from any action to move electricity rates closer to actual costs for transmission and distribution.
Any investment in a company domiciled outside of the U.S also presents geopolitical risk. Argentina’s socialist government has long subsidized public utilities in the country, attempting to foster economic growth by freezing costs for basic services such as water and electricity. While this strategy did help the country to recover from the 2001/20012 economic crisis, recent growing budget deficits have meant the end of many long-running public utility subsidies giving way to higher utility bills for the consumer. Reliable electric power is of vital importance to Argentina’s growth and economic viability. With a new government poised to take control at the end of this year, there will certainly be positive changes on the horizon for Argentina’s many subsidized utilities.
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 between Argentine pesos and US dollars, especially as it relates to payments of interest and principal to bondholders.
These 10% Transener 2016 bonds appear to have similar risks, features and maturities to other Yankee bond issues such as 7.75% Hidroelectrica Piedra Del Aguila, 9.5% Autopistas Sinking Bonds, and 10%+ Transportadora de Gas Del Sur (TGS), previously reviewed on our Bond-Yields.com website.
Summary and Conclusion
Transener’s electrical distribution services are absolutely essential for Argentina. Without an option to replace or rebuild high voltage transmission lines, we think Argentina is highly likely continue to ensure that Transener remains a viable utility. As the country prepares for its next chapter with a new government later this year, Transener is also more likely reap the benefits of a reassessment of tariff rates and subsidy reductions. These relatively short-term 71 month bonds, which are currently yielding an outstanding 12.5% have been marked for addition to both our FX1 and FX2 managed portfolios.
Issuer: Compania de Transporte Energia (Transener)
Yield to Maturity: ~12.5%
About Durig Capital
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When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.
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.
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