Emerging Market Bonds
Short Term High Yielding Bond
Durig Capital Fixed Income Review
We have long searched for a good fixed income investment opportunity in what is considered by some of financial industry’s pundits to be one of the world’s best currencies, the Singapore dollar. This week we target a medium term investment grade note denominated in Singapore dollars from IndianOil Corporation, which appears to be yielding over 4%. While this yield may not initially appear to be as robust as many of shorter maturity bonds that we have recently identified, if this bond’s currency continues on its longer term strengthening trend against the U.S. dollar, then the appreciation or changes in the valuation of the Singapore dollar over the next 9 1/2 years to its maturity can be viewed by US based bondholders as being added to its leaner 4.1% coupon. This IndianOil Corporation note is one of the very few fixed income vehicles that we could find in Singapore dollars that meets the strict standards of Durig Capital and offers an attractive return relative to the risks that we can identify, and it is why we are adding it to our Foreign and Global Fixed Income Portfolio.
Corporate Bond linked to the Singapore Dollar
This IndianOil Corporation debt, denominated in Singapore dollars, has a coupon of 4.1% and currently trades near or slightly above par. This is a noticeably lower yield than some of the bonds we have selected in the recent past, especially considering its longer 9 1/2 year maturity.
However, it does carry a high investment grade rating from a very reputable issuer with fundamentally sound financials, as explained in further detail below. Without question, the primary attractiveness of this instrument is the exposure it offers investors to the relative strength and stability of the Singapore dollar. Singapore’s monetary policy has been centered on the management of the exchange rate since the early 1980s, with the primary objective of promoting medium term price stability as a sound basis for sustainable economic growth.
Three main features of the exchange rate system in Singapore, as stated on its website, are:
The Singapore dollar is managed against a basket of currencies of our major trading partners.
MAS operates a managed float regime for the Singapore dollar with the trade-weighted exchange rate allowed to fluctuate within a policy band.
The exchange rate policy band is periodically reviewed to ensure that it remains consistent with the underlying fundamentals of the economy.
Below is a five year chart illustrating the strength of the Singapore dollar (SGD) relative to the U.S. dollar (USD). Double clicking on the chart itself will reveal its longer 10 year, and perhaps much more startling, trend.
We believe the dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power, and although Japan’s central bank willingness to pursue quantitative easing has recently strengthened numerous other major currencies, including both the Euro and the U.S. dollars, we view the current relative strength of the US dollar as providing a good opportunity for diversification away from the dollar and into a variety of other strong global currencies, which necessitates including an exposure to the Singapore dollar.
Singapore was founded as a British trading colony in 1819. It joined the Malaysian Federation in 1963 but separated two years later and became independent. Singapore subsequently became one of the world’s most prosperous countries with strong international trading links (its port is one of the world’s busiest in terms of tonnage handled) and with per capita GDP equal to that of the leading nations of Western Europe.
Singapore has a highly developed and successful free-market economy. It enjoys a remarkably open and corruption-free environment, stable prices, and a per capita GDP higher than that of most developed countries. The economy depends heavily on exports, particularly in consumer electronics, information technology products, pharmaceuticals, and on a growing financial services sector. Real GDP growth averaged 8.6% between 2004 and 2007. The economy contracted 0.8% in 2009 as a result of the global financial crisis, but rebounded 14.8% in 2010, on the strength of renewed exports, before slowing to 5.2% in 2011 and 1.3% in 2012, largely a result of soft demand for exports during the second European recession. Over the longer term, the government hopes to establish a new growth path that focuses on raising productivity, which has sunk to an average of about 1.0% in the last decade. Singapore has attracted major investments in pharmaceuticals and medical technology production and will continue efforts to establish Singapore as Southeast Asia’s financial and high-tech hub.
Growing housing and car prices and tighter foreign manpower controls have recently created an upward pressure on the inflation rate, thus preventing the monetary authority from easing its exchange rate policy. In addition, retail sales declined 2.7 percent in February from a year earlier, hurt by a 39.7 percent drop in sales of motor vehicles, as a result of restrictions put on the car sales. On the positive side, in the last three months of 2012, unemployment rate decreased even further to 1.8 percent, the lowest level since 2007. The Singapore Government’s fiscal policy is to run a surplus, and the estimated surplus for 2013 is about S$2 billion (US$1.6bln), or 5% of its total revenue.
As a means of comparison, over the last year Singapore’s Government Bond Yield for 10 Year Notes have declining 0.21 percent to 1.40%, while the benchmark interest rate in Singapore was last recorded at 0.03 percent. Standard & Poor’s credit rating for Singapore stands at AAA. Moody’s rating for Singapore sovereign debt is Aaa. Fitch’s credit rating for Singapore is AAA.
IndianOil Corporation Ltd. is India’s flagship national oil company, with business interests that straddle the entire hydrocarbon value chain – from refining, pipeline transportation and marketing of petroleum products to exploration & production of crude oil & gas as well as marketing of natural gas and petrochemicals. It is the highest ranked Indian corporate in the prestigious Fortune ‘Global 500’ listing, ranked at the 83rd position in the year 2012, and is 78.9% owned by the government of India. Indian Oil is India’s largest company by sales, with revenues of Rs.4,09,957 crore ($85.55 billion) and profits of Rs.3,955 crore ($825 million) for the year 2011-12.
IndianOil and its subsidiaries own and operate 10 of India’s refineries and its cross-country network of crude oil, product and gas pipelines is the largest in the country. Its Gross Refinery Margins have gone through a tumultuous phase last year, being at reasonable levels in the first six months and then falling into a tightening trajectory before recovering in the last quarter of the year. Despite the tight margins for the year, it was able to achieve healthy profit levels. However, profits were lowered after the imposition and payment of an Entry Tax by the State Government of UP on crude oil received at its Mathura Refinery (retrospectively from 2007 onwards). Subsequent to this, it has taken various steps to prospectively pass on a sizeable component of this tax through sale of major petroleum products in the State, and expectations are that the impact of the entry tax for the past period to be mitigated. Barring such one-time burdens, IndianOil continues to grow at a healthy pace and retains market leadership in India’s Downstream Sector.
As a country, India has achieved 8-9% growth rates continuously over the last six years. However, the year 2011-12 saw the growth rate plummet to 6.5%, which although lower than previous years, is still much higher than many other countries. The widening fiscal deficit and trade gap, combined with high inflation and reduced growth has pushed the country at the moment into the danger zone of stagflation, having the worst of both the worlds – anemic growth and high inflation. However, POL (Petroloeum, Oil, and Lubricant) demand growth remains robust at 4.9%, and in terms of value, crude oil imports stood at 7.5% of the GDP – easily amongst the highest in the world. Due to uncertainties in domestic gas production, India has turned into the third largest importer of natural gas among Asian countries, after Japan and South Korea. If the country is to continue to grow on a high trajectory, access to energy has to be ensured, and India’s polymer market is set to grow to over 12 MMTPA in the next five years (supported by demographics, changing lifestyles and growing income levels.)
The total debt of IndianOil appears to be about $14.8 billion, or about 10.4% of its current enterprise value, and its operating cash flow is about $5,240 million compared to interest expenses of about $229 million. This IndianOil bond is currently rated Baa3 by Moody’s.
The default risk is IndianOil’s ability to perform. Considering that the company is essentially state owned (78.9%), the primary operator within the Indian economy’s vital oil industry, has excellent revenues and cash flow, very low debt to equity, and has a high investment grade rating by Moody’s, and it is our opinion that the default risk for this issue is relatively low compared to the currency risk of the Singapore dollar.
Globally, the Oil & Gas industry continues to be impacted by geopolitical tensions that rock the oil markets and bring heightened volatility in oil prices. The refining sector especially is expected to pass through a tough time, primarily because of the slowdown in growth all around, including in scaling down of growth rates in emerging economies from Asia essentially due to the increased inter-connectivity of the global business.
The Indian petrochemicals industry will face competition from larger, very well financed oil industry giants with hubs in China, Singapore and West Asia for global markets. However, the growing market of India places IndianOil in a unique and advantageous position to tap these opportunities.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Singapore’s economy.
Accessibility and Liquidity
IndianOil has relatively little debt for a company of its size and nature, and we have specifically targeted this debt denominated in Singapore dollars for the express purpose of diversification away from the US dollar. We believe having a portion of fixed income revenues outside of the dollar actually helps lower the overall portfolio risk to the greenback’s potential devaluation against other global currencies. We also 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. Achieving an institutional sized yield typically requires an institutional sized bond purchase, and even though broker/dealers may require an institutional sized bond purchase, it is possible with an advisor or an investment manger’s assistance for a number of retail clients to be combined together in order to make a larger institutional sized purchase. This is how we have been able to facilitate purchases as low as US $5,000 for many retail buyers.
While acknowledging that every investment vehicle involves varying elements of risk, we believe that recent pricing of the Singapore dollar relative to the U.S. dollar represents an good opportunity for initiating a longer term exposure to it with a relatively high yield from such a sound issuer as IndianOil. The economic policies and fiscal responsibility of Singapore appear have resulted in its currency having appreciating against many other global currencies over the last ten years, and should this continue on the same path for the next ten years, we expect that comparative yields when measured against a U.S. dollar based investment have a high possibility of being outstanding relative to the risks that we can identify. Therefore, we view the currency risk of this remarkable city-state nation as one that we have highly recommended our clients take in their continued effort to diversify away from overweighted US dollar based assets, and it is why we are adding these long 9 1/2 year IndianOil bonds in Singapore dollars to our Foreign and World Fixed Income holdings.
Yield to Maturity: ~4.05%
Disclosure: Durig Capital clients may currently have positions in these IndianOil 2022 bonds.
To know more about this IndianOil bond call our fixed income specialist at 971-327-8847
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.