Each week, we examine hundreds of bond offerings from around the globe in search of excellent yields for our clients relative to risks we can identify. This week, we have found an excellent bond offering from an agricultural company in Hungary. Nitrogénművek produces and sells fertilizers in Hungary and the surrounding regions. They are the sole producer of nitrogen-based fertilizers in Hungary and one of the largest in central Europe, with an astonishing 74% market share in their home country. Their market share dwarfs that of its competitors, with the next best company registering only an 8% market share. Nitrogénművek has demonstrated solid revenues and profits, and has sound financial ratios. The company has proven its reliability to creditors with successful repayment of a EUR 50 million bond issue in 2013. It also has outstanding growth possibilities given the fact that current demand for its products exceeds production capacity. This bond issue is $200M USD with a coupon of 7.875% maturing May 2020, and is rated BB- with a stable outlook by Standard & Poors and Fitch. We view this as an excellent rating when it is considered that debt ratings of foreign corporations are typically limited by the ratings of the county that they operate within, as it puts Nitrogénművek’s BB- ratings only one notch below Hungary’s sovereign debt rating of BB. We frequently refer to this as “the glass ceiling,” giving us reason to believe that if Nitrogénművek’s operations were located within the U.S. it would likely be awarded a much rating, possibly even an investment grade rating in the A’s. Consequently, we think these bonds are a quality addition to our balanced and diversified global fixed income portfolios, FX-1 and FX-2.
A Look at the Issuer
Founded in 1931, Nitrogénművek is the sole producer of nitrogen-based fertilizers in Hungary and one of the largest producers in central Europe with an annual capacity of one million tons of fertilizer. Nitrogen is vital for plant growth and development. Consequently, nitrogen-based fertilizers, which are used in agriculture in order to obtain high-yielding crops, are the most widely used type of fertilizers in the world. The company’s primary products are calcium ammonium nitrate, ammonium nitrate, urea and urea-ammonium nitrate. In addition to these primary products, the Company also sells NPK (nitrogen, phosphorus and potassium) products that are produced by its Bige Holding affiliates. The company focuses its sales efforts mainly in its home country of Hungary, but also has export sales to surrounding countries. The company’s headquarters and main production facilities are located in Petfurdo, approximately 100 km south-west of Budapest, Hungary. Nitrogénművek is a privately held company. Since 2003, Laszlo´ Bige and Zoltan Bige have been the direct shareholders of the Company.
Nitrogénművek currently commands a 74% share of the fertilizer market in Hungary. For the remaining 26% of the market, none of the company’s competitors own more than an 8% market share. There are several factors that favor Nitrogénművek’s continued market domination.
First, the nitrogen-based fertilizer industry has high barriers to entry, including significant capital requirements, extensive technology, specialized knowledge, strict safety requirements and existing customer relationships. Hence, any new competitors would not only be subject to tremendous financial investment (estimated to be HUF 200 billion, or $800 Million in USD, to establish a new operation), but would require a significant period of time before their operations were efficient and profitable.
Secondly, many of the company’s regional competitors have limited production capacity, limited product range (how far they can effectively transport their products), and only offer lower quality products. In the local fertilizer market, the final product can be distributed and sold economically only within a radius of about 1,000 km. Above this distance, the cost of transportation results in a product that is not competitively priced in the marketplace. Nitrogénművek is strategically located within their main target market of Hungary, and can also capitalize on their proximity to Austria, Slovakia, the Czech Republic, Romania and Poland. The company also offers a full range of high quality fertilizer products and has the ability to quickly shift production levels to meet customer’s demands.
Finally, demand for Nitrogénművek’s products generally exceeds its production capacity. Agriculture is one of the key industries in Hungary, with the agricultural area accounting for roughly 50% of the country’s total size. Additionally, the per hectare use of nitrogen fertilizers in Nitrogénművek’s primary markets of Hungary, Serbia, Romania and Slovakia is considerably lower than in more developed agricultural markets. In order to address this shortfall, the company has developed an HUF 82 billion (Hungarian forint) capital expenditure plan for the 2013 – 2020 timeframe to increase production capacities as well as improve production efficiencies. A portion of the funding for this plan will come from this bond offering.
Nitrogénművek continues to be profitable. In 2010, consolidated revenues were HUF 54,820 million ($232.1M USD) growing to HUF 81,187 million ($343.8 M USD) in 2011, an increase of 48%. Revenues for 2012 declined slightly by .4% to HUF 80,809 million ($342.2 M USD), but fell to HUF 52,331 million ($224.0 M USD) in 2013. More notably, annual company profits have remained solid. In 2010, annual net profits were HUF 4,785 million ($20.2 M USD), growing to HUF 15,788 million in 2011 ($66.8 M USD) and HUF 18,662 million in 2012 ($79.0M USD). In spite of 2013 revenues declining significantly due to some technical difficulties at its nictric acid plant during its peak selling season (between Feb and April), it was still able to post net year end profits of HUF 6,274 million ($26.9M USD). Following Nitrogénművek’s update on plant status of full capacity production since September of 2013, we think that this was a onetime temporary setback that isn’t likely to have an extended impact on its long term EBITDA generating capability. Its strong cash position at the end of 2013 cushioned its net debt to EBITDA (3x.)
This isn’t the first time Nitrogénművek has stepped into the international market to raise capital. The company proved its reliability to its creditors in 2013 when it repaid a short-term EUR 50 million bond offering that was issued in 2011. Also in 2013, the company’s Standard and Poor’s rating was renewed during which the rating agency changed the former BB- negative outlook to stable. The long term business plan (thru 2018) includes capital expenditures of EUR 329 Million, with the majority of it going towards plant expansion. We also note that the company has a flexible dividend policy which is designed to support its long term strategy, having paid out a dividend of HUF6 billion (about $25M in USD) in 2013.
The default risk is Nitrogénművek’s ability to perform. We feel their solid revenue and profit growth in recent years will continue as they increase production capacity to fill unmet demand for their products. This will translate to increased sales in Hungary as well as allow them to increase their export sales. Also, the company recently had its fixed assets appraised by American Appraisal Company, one of the world’s largest valuation companies. The value of these fixed assets (lands, buildings, machinery and equipment) was determined to have a fair market value of HUF 104 billion ($440 M USD). In the unlikely event of a cash shortage, assets could be liquidated to meet obligations.
Nitrogénművek’s primary market is in Hungary, but they are increasing their export business. Because of this, there are risks related to currency fluctuations. The company’s sales and revenues are primarily denominated in the HUF, however it also has revenues and operating costs denominated in other currencies, primarily the Euro. This could cause the value of its financial results to decrease due to exchange rate movements. Also, the issuance of these notes (denominated in USD) exposes the company to additional risk of fluctuations in the US dollar-HUF exchange rate.
The principal raw material used by Nitrogénművek in the production of its products is natural gas, which accounts for over half of the company’s total operating costs. An increase in natural gas prices could adversely affect production costs and profitability. However, at times of high natural gas prices, the increase in demand for agricultural products and the corresponding increase in fertilizer prices tend to result in higher margins for the company. This provides Nitrogénművek a buffer to some of the negative impact from higher natural gas prices. Also, Nitrogénművek has contracted for long-term gas transportation capacity on the Austria-Hungary natural gas pipeline. This allows for spot purchases, which provide a hedge to natural gas price exposure.
Geopolitical risk is difficult to measure and assess. Fertilizer production is subject to government regulation regarding licensing and competition. Changes in laws, regulations or policies that affect the company’s business activities could adversely affect the company’s financial condition and results of operations, both in Hungary and within the European Union. With agriculture comprising such a large part of Hungary’s economy, it is unlikely the government would take any action that would jeopardize one of their primary industries.
We think these Nitrogénművek US dollar bonds have similar risks and maturities to other Yankees bonds such as the 8.25% Gajah Tunggal, the 8.45% Camposol S.A, or the 9.5% Autopistas del Sol bonds, which we have reviewed previously on our Bond-Yields.com blog.
Summary and Conclusion
Nitrogénművek is extremely well positioned within its home market in Hungary. With a near-monopolistic 74% market share, increasing profits, and high demand for their products, the company has a large and distinct advantage over its competitors, and it continues to reap the rewards of a defined niche strategy. The company has proven its worth to creditors via a successful bond repayment in 2013. By increasing their production capacity, they will be able to capitalize on existing, unmet product demand in their primary market. Increased (and full capacity) production capabilities will also allow them greater expansion in the export of their products to neighboring countries. In light of these factors, we believe the 7.3% yields indicated with the slightly premium that these bonds trade at will add both good cash flow and sound diversification to our managed Fixed-Income1.com and Fixed-Income2.com global high income portfolios.
Issuer: Nitrogénművek, Zrt.
Yield to Maturity: ~7.3%
Disclosure: Durig Capital and certain clients may have positions in Nitrogénművek 2020 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 Nitrogenmuvek bond, call our fixed income specialist at 971-327-8847
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