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In today’s world, electricity is almost as imperative to our existence as food and water. With that in mind, we look to Argentina, where the largest, private hydroelectric power plant in the country had issued a 9% coupon, sinking Yankee bond, with one-fourth of its principle scheduled for return each July starting in 2014 and maturing in 2017. This Argentina based issuer, rated at B- by S&P, has already paid back the first 25% of this bond’s debt, the remainder of which is callable at par in July 2015. Hidroeléctrica Piedra del Águila S.A (HPDA) was recently been absorbed (along with two other electric generating companies) by Central Puerto SA, a subsidiary of Sociedad Argentina de Energía S.A (SADESA).
Central Puerto has total cash that exceeds total debt, as well as excellent profitability ratios. In addition to strong financials, through the benefit of its recent merger Central Puerto has more than doubled its electricity generating capacity, going from three electric generating plants to ten plants. Argentina is still seeking to fill the gap between electricity supply and demand. With its recently increased generating capacity, Central Puerto definitely stands to benefit from this need. Pairing this with recently authorized, increased electricity tariff rates for Argentine generating companies, we believe these very short maturity sinking bonds represent a unique and savvy investing opportunity. Therefore, we see these lesser known, thinly traded, emerging market bonds from Hidroelectrica as offering both high cash flow and excellent short term yields and have targeted them for addition to our FX1 and FX2 portfolios.
Electricity in Argentina
Argentina’s demand for energy is close to surpassing its supply. Demand for energy closely mirrors GDP growth. At an average growth rate of 5% per year, Argentina should be adding 1000 MW per year to its electricity supply. (Argentina’s GDP grew 8.8% in 2003, 9.0% in 2004, 9.2% in 2005 and 8.5% in 2006). The country increased its electricity supply between 1992 and 2001, but this added capacity stalled between 2002 and 2007, when supply did not increase, largely due to the government controlled fixed tariffs after the Argentine economic crisis of 2001-02. For Argentina, reform in the energy industry is necessary to increase private investment and generate more supply of electricity in order to absorb the country’s increasing demand and avert future blackouts.
Argentina’s policies have led to excess demand over supply. After a severe economic crisis in 2001-2002, the government of Argentina enacted the “Emergency Law”. The operation of generators and the wholesale electricity market (WEM) in Argentina was substantially altered. Tariffs (the amount companies can charge) of electricity distributors and transmission companies were frozen. In order to cover the deficit between production costs and tariffs charged, Argentina’s National Treasury covered the deficit via subsidies to the companies involved. The situation caused many Argentine generators, transmission companies and distributors to defer any further investment. Many market participants, especially generators, are currently operating near full capacity. As a result of this over regulation in the Argentine electricity industry, electricity generators are even more essential today as they have the capability to fulfill the discrepancy between supply and demand.
About the Issuer
Hidroeléctrica Piedra del Águila S.A (HPDA) generates and distributes hydroelectric power in the province of Neuquen in Argentina. The company was incorporated in 1993 and is based in Piedra del Águila, Argentina. Hidroelectrica Piedra del Aguila S.A. operates as a subsidiary of Sociedad Argentina de Energía S.A. (SADESA). HPDA is the largest private hydroelectric power plant in Argentina. It is located on the Limay River, approximately 1200 kilometers southwest of Buenos Aries. The plant has a 1400 MW capacity generating nearly 5000 giga-watt hours each year, making it a key part of the national grid. Hydroelectric power is vital to Argentina’s electricity generation and currently makes up 35% of total electricity generated, surpassed only by thermal generation (steam, natural gas and diesel). HPDA issued these bonds in 2007 to refinance all senior, outstanding debt, and they are currently “B-” by Standard and Poors.
SADESA currently comprises 15% of the total electricity generation in Argentina. In August of this year, SADESA subsidiary Central Puerto SA absorbed three other SADESA subsidiaries including Hidroeléctrica Piedra del Águila, Centrales Termicas Mendoza and La Plata Cogeneracion, effectively combining the four companies into one generation utility company. Central Puerto SA is engaged in the generation, transmission and distribution of energy, as well as the exploration, extraction and commercialization of hydrocarbons and its derivatives. The Company’s facilities included three thermoelectric power plants located in Puerto de la Ciudad de Buenos Aires, which accounted for 10% of the Argentine Interconnection System. With the merging of Central Puerto with the three other SADESA subsidiaries, the company has added five additional thermal generation plants, one hydroelectric plant and a cogeneration plant to its generating capacity.
As one company, Central Puerto now assumes the debt issued by HPDA, including this sinking bond issue. These sinking bonds carry less risk than non-sinking bonds, as the issuer is required to repay 25% of the debt in each of the three years preceding its maturity, and is therefore not as likely to face a required refinancing of the last 25% of the debt at the notes maturity in 2017.
Central Puerto’s stock has experienced superb growth within the past year. In late December 2013, the stock was trading at ARS $14.35. Its highest trading price within the last year was in late September, when it traded for ARS $55.90. This represents an increase in stock price of 186%. As of mid-November, the stock is trading at approximately ARS $48.50. With the addition of the added electric generation capacities, the company should continue to return solid performance, especially in light of the increased demand for electricity in Argentina.
The company has a strong balance sheet as well. As of the most recent quarter (ending September 30, 2014), Central Puerto had total cash of ARS $297.79M and total debt of ARS $182.33M. This cash and debt amounts do not reflect the addition of cash or debt acquired from the additional utility companies recently acquired.
Quarterly cash flow has shown healthy increases from Q3 2013 to Q2 2014. For Q3 2013, net income was ARS $33,000,000 growing to ARS $55,000,000 in Q4 2013. In Q1 2014, net income was ARS $81,000,000, growing to ARS $169,000,000 in Q2 2014. Over this time period, this represents an increase of over 400%. For Q3 2014, net income fell to ARS $45,000 due to increased operating expenses. We anticipate net income increasing moving forward due to the added generation plants from the recent merger.
Central Puerto also has solid profitability ratios. Over the last twelve months, their profit margin was 41.10%, with an operating margin of 14.99%. Quarterly revenue growth (year over year) increased by 62.80%.
The default risk is HPDA’s / Central Puerto’s ability to perform. With the recent merging of Central Puerto with the three other SADESA subsidiaries in August, Central Puerto has more than doubled its capacity for electricity generation, going from three generating plants to ten generating plants. The additional plants will increase revenues, which we feel will be evident as early as Q4 2014. Given that the issuer has already repaid 25% of this debt to bondholders, we think the sinking feature of this bond has significantly lowered its default risk.
Central Puerto’s operations take place in Argentina; hence its revenues are based on the Argentine peso. With this issue being denominated in US dollars, there is currency risk present as the exchange rate fluctuates between the peso and dollar.
Perhaps the most difficult risk to ascertain is the geopolitical risk in Argentina. As stated earlier in this review, the Argentine government has kept electricity tariffs artificially low for over a decade, since the Argentine financial crisis in 2001 and 2002. This translated to little or no investment in the electricity infrastructure during that time as the revenues to electricity generators were often insufficient to cover increasing costs. However, in light of growing budget deficits from energy imports, the Argentine government moved to grant higher electricity rates to power generators in May 2014. Rates will ultimately increase from 25% to 110%. The government has also created a fund for the maintenance of the supply networks, and to assist with increasing generating capacity, as demand for energy grew 41% between 2003 and 2011. Our strategy with this bond, as with other Yankee bonds, is to focus on unique or essential services that can be seen as adding economic prosperity to the country or community where it is located.
We believe these Hidroeléctrica Piedra del Águila Yankee bonds have similar features and risks as other Latin America Yankee bonds we have previously reviewed such as Alta Palermo, Transportadora de Gas Del Sur, and Autopistas Del Sol.
Summary and Conclusion
Electricity is a vital and necessary component of modern life. It powers our world. Argentina has continued to grow its economy, but has not invested in the necessary infrastructure in its electricity and energy industry to keep pace with the country’s growth. Central Puerto stands poised to benefit from its recent merger with three other electricity generators (including Hidroeléctrica Piedra del Águila), providing an imperative product to the Argentine nation. With the recent approved increased tariffs for electricity generation, Central Puerto will not only be able to fully cover costs, but will be able to grow, adding much needed capacity for an increasingly energy hungry nation. We think the 6% yield to worst call (in 8 months) is unlikely, and the more probably 20 month average life yield of 7.75% of these of these sinking bonds from Hidroelectrica offers a superior return relative to the risks that we can identify, and have therefore selected them for addition to our FX1 and FX2 income portfolios.
Issuer: Hidroelectrica Piedra del Aguilai
Maturity: 7/11/2017 (average remaining life 7/02/2016.)
Sink Factor: currently .75 (returned .25 on 7/11/2014)
Scheduled Sink: second ¼ on 7/11/2015, third ¼ on 7/11/2016, final ¼ on 7/11/2015.
Yield to Worst Call: ~6% (at par, 7/11/2015)
Yield to Average Life Maturity: ~7.75% (7/02/2016)
Disclosure: Durig Capital and certain clients may have positions in Hidroelectrica Piedra del Aguila 2017 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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