After the news of the passing of Hugo Chavez, we thought it appropriate to reconsider Petroleos de Venezuela S.A. (PDVSA) bonds, in US dollars, that currently indicate an 9% yield to maturity. Although this Yankee note may lack some appeal because of the greater geopolitical risk associated with the unpopularity of Venezuela's current socialistic government among many foreign investors, it does represent the senior unsecured debt of one of the most highly prized and crucial state owned companies in the country's most valuable industry. We have developed our own strict criteria for evaluating high yield "junk" bonds, some of which is presented in more detail below, and we believe that the slightly discounted price of this 8.5% coupon bond represents one of the best short term "risk to reward" opportunities denominated in US dollars. Although it appears that acting president Nicolás Maduro, the front runner in Venezuela's upcoming elections, will likely be little change to the country's existing socialistic and economic policies, we think the current air of uncertainty has presented us with an opportunity to acquire these bonds at a discount to par. Therefore, we have marked these 55 month high yielding PDVSA Yankee bonds for addition to our Foreign and World Fixed Income holdings.
Wealth Preservation Concerns
Wealth preservation remains as one of the biggest concerns among our clients, and we continue to look for the most "intelligent risks" that are more likely to achieve reasonable returns that can simply outpace moderately rising inflation. With US Five-Year treasury yields stuck well below 1% and the official CPI still over 2%, a certain degree of wealth destruction is virtually assured within these otherwise commonly considered "safe" US government notes.
Part of our effort to protect our client's assets against the persistent destruction associated with an ever increasing supply of US dollars is to lower overall portfolio risk by diversifying into a variety of higher yielding instruments denominated in US and foreign currencies both within and away from the US economy.
Venezuela remains highly dependent on oil revenues, which account for roughly 95% of export earnings, about 40% of federal budget revenues, and around 18% of GDP. Venezuela is the fifth largest member of OPEC, and is reported to have the world's largest proven oil reserves, surpassing both Canada and Saudi Arabia. However, a lack of technology and limited drilling sees its output at only 31 percent of Saudi Arabia's and its exports at only 22 percent that of Saudi Arabia. GDP growth rose to 5.12% in 2012, while government spending, minimum wage hikes, and improved access to domestic credit continues to cause high inflation - roughly 22% in 2012. The government tightly controls Venezuela's currency, the bolivar. It was devalued by 32 percent in February and now officially trades at 6.3 bolivars to the dollar, pushing up prices for most products. Since oil is priced in dollars, a weaker bolivar increases the local value of oil revenues, giving the government more cash.
While Venezuela continues to wrestle with a housing crisis, higher inflation, an electricity crisis, and rolling food and goods shortages - all of which were fallout from the government's unorthodox economic policies - a healthy Venezuela would quickly become one of the most attractive destinations for investment in South America. Its size, geographic position, resources and educated workforce would find it relatively easy to attract international investment as it did in the past. Closer relations with powerhouses, such as Brazil and Colombia, that have prospered without alienating the US are a chance for Venezuela to reintegrate the international fold.
A handful of oil companies have stuck it out in Venezuela, especially Chevron (CVX), which takes the long view that by sticking with the country through difficult times it might end up in a favorable position when a more reasonable regime comes to power. Whether or not Venezuela contemplates a liberalization of its oil economy that would allow or encourage greater investment from giants like Chevron, currently involved in five important onshore and offshore projects in Venezuela through a partnership with Petróleos de Venezuela S.A., we prefer the similarly yielding debt of the state owned oil company PDVSA over any of Venezuela's sovereign debt issues.
Petroleos de Venezuela S.A. (PDVSA)
Petróleos de Venezuela S.A., the state-owned corporation of the Bolivarian Republic of Venezuela, is responsible for the efficient, profitable and dependable exploration, production, refining, transport and commerce of hydrocarbons. Its main objectives are to foster the harmonic development of the country, to guarantee sovereignty of national resources, to increase endogenous development and to serve and benefit the Venezuelan people, who correspond to their share of the country's national wealth. PDVSA is constitutionally the owner of the country's oil reserves. The State of Venezuela is PDVSA's sole stockholder under the provisions of the Constitution of the Bolivarian Republic of Venezuela and represents the economic and political sovereignty exerted by the Venezuelan people over oil, their major energy resource.
Therefore, PDVSA's actions must follow the Ministry of Energy and Petroleum's guidelines, plans and strategies, as well as the norms issued by the National Development Plans for the hydrocarbon sector. Transparency and clear control of accounts is stated as being a fundamental value for PDVSA. PDVSA has not yet reported its 2012 results, but given the strong average export price of oil in 2012, we expect that revenues for the year to be comparable to the US$124.75 billion of revenues reported in 2011. Total assets for PDVSA were last stated as being US$182.16 billion at the 31st of December 2011, however the actual amount of debt PDVSA may be responsible for isn't as clearly communicated. US$108.27 billion was stated as being "mirrored in liabilities" in 2011, but differently labeled "thorough review" stated it as being only US$32.49 billion. Reuters reported it as being US$32.50 billion, and it was reported by El Universal elsewhere as having increased to US$43.3 billion.
It bears repeating (from our previous review) that PDVSA is using the lending in US dollars to bring in equipment and technology, while Asdrúbal Oliveros, an economist and director of economic research firm Ecoanalítica, commented that these bond issues are mainly made to maintain the exchange rate policy. "PDVSA is borrowing money at expensive rates to grant the private sector access to foreign currency," he remarked.
One of the key metrics that we examined when reviewing this issue was cash flow, profitability and the longevity of its proven reserves (which is estimated at 387 years.) While the investment spending by the company's growth and expansion strategy are more concerning to from a long term perspective, the short to near term prospects for a return of capital appear to us to be favorable. Consequently, we think the higher yields associated with the slightly longer term (4½ year) PDVSA Yankee bonds represent a great opportunity to both increase and maintain good exposure to this debt instrument's enduring high return potential.
The default risk is PDVSA's ability to perform. Given the importance of the state-owned company's oil export business to the economy of Venezuela, we do not believe the performance risk differs significantly from slightly lower yielding sovereign debt of similar maturity. Therefore, we see higher yield of this bond is an intelligent reward opportunity relative to its performance risk.
These bonds do carry geopolitical risk associated with the policies and actions of the sovereign government of Venezuela.
We view these bonds as having other risks similar to other lower or unrated high yield short to medium term bonds that we have recently written about, such as the 11.75% Transportadora de Gas Del Sur (TGS) bonds, the 7.4% yielding bonds from Ferrexpo or the 10.5% yields from Myria Agro.
Accessibility and Liquidity
PDVSA has numerous outstanding US dollar denominated bonds with maturities ranging out to 2037. We 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. Even though many times broker/dealers require an institutional sized bond purchase, it is possible with a broker and advisor's assistance for a number of retail clients to be combined together in order to make a larger institutional sized purchase.
Given the savvy high reward to risk opportunity we see these bonds represent, we are recommending these short term PDVSA Yankee bonds for our clients looking for both greater cash flow and diversification away from overweighted US economy based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Yield to Maturity: ~9.04%
Disclosure: Some Durig Capital clients may currently own these 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 to achieve higher yields for retail clients.