Each week we screen thousands of corporate bond listings to find what we believe are currently one of the best corporate bond for investors needing or seeking higher yields with the least amount of risk possible relative to their projected return. This week, we look at 4½ year Yankee bonds (in US dollars) from Gajah Tunggal (OTCPK:PTGJY), the largest integrated tire manufacturer in Southeast Asia. Although the approximately 8.25% yield currently indicated with this bond only carries a B+ rating from Standard & Poor's, the following review shows why we see these 55 month high yield notes are a good choice to both increase cash flow and preserve capital. We also believe this debt instrument offers sound diversification away from the financial services sector of the global economy. Consequently, we think these bonds are a very reasonable choice for two of our high-yield managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
A look at the issuer
Established in 1951, PT Gajah Tunggal Tbk began its tire manufacturing by producing bicycle tires and has grown to become the largest player in the Indonesian tire industry. In 1981 the company started producing bias tires for passenger and commercial vehicles with technical assistance from the Yokohama Rubber Company of Japan (OTC:YORUF), and in May of 2004, Gajah Tunggal and Michelin (OTCPK:MGDDF) signed business cooperation agreements focused on the manufacturing of passenger car tires for Michelin markets outside Indonesia and distribution activities in Indonesia. Michelin also acquired 10% of the company's equity in 2004, and Gajah Tunggal was to produce 5 million tires per year for Michelin in export markets by the year 2010. In 2010 the company's net sales surpassed $1 billion, and in 2011 Gajah Tunggal exported more than 10 million radial tires, and surpassed the IDR 10 trillion in net sales. It was also named "Top 10 - best managed companies" by FinanceAsia and "Top 10 - best big companies" by Forbes Indonesia. As of December 31, 2012, the company employed a total of 13,363 employees, compared to 12,423 employees in 2011. Its stock has been listed on the Jakarta Stock Exchange (currently the Indonesian Stock Exchange) since May of 1999.
Although not fully funded, it appears that Gajah Tunggal's aggressive capital expenditures will keep it on a secular growth trend as benign commodity prices have helped bolster profitable margins. Gross margins increased to 19.3% in 2012, from a 14.1% level in the year before, primarily a result of decreases in raw material costs (which make up 76% of its production costs.) This led to record EBITDA for the company of USD 226 million in 2012 up 41% from USD 160 million the year before. The work done by its management to build the strong financial credits of the company over the past four years appears to be successful, with overall credit metrics improving across the board. Gajah Tunggal has several advantages in terms of production over it global peers, for which the conversion costs portion would be significantly higher. The proximity to the raw materials needed in the production of tires reduces logistic and inventory costs as does the vertically integrated production of Synthetic Rubber and Tire Cord. Furthermore, labor costs as well as energy costs are competitive in Indonesia compared to most other tire producing nations.
In 2012, the company ramped up efforts to increase brand awareness in both its domestic and export markets, and announced a number of initiatives to enhance its R&D capabilities. The development of a Tire Performance Testing Facility is expected to be completed in 2014. These initiatives should allow the company to enhance its manufacturing efficiency, improve its cost competitiveness, and be better able to cater to evolving consumer preferences and demands. Furthermore, considering that the company's focus is on the inherently more stable replacement market and the fact that its "value-for-money" brands tend to gain traction in recessionary environments, some of the weakness in developed markets is more likely to be cushioned and we think the overall demand prospects for the company look very good. Given Gajah Tunggal's position as Southeast Asia's largest integrated tire manufacturer, the company is likely to benefit from continued growth within Indonesia, the fourth most populated country in the world with one of the lowest vehicle densities of all major emerging markets. Indonesia has maintained economic growth of above 6 percent for 10 consecutive quarters since October 2010, thanks to strong domestic consumption that accounts for almost 60 percent of its gross domestic product.
We like companies that are profitable
Despite a softer export market, overall sales revenues for 2012 reached Rp 12,579 billion (US$1.25 billion), a 6% increase over the Rp 11,841 billion of 2011. More impressive was the increase in net income to Rp 1,132 billion (US$112.4 million), a 65% increase from the Rp 685 billion recorded for 2011.
Interest Coverage Ratios
Gajah Tunggal's 2012 finance costs of Rp 479 billion (US$ 47.6 million) are expected to increase slightly in 2013 following the replacement of its 2014 step-up bonds (approximately US$ 412 million) with the issuance of this US$ 500 million 7.75% note maturing in 2018. With 2012 EBITDA reported at US$ 226 million, it appears there should be ample interest rate coverage even if finance costs were to double from 2012 levels. First quarter 2013's net income was reportedly increased 35% over 1Q 2012 as margins expanded, while EBITDA was stable at US$ 55 million.
We like companies with lower debt to cash ratio
Gajah's financial debt at the end of 2012 was Rp 3,989 billion (US$ 412.5 million), while cash and cash equivalents increased 54% from 2011 to Rp 904 billion (US$ 89.7 million). Trade receivable grew by 24% year-on-year to Rp. 1,800 billion, which was in-line with increased sales. While the company's continued expansion and aggressive deployment of capital seems likely to continue, lower commodity prices and rising margins appear to be proving strong and relatively stable earnings.
We like companies that have good balance sheets
The total market capitalization of Gajah Tunggal has improved significantly from the end of 2012, and it currently appears to be about Rp 12,200 billion, or US$ 1.2 billion. We estimate its current debt to enterprise value to be less than 30%. In accordance with its stated dividend policy, the company distributes cash dividends to shareholders only if has a positive profit balance (including any carry forward losses), and has paid a cash dividend each of the last three years. Considering its strong revenue growth and solid margins of profitability, we think the company would have little difficulty in accessing additional capital through the equity markets if it were deemed necessary or desirable.
We like higher yields
This five-year $500 million US dollar denominated debt of Gajah Tunggal was issued in February of 2013 at the coupon rate of 7.75%, payable semi-annually, to replace a 2014 note that was scheduled to step up to 10.25% The principal of this new note is non-callable for three years, and after considering the sound fundamentals of this company, we believe that acquiring this bond at or below par represents a strong addition to the high cash flow instruments in our client's foreign and world fixed income holdings.
When comparing the yield, maturity, and expenses of both the iShares Emerging Markets Corporate Bond (CEMB) and the iShares JPMorgan USD Emerging Markets Bond ETF (EMB) to these Gajah Tunggal Feb 2018 bonds, the iShares instruments appear to have lower yields, longer average maturities, higher expenses, while offering only a slightly better average credit rating. In an environment of rising interest rates, we think there are notable advantages to shorter, maturity certain, bonds. However, we acknowledge that a widely diversified bond portfolio does mitigate the default risk of any one issue, and we offer the following chart for comparison purposes only.
|iShares Emerging Markets Corporate Bond CEMB|
|iShares J.P. Morgan USD Emerging Markets Bond ETF|
GT Gajah Tunggal Feb 2018 Bonds
B2 / B+
GT to best ETF in that category.
The GT bond provided a 53% higher boost in yielding than the J.P. Morgan ETF.
The GT bond cost 16% less to own then both funds
The GT bond is 18% shorter than the shorter CEMB ETF
The GT bond is
whole grade below better graded CEMB
*This is a proposed cost only.
The default risk is Gajah Tunggal's ability to perform. Considering its historical and recent performance, flexible balance sheet, sound cash position and the good cash flow that is projected to service its interest bearing debt, as outlined above, it is our opinion that the default risk for this short to medium term bond is minimal relative to its more favorable return potential. Gajah Tunggal's B+ credit rating is only 3 notches below the BB+ rating given to the country of Indonesia. It is our opinion that if or when the credit rating of Indonesian sovereign debt improves, it will increase the possibility of a more favorable rating for Gajah Tunggal.
A harder risk for us to identify is the geopolitical risk. Since we find it hard to understand many of the political changes even in our own country, perhaps the uncertainties of changes on foreign soil become less formidable. With that said, it is our opinion that diversification into other forms often serves to reduce risk. Our strategy here, as with other Yankee bonds, is to focus on unique or required services that can be seen as adding key economic value to the society it's associated with. Gajah Tunggal's products are basic within the transportation needs for any society, and it is highly regarded as one of the best managed companies in its homeland.
Gajah Tunggal is relatively small compared to other global competitors, such as Bridgestone Corp. (OTCPK:BRDCY), Continental AG (OTCPK:CTTAY) or Goodyear Tire (GT). As such it may face increasing competition from substantially larger and better financed companies attempting to capture part of the increasing Indonesian tire market.
The cost of raw materials plainly has a material impact on the margins that Gajah Tunggal is able to achieve, and we acknowledge that higher commodity prices may significantly reduce the company's operating profits. However, the financial and operational performance of the Company reflects the capability of the Board of Directors to execute its strategy planning while adjusting to changing market conditions and it may be possible to pass on rising raw material costs and recover margins. This kind of resilience let the company compensate the weakness of demand in one market, the OE motorcycle tire market and the export market, with strength in domestic replacement markets - resulting in overall good utilization rates of the company's manufacturing facilities.
We believe that these Gajah Tunggal bonds have similar risks and maturities to other Central and South East Asia based Yankees bonds we have previously reviewed, such as Berau Coal's 8.9%, B1/BB- rated, Yankee bonds maturing in Mar. 2017, the Trade & Development Bank of Mongolia's 10% bonds maturing in Oct of 2015, and 7.7% Yields, Vedanta Resources 7.7%, BB/Ba3 rated bonds maturing in July 2018. These reviews can be read on our Bond-Yields.com blog.
Summary and Conclusion
It is our opinion that Gajah Tunggal is positioned well for the future with its expansion and growth initiatives, and its management has demonstrated remarkable flexibility in adjusting to changing market conditions. Furthermore, we think the macro economic conditions in Indonesia are conducive for sustained growth in the domestic tire industry going forward and its strong domestic growth should help shield the Indonesian economy from global weakness. In light of this and its fundamentally sound metrics, we believe these relatively short 55 month Gajah Tunggal Yankee bonds offer an extremely high yield relative to the financial risks that we can identify, and have selected these bonds for our managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
Issuer: Gajah Tunggal
Yield to Maturity: 8.25%
Disclosure: Durig Capital and certain clients may have positions in Gajah Tunggal 2018 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.