Diamorph AP (FOE:OSL) has a short (possibly very short if called in 2014) high 12% coupon bond maturing in July 2017, denominated in the Swedish krona, and currently has an indicated yield to worst call (in less than 9 months) of about 7% yield. Although we think it is likely that these bonds will be called at the premium price of 107.5 in 2014, should they not be called in 2014, the yield to call in 2015 is over 8%, and nearly 8.5% in the year after that.
Corporate Bond linked to the Swedish Krona
The desire to locate a corporate bond denominated in Swedish krona that both steps away from many of the concerns associated with the banking industry and offers an attractive yield motivated us to look outside the normal "investment grade" rating boundaries set by official rating agencies. Although this week's best bond is unrated by either Moody's or Standard & Poor's, we will present why it meets the strict criteria that we have previously developed and found highly successful for evaluating and avoiding any defaults from unrated or lower rated bond issuers. Consequently, we believe that the significantly higher return potential offered in this rare and limited availability Swedish krona bond from Diamorph Energy represents a savvy investment choice in what is historically regarded as one of the world's stronger currencies, and one in which high yields seem to have been very elusive to find.
Although neither the Swedish currency nor the Swedish economy are big enough to qualify as a "safe haven" for many large institutional investors, the strength of the currency mixed with a high coupon rate date works extremely well with our laddering strategy to diversify clients away from heavily weighted US dollar based assets, and it is why we have selected it for our Fixed-Income2.com and Fixed-Income3.com portfolios.
US Debt Woes
With the US National debt at $16.74 trillion, it remains a major drag on the economy, weighing down growth and job creation. This now exceeds the total Gross Domestic Production for the first time since WWII. Viewed from another perspective, the average American's share of government debt will be more than an average American makes in a year. Yet, the size and scope of the US economy and financial markets, combined with the relative stability of the political climate, have made the US dollar a preferred currency for international trade, and there can be little doubt that the US dollar has reaped tremendous benefits from being the world's reserve currency.
One of the most cited reasons for the dollar dominance, however, is not the United States' role in international commerce. Most notably, it results from its oil trade monopoly. However, China has been busy with bilateral currency swap deals and the rearranging of oil and energy trade agreements to circumvent the use of the US dollar. Not only is China conducting trade of oil and energy products with Russia in their own currencies, it also began conducting business earlier this year with both Japan and Australia directly with the Chinese currency, the renminbi. Furthermore, it's been nearly a year since the first gold contracts denominated in the Chinese Renminbi (also known informally as "yuan") came to the Hong Kong market. In allowing the markets to buy gold denominated in the Chinese currency, investors can essentially exchange yuan directly for other currencies, using gold as a proxy. Latest in a series of currency swap deals and the country's push to transform the yuan into a major world currency, China launched a three year currency swap deal (equal to $60.9 billion in USD) with the euro zone last Thursday.
While the notion of a strong dollar may initially sound good or even invoke a sense of national pride, easy money and currency depreciation appears to be one of the few (if not the only) weapons being employed by the Fed to combat the nation's unemployment issue. Janet Yellen's nomination to replace "Helicopter Ben" Bernanke will likely have no choice but to continue on autopilot. Another reason that Yellen is likely to be locked into continuing the stimulus is the Congressional willingness to play dice with the nation's economic health. The bottom line here is that the Federal Reserve can't pull the plug on the shower of easy money until the economy improves, and the way things are going, that doesn't appear likely to happen in the first year or two of Yellen's tenure. Therefore, what we are looking for here at Durig Capital, are the fundamentally soundest economies to diversify towards, and away from the risk of being overweight in US assets should the longer and broader term global confidence in the dollar continue to deteriorate.
Norway is one of the world's more prosperous countries, and is ranked 18th in the 2013 global index of economic freedom. Recording a notable score improvement, the Swedish economy has become one of the world's 20 freest economies for the first time in the history of the Index due to improvements in the management of government spending, monetary freedom, and freedom from corruption. Despite the high level of public spending on social programs, Sweden's economic policies over the past decade have centered on transforming the public sector through downsizing and improved efficiency. Decisive tax reforms, which have made the corporate tax rate competitively low, have enhanced private-sector productivity. Monetary stability is well maintained, and inflationary pressures appear to be under control. Sweden is ranked 9th out of 43 countries in the Europe region. Sweden joined the European Union in 1995 but rejected adoption of the euro in 2003, and its public remains hostile to eurozone membership. Sweden's economy was healthy before the international financial crisis but, being heavily dependent on European trade, experienced a downturn in 2009 that led to a slight increase in unemployment. Banks remained well capitalized, and Sweden has weathered the financial crisis better than other countries in Europe. Principal exports include automobiles, telecommunications products, construction equipment, and other investment goods.
From 1994 until 2013, Sweden's Interest Rate averaged 3.8%, reaching an all time high of 8.9% in January of 1996 and a record low of 0.3% in July of 2009. The benchmark interest rate in Sweden was last recorded at 1 percent, and the inflation rate in Sweden was recorded at 0.10 percent in September of 2013. Second-quarter 2013 output growth was revised lower last month as weak demand from Europe held back exports and investments declined. Sweden's central bank said last week it won't raise its main interest rate until late next year after keeping it at 1 percent for a fourth meeting to support demand. Sweden's government said last month it will spend 25 billion kronor ($3.8 billion) on new initiatives next year to boost the economy, which it predicts will grow 1.2 percent this year and 2.5 percent in 2014.
Diamorph - Advanced Materials Expertise
Founded in 2003 on 50 years of experience from the world leading materials research department at Stockholm University, Diamorph AB supplies advanced material solutions for especially demanding industrial applications. Headquartered in Stockholm, the Diamorph group has customers in more than 60 countries and 270 employees at units in Sweden, Czech Republic and England. With a strong R&D capability, the company's expertise lies in innovation and tailoring materials for unique applications in extreme conditions. Diamorph's technology is based upon sintering, creating ceramics and composites from powders, and its main product which a significant revenue stream is ceramic rollers. Diamorph shares are closely held and are not listed or traded on any exchange.
In September, 2012, Diamorph completed the acquisition of TENMAT, a British manufacturer of specialized high performance materials. TENMAT has a leading position in several niches and has successfully introduced innovative products that have become industry standard. The acquisition of TENMAT has enhanced the product portfolio and enabled a wider offering in several fields within advanced materials. Headquartered in Manchester, it has a global presence and sales in over 50 countries, and was renamed to Diamorph UK. Diamorph UK has won the prestigious Queen's Award for Enterprise in the United Kingdom for the last two years, as well as the Queens Award for outstanding achievement in International Trade in 2013 as a result of over 20% year on year sales growth in export sales over the past 3 years, while at the same time significantly increasing profitability. Customers for Diamorph UK's engineering composites are located worldwide, and about 80% of the company's revenue is generated overseas.
With cutting-edge R&D, efficient production and a global sales network, Diamorph is very well positioned to continuously bring new products to market. Diamorph has three main product groups: bearing and wear components, high temperature materials and fire protection. The company currently has over 100 products that generally place no. 1 or no. 2 in their respective niches. Diamorph's business model is to develop differentiated products to solve particularly demanding industrial challenges, in close cooperation with potential customers. Demand is increasing for multifunctional materials that combine multiple properties to solve demanding industrial challenges, such as high temperatures, abrasion resistance, chemical stability and thermal conductivity. Customers are demanding increasingly sophisticated components that, while costing more upfront, ultimately reduce the total life cycle cost. The close collaboration with customers during product development often results in high barriers to entry for competitors, and Diamorph's technology provides ceramic materials and glasses with properties, such as hardness, refractivity, and thermal stability, as well as user designable chemical and magnetic properties. Generally Diamorph aims to be the first leading company to develop a product, go through the relevant tests, and then expand distribution to other geographies. In other words, the Company focuses on developing and selling products and licenses based on its proprietary materials technology.
Gross revenues for the Diamorph group (ProForma) in 2012 were SEK 353 million ($54.5 million) and adjusted earnings (EBITDA) were SEK 120 million ($18.5 million), compared to SEK 365 million ($56.3 million) and SEK 127 million ($19.6 million) for 2011. Profit margins remained about the same at 34% (35% in 2011.) Net debt at the end of 2012 was SEK 389 million ($60 million), attributable primarily to the issuance of this senior secured bond (SEK 425 million) and utilized for the acquisition of TENMAT. With TENMAT consolidated in the books in the last quarter of 2012, much of the risks related to integration are diminished.
The first half of 2013 sales and EBITDA improved from the second half of 2012 but fell year over year due to tough comparables from a strong 1H 2012. However, the results mark a continued positive trend in earnings and cash flows and with an LTM EBITDA margin of 32%.
(in millions of krona)
last 12 m.
During the second quarter, a fully subscribed rights issue of 18 million shares was completed. At the end of June, 2013, total fixed assets were reported at SEK 707.4 million, with total assets being SEK 942 million.
There are three primary areas that we focus upon for our bond reviews to help assure the return of our clients' capital. After reviewing their most recent 2Q 2013 statements, Diamorph passes all three categories:
Debt to Equity - about 50%. Higher than we normally prefer, but acceptable.
Debt to Cash - under 3.5 to 1. This is reasonable, and again, quite acceptable.
Cash Flow to Debt obligations - over 1.5x's. Acceptable considering its depth of sales.
Diamorph's vision is to become a world leader in niche advanced materials. Its strategy of working closely with industrial partners to develop and produce advanced materials and components has resulted in a continuously expanding product portfolio, and we are impressed with both the company's performance and its future growth potential.
Using a benchmark of yields (in the chart below), we compared Diamorph's high yield bonds with iShares Short Maturity Bond ETF (NEAR) and The Guggenheim BulletShares 2014 Corporate Bond ETF (BSCE). This is a small sub-sample of highlighted issues, and not a complete comparison that can or should be reviewed, as we have chosen to focus more on short maturity certain bonds cycles when interest rates are climbing. As can be seen in several categories, such as cost and current yields, our approach is very attractive. Again, we are a short maturity focused income house that holds most bonds to maturity and have avoided any bond defaults.
iShares Short Maturity Bond ETF
Guggenheim BulletShares 2014 Corporate Bond ETF
0.70 % Call to worst
Diamorph Swedish Krona bond
7.0% Call to worst
.75 years to first call
Diamorph Krona, Bond compared to the best.
Diamorph Swedish Krona bond indicates an over 800% boost in yield compared to the NEAR short term corporate bond ETF.
Diamorph Swedish Krona bond cost .26 basis points more than the very low cost BSCE ETF.
This is not an accurate calculation because of several calls
*This is a proposed cost only.
The default risk is Diamorph's ability to perform. Considering its performance to date, we believe that these results and its current credit metrics are representative of what can be expected during the coming economic quarters. Likewise, we see the cash flow as being sufficient to service its interest bearing debt. Therefore, it is our opinion that the default risk for this short term bond is minimal relative to either its favorable return potential and/or the currency risk.
The Diamorph group operates in number of different countries and its operations are therefore dependent on global economic developments as well as conditions that are unique to certain countries and/or regions. As in virtually all businesses, general market conditions affect the inclination and the capability of existing and potential customers to invest in advanced materials. Weak global or regional economic development trends may result in the group growing and developing at a lower rate than expected and this could have a negative effect on Diamorph's business, financial position and results.
The company is in a stage of development where several of its products are in a research and development phase. Therefore the company's future growth depends on its ability to render these products successful as well as on its ability to improve existing products, in order to meet customer requirements and to avoid losing market share to competitors. Diamorph's largest competitors are Trelleborg Sealing Solutions in the stock and wear components, Faigle Kunststoffe in wear components for railways and 3M in fire protection. Diamorph actively seeks deep niches in larger markets in order to differentiate itself from the competition and to obtain long lasting customer relations.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Swedish economy and the value of its currency relative to the dollar and other global currencies.
We believe that these Swedish Krona, Diamorph bonds have similar risks and maturities to other European bonds and currencies we have previously reviewed, such as the 8.5% Yield in Rubles, Federal Grid Co, maturing Mar. 2019 (a Company providing the electrical power grid that could affect production and transportation in parts of Europe), the 8% Yields in Swiss franc, SRLEV N.V., with First call Dec. 2016 (a Netherlands insurance company), and the 10.76% Yield Yankee bonds from Myria Agro, maturing in March 2016, (a Ukraine food grower that supplies much of Europe).
Summary and Conclusion
In summary, Diamorph is a very innovative company that we see as being positioned well as a leader in the markets it serves, with strong margins, sound cash flow, a good cash position, and excellent growth potential in a very compelling industry. While we would prefer the longer 46 month exposure to the Swedish kronor indicated in 2017 maturity date of these bonds, we do think it likely that these high coupon (12%) bonds will be called early, possibly next July at the price of 107.50. The premium price now commanded by these bonds clearly lowers what might otherwise be an exceptionally high yield, yet we still see the very short term yield of over 7% as being very attractive relative to the financial risks that we can identify. In light of this and its fundamentally sound metrics, we believe these Diamorph 2017 bonds offer a very good return in Swedish krona as well as a more intelligent venue to lower the risk of being overweighted in US dollar denominated assets. Therefore, we have selected these bonds for addition to our managed income portfolios, Fixed-Income2.com and Fixed-Income3.com
Yield to Worst Call (107.5 in 2014): ~7.0%
Yield to Maturity: ~8.6%
Additional Disclosure: Durig Capital and certain clients may have positions in Diamorph 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.