This week we look at a short term Dana Gas Sukuk, in US dollars, ending in October of 2017 and currently indicating about a 9% yield to maturity. Although this unrated issue may lack some appeal because of the geopolitical risk associated with various regions of the Middle East, it does represent a key stakeholding in a very profitable natural gas company that produces over 65,000 barrels of oil equivalent per day of oil, gas and natural gas liquids from its operations in Egypt and the Kurdistan Region of Iraq. Here at Durig Capital we have developed our own strict criteria for evaluating unrated and/or high yield junk bonds, and as a result of our research as presented in more detail below, we believe that the below par pricing of this 9% coupon represents one of the best short term "risk to reward" opportunities denominated in US dollars and are therefore targeting it for addition to our Fixed-Income1.com and Fixed-Income2.com portfolios.
A Look at the Issuer
Incorporated in the Emirate of Sharjah, the United Arab Emirates, Dana Gas was established in 2005 with over 300 prominent founder shareholders from across the Gulf Cooperation Council (GCC) region and is listed on the Abu Dhabi Securities Exchange (ADX). Dana Gas's single largest shareholder is Sharjah-based Crescent Petroleum. As the Middle East's first and leading private-sector regional natural gas company, Dana Gas has proven plus probable reserves of 152 million barrels of oil equivalent and a resource potential of some 900 million barrels from its world class acreage in Egypt and Iraq. Dana Gas' primary area of activity is in the upstream sector (exploration and production) with activities and the Company also operates in the midstream and downstream sectors, in particular where it adds value to its upstream activities. Dana Gas PJSC employees around 500 people, and has a geographic focus on the Middle East, North Africa and South Asia (MENASA) Region.
In October 2012, Dana declared payment delays on its previously issued $1 billion Sukuk certificates as a result of the challenges in collecting outstanding receivables in Egypt and the Kurdistan Region of Iraq. (A Sukuk, despite its Eastern verbiage, is little more than fancy alchemy for a bond.) Additional issues with the Egyptian political turmoil since 2011 disrupted economic activity in Egypt, which had an impact on the value of the Egyptian pound, oil and gas production and trade and foreign investment. Both Egypt and Kurdistan were faced with internal political events that paralyzed the state bill-paying mechanisms, and this in turn also affected Dana's investments and returns. Dana Gas said that its problems stemmed from cash flows rather than any structural issues in its core business. In December 2012, Dana Gas, entered into a Lockup and Standstill Agreement with its Sukuk holders/creditors which set out the terms of a refinancing of the existing certificates. In May 2013, Dana issued a $850m Sukuk that comprised two Sukuk, both structured as Sukuk al-Mudarabah - a $425m Convertible Sukuk and a $425m Ordinary Sukuk, both with a 5 year maturity to October 31, 2017. There isn't much publicity surrounding this new Sukuk but the key item to note from a legal/commercial perspective is the provision of $300m worth of security that has been provided as enhanced collateral (largely of Egyptian assets) in respect of the New Sukuk, and the company will also have the option to pay down the outstanding securities prior to their maturity.
After reviewing Dana Gas most recent financial news, we find it very encouraging and see both of these newer issues as offer excellent yields. However, we believe the higher cash flow of the ordinary bond (couponed at 9%) and its higher 9% yield are better suited for our FX1 fixed income portfolio than the lower cash flow of the convertible (couponed at 7%) and its slightly lower 8¼% yields. However, the convertibles do carry the potential for much higher returns should the common stock of Dana Gas (currently at .64 AED) trade significantly higher than the 0.75 AED exchange price of the latter issue, and may be a good choice for those looking for more growth potential.
We like companies that are profitable
Revenues for the third quarter of 2013 was significantly higher at AED 623 million (US170 million), an increase of 21% over Q3 2012. Earnings before interest, tax, depreciation, amortization and exploration (EBITDAX) was AED 340 million (US$93 million) which was considerably higher by AED 23 million (US$6m) than in Q3 2012. Net profit, which remained flat year-on-year due to higher royalty and higher depreciation in line with higher production in Egypt, was AED 102 million (US$28 million) for the quarter, while nine month profits for 2013 were AED 443 million (US$121 million.)
The Company's average production volumes were substantially higher in the third quarter at 66,850 barrels of oil equivalent per day (boepd), an increase of 17% on Q3 2012 (57,000 boepd) and 8% increase on Q2 2013 (61,700 boepd). This significant increase in production was driven by Egypt, which saw a sharp increase in quarterly production of around 30% to 39,350 boepd from 30,400. Dana Gas's share of production in Kurdistan Region of Iraq ('KRI') for Q3 2013 remained stable at 27,100 boepd, up 2% quarter-on-quarter and similar to the Q2 2013 output of 27,000 boepd.
Interest Coverage Ratios
Interest expenses for the third quarter of 2013 was US$ 54 million, while profit before tax for the period was about $162 million, indicating a reasonable interest coverage ratio of about three to one.
We like companies with lower debt to cash ratio
Cash balance, as of 30 September 2013, stood at AED 674 million (US$184m). This, in addition to the Company's other liquid investments allows the company to follow a prudent cash utilisation policy in terms of fulfilling its business-critical capital expenditures and operating expenses and meeting its financial obligations. Overall trade receivables, as of 30 September 2013, stood at AED 2,775 million (US$757m). Long term debt appears to be US$ 831 million, giving it about a 4.5 to 1 debt to cash ratio.
In Egypt, Dana Gas collected AED 30 million (US$8m) in Q3 2013 against its receivables and, as of 30 September 2013, the trade receivable amount was AED 1,093 million (US$298m). In the Kurdistan Region of Iraq, Dana Gas collected AED27 million (US$ 7m) in Q3 2013 against its share of receivables in Kurdistan and, as of 30 September 2013, the balance was at AED 1,646m (US$450m).
Dana Gas is actively engaged in ongoing dialogue with relevant government authorities in Egypt and the Kurdistan Region of Iraq regarding receivables and its future capital expenditure plans. In the interim, the company continues to follow a prudent cash utilization policy and a calibrated capital expenditure programme.
We like companies that have good balance sheets
Dana Gas long term liabilities/debt of $831 million appears to represent about 46% of the near $1.8 billion enterprise valuation currently given it by the equity markets. While the more closely held nature of the stock might limit opportunities for raising additional capital should it be needed, it should be noted that the nature of the convertible sukuk inherently assures the possibility of retiring the one half of the debt obligation with additional company stock if and when it comes due.
The default risk is Dana Gas' ability to perform. Considering the Company's increasing production and its importance to the economies of both Egypt and Iraq, we see the performance risk as being very minimal relative to the geopolitical risk.
These bonds do carry geopolitical risk associated with the policies and actions of the sovereign governments of Egypt and/or Iraq. The political turmoil in Egypt after President Morsi's removal open an uncertain chapter for the country as well as for investors. Since 2011, equity markets have priced in deep discounts for oil companies with exposure to Egypt as a means to reflect the geopolitical risk. An example is Apache Corporation (APA), where Egypt accounts for 16% of production, or TransGlobe Energy (TGA), with much of its production also located in Egypt. However, in 2013, the Egyptian government began efforts to issue billions in bonds to finance the amount owed to these companies. Saudi Arabia, Kuwait and the UAE pledged Egypt a combined $12 billion in grants and interest-free loans. The most recent event suggesting improvement in Egypt's ability to repay debt occurred on November 15th, 2013, when Standard & Poor's raised Egypt's long and short-term foreign and local currency sovereign credit rating from CCC+/C to B-/B, following a "stable" outlook.
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 10% Transglobe Energy Convertible Bonds, the 14.38% Brigus Gold (BRD) Convertible Bonds, or the 10.76% Myria Agro Bonds.
Accessibility and Liquidity
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. Previously, we have been able to facilitate purchases as low as US $10,000.
Using a benchmark of yields (in the chart below), we compared Dana Gas high yield bonds with iShares JPMorgan USD Emerging Markets Bond Fund (EMB) and Vanguard Intermediate-Term Corporate Bond ETF (VCIT) . 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 JPMorgan USD Emerging Markets Bond Fund
Vanguard Intermediate-Term Corporate Bond ETF
US Dollar Bond
Dana Gas Bond compared to the best.
Dana Gas US dollar bond indicates an over 69% boost in yield compared to the iShares JPMorgan USD Emerging Markets Bond Fund
Dana Gas Bonds cost .38 basis points more than the very low cost BSCE ETF.
Dana Gas bonds are 92% shorter than the VCIT fund.
We think Dana Gas is well positioned in the highly profitable oil and gas industry of the regions it is operating within, and it is our opinion that diversification into other economies, in unique and or vital services, and with other forms of fixed income vehicles often serves to reduce risks and increases yields. In light of this and its fundamentally sound metrics, we are selecting these short term US dollar instruments for our clients looking for higher cash flow, high yields, and global diversification, and we are adding it to our managed income portfolios, Fixed-Income1.com and Fixed-Income2.com
Yield to Maturity: ~9.66%
Disclosure: Durig Capital and certain clients may have positions in Dana Gas 2017 Sukuks.
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.