- Discounted bond price offers a high 8.67% yield to maturity in just under 4 years.
- The company operates the biggest fleet of oil fuel tankers in Kazakhstan.
- Record a 29.9% increase in gross profit, and a 35.9% increase in profit after taxes.
Every week we screen thousands of corporate bond listings, searching for the instrument that offers investors higher yields with lower risks relative to its projected returns. This week, we look at 47-month US dollar bonds from Eastcomtrans, the largest private railway operator in the freight transportation market of Kazakhstan. Rated at B3/B by Moody's and Fitch, these 7.75% couponed notes are currently trading a few points below par and indicating a yield to maturity of about 8.67%. Grown from a small transport company, in nine years Eastcomtrans has become a market leader in oil cargo rail transportation. Having increased its gross profits in 2013 nearly 30% over the previous year, we think these short-term notes are a superior choice for good cash flow, high yields, and sound diversification. Therefore, we have targeted them for addition to our high yielding managed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
The nation of Kazakhstan
Kazakhstan is the largest of the former Soviet republics, excluding Russia, and straddles the boundary between Europe and Asia. It is the ninth largest country in the world by land area. At 1,052,085 square miles, it's about 1.5 times the size of the state of Alaska, and just under four times the size of the state of Texas. For all its land area, only 9% of the land is arable, and a minuscule 20,660 square miles (less than 2%) is irrigated. Consequently, the economy is heavily dependent on the extraction of mineral wealth, of which the country has a sizable supply. Kazakhstan possesses large fossil fuel reserves and plentiful supplies of other minerals and metals, such as uranium, copper, and zinc.
Kazakhstan is currently the twelfth largest oil exporting country in the world, and oil is the country's leading economic sector. Kazakhstan holds about 4 billion tons of proven recoverable oil reserves and 2,000 cubic kilometers (480 cubic miles) of gas. Production of crude oil and natural gas amounted to 79.2 million tons in 2012, up from 51.2 million tons in 2003. According to U.S. Energy Information Administration figures, Kazakhstan produces about 1.5 million barrels of oil per day, and industry analysts estimate that expanding oil production and developing new fields could eventually enable the country to produce as much as three million barrels per day. That would put Kazakhstan among the top 10 oil-producing nations in the world. However, there are only three refineries within Kazakhstan. These refineries are located in Atyrau (near the Caspian Sea), Pavlodar (in the northeastern part of the country), and Shymkent (in south-central Kazakhstan). These are not capable of processing the total crude output. Much of it, therefore, is exported to Russia.
In addition to fossil fuels, Kazakhstan has deposits of coal, iron ore, manganese, chrome ore, nickel, cobalt, copper, molybdenum, lead, zinc, bauxite, gold, and uranium. Getting all this mineral wealth to the markets that can consume it, however, is difficult. Kazakhstan is the world's largest landlocked country, bordering no ocean. As a result, the vast majority of the country's extracted minerals (including oil, its most plentiful and valuable product) must at some point be transported by rail.
A look at the issuer
Eastcomtrans LLP was established by the group of international investors as a result of analyzing the strategic prospects of the rolling stock market in Kazakhstan in 2003, and is based in Almaty, Kazakhstan. In 2006, the railway car fleet of the company reached 1700 units, and in 2009, the fleet was doubled, to over 5000 units. Today the total car fleet consists of more than 8,000 wagons. The amount of the company's investments in its rolling stock fleet during 2002-2011 exceeded $450 Million, and in the next three years the total investments into rolling stock and infrastructural projects (construction of own car-repair depot and other) will exceed $500 Million.
The company operates the biggest fleet of oil fuel tankers in Kazakhstan, which consists of 5598 units. The average age of tankers is under 5 years. The company also provides maintenance and repair, cleaning and steaming for railway tanker car surfaces, logistical service for oil companies and terminals, and cargo dispatching and customer information services. Eastcomtrans transports oil, chemical, and petrochemical products; ferrous metals; ores; coal and coke; mineral and construction materials; and timber cargo. The clients and partners of Eastcomtrans LLP include big oil companies such as Maersk Oil and Lukoil (OTCPK:LUKOY), industrial organizations, transportation and forwarding companies.
There are very few companies on the public market that is exposed to tank car manufacturing, with one of the main ones being Greenbrier Companies (NYSE:GBX), which just last week entered a $1Billion alliance with Mitsubishi (NYSE:MTU) . Another is American Railcar Industries (NASDAQ:ARII), a company that we reviewed for its 6.74% bonds over 2½ years ago.
We like companies that are profitable
In the income statement of its latest annual report (December 31, 2013), Eastcomtrans stated that revenue grew by 13.5% in the last twelve months, while the cost of sales fell by 12.1%. The result was a 29.9% increase in gross profit. The company's increase in profit before tax was 35.1%, and the company's increase in profit after taxes was 35.9%.
The following chart shows these improvements for the year ending 12/31/2013:
for the year ended 31 December 2013
in thousands of tenge
Cost of sales
Profit before income tax
Profit and other comprehensive income for the year
We like companies with high profit margins
This company appears to enjoy almost monopolistic profit margins. Operating profit is nearly 64% of revenues. (For 2013, the company's EBITDA was equivalent to about $89.6 Million on revenues equivalent to about $140.1 Million). Profit margins that high are hard to find, and are a good sign of the company's competitive position in its market.
We like companies with good cash flow
In the last two years, the company has shown net cash flows from operating activities of $63.9 Million USD (2012) and $77.3 Million USD (2013). These figures bode well for Eastcomtrans's ability to handle the $28 Million/year cost of servicing its total debt. The interest coverage ratio appears to be better than 3 to 1, and easily within our acceptable parameters.
Debt to Cash ratio
The company reported about $7 million in cash as of the end of 2013. While nearly $256 Million in total debt liabilities makes for a much higher debt to cash ratio than we typically prefer to see, it is not a ratio that is unusual for the railroad industry. In addition, the transportation of oil is consistent and predictable, and with its good cash flow we are not as concerned about the cash position.
We like companies with good balance sheets
In 2012, Eastcomtrans recorded about a $5.1 Million dividend distribution to its owners, and last year increased the dividends to about $8.2 Million. We also note that there was an infusion into the company of an additional $16.5 Million of paid in capital, bringing the retained earnings total up to about $242.3 Million. While being a private company certainly limits its options for raising additional capital through the equity markets, it is evident that company management seeks and is able to maintain a sufficient capital base for meeting the company's operational needs, and maintain the confidence of its private investors. Given its remarkable growth in such a relatively short period of time and its increasing profitability, we have little doubt that additional paid in capital could be raised should it be deemed necessary.
We like higher yields
This five-year $100 million US dollar denominated debt of Eastcomtrans was issued in April of 2013 at the coupon rate of 7.75%, payable semi-annually. Acquiring this bond at a discounted price of 97.0 would result in an indicated yield to maturity in 2018 of about 8.67%, and provide added strength to the high cash flow in our client's foreign and world fixed income holdings.
The default risk is Eastcomtrans's ability to perform. Considering the consistent growth of revenues, good cash flow with excellent margins, and the increasing profitability of the Company 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.
The hardest risks for us to identify are the geopolitical risks. Kazakhstan is not a model democracy, by any means. Concerns about election irregularities have been expressed. Muslim influence is growing, in a country that is 70% Muslim but has a secular government. Russia has an interest in the region; as we are learning in Crimea and Ukraine, this can lead to unpredictable results. However, we often find it hard to understand many political changes in our own country, and it is our belief that diversifying into other regions, countries, and currencies often reduces overall risk. Our strategy here, as with other foreign bond issues, is to focus on services that add a key economic value to the society they are associated with. In this light, it is easy to see that the railroad industry is essential to the smooth functioning of Kazakhstan's economy.
The company's concentration of revenues from a single client is a concern. Eastcomtrans's transportation contracts with oil company Tengizchevroil LLP constitute 62% of revenues. However, this relationship goes two ways; it's hard to envision a transportation alternative for the oil company in landlocked Kazakhstan. So, the oil company needs the railroad transportation, and Eastcomtrans needs the oil company. In addition, Eastcomtrans has been diversifying its client and revenue base in recent years. The percentage of its business coming from Tengizchevroil is down from 70% to 62%, and the company continues its efforts to diversify.
The company is exposed to currency risk on sales, purchasing, and borrowings that are denominated in a currency other than the Kazakhstan tenge, and a sudden reduction in the value of the Kazakhstan tenge relative to the U.S. dollar could affect the company's profitability. However, with that said, the cash flows generated by the company are primarily in US dollars.
We believe that these bonds have similar risks and maturities to other Yankee bonds such as 7.58% Georgian Railway, 12% MNC Investama, or 10.75% Rolta bonds which we have reviewed previously on our Bond-Yields.com blog.
Summary and Conclusion
It is our opinion that Eastcomtrans helps unlock Kazakhstan's substantial mineral wealth, and it appears to be well positioned for continued growth in a key sector of the nation's economy. It has excellent and improving margins, solid earnings and cash flow, and reasonable interest expense coverage. As a result, we think that these 47-month, U.S. dollar denominated Yankee bonds from Eastcomtrans, a company with significant competitive advantages in its country of operation, offer an attractively high yield relative to the financial risks that we can identify. We have therefore chosen them for addition to our FX1 and FX2 global income portfolios.
Issuer: Eastcomtrans LLP
Yield to Maturity: ~8.67%
Disclosure: Durig Capital and certain clients may have positions in Eastcomtrans 2018 bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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.
Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.