The increasing desire to find a higher income yield denominated in Norwegian krone that steers clear of many of the concerns currently plaguing the financial industry has motivated us to look at Norwegian coporate issues aside from the normal “investment grade” rating boundaries set by the official rating agencies. Although this week’s best bond stands as “unrated” by these popular agencies, we will present in the following article how and why a relatively new bond from Fred.Olsen Energy ASA (FOE.OL, GM:FOEAF) both meets and exceed the strict criteria that Durig Capital has previously developed and found highly successful for evaluating lower rated bond issues. As a result, we believe that the significantly higher return potential offered in this floating rate debt instrument for Fred.Olsen Energy represents a savvy investment choice in what is historically regarded as one of the world’s strongest currencies, and one in which reasonably high yields have in the past seemed rather elusive to find from sound issuers.
Therefore, we find this an ideal opportunity to include these relatively short 4 1/2 year Fred.Olsen bonds (currently yielding 7.38%) in our Foreign and World Fixed Income holdings, as it offers additional diversification protection against the continued erosion of the dollar’s buying power and status as the world’s reserve currency, as well as offering an opportunity to keep pace with potential changes in Norwegian bank rates. While the US dollar strengthened recently in the wake of the Greek financial crisis and its impact on the euro, much of its effect appears to wax or wane as quick as the wind. The longer term trend of the Norwegian kroner appears to have very convincingly held its ground against the dollar in spite of weaker oil prices, and its currency exchange rate remains firmly on a 10 year bullish trend against the dollar. Slightly over two years ago, banking giant HSBC analysts dubbed the Norwegian krone “The World’s Safest Currency“, and as recently as last summer, HSBC’s chief FX strategist David Bloom stated the belief that “there is no better currency than the NOK.”
Norway, like Switzerland, isn’t a member of the European Union and is the second richest country per capita in the world. Although Norwegian krone and the Norwegian economy isn’t big enough to become a safe haven for many large institutional investors, the strength of the currency mixed with a longer maturity 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 chosen it for This Week’s Best Bond.
US Debt Woes
With the US National debt fast approaching $15 trillion, it appears it will very soon surpass our total Gross Domestic Production for the first time since WW II. In other words, the average American’s share of government debt will be more than an average American makes in a year. Not included in the aforementioned national debt, is the estimated $2 to $4.2 trillion U.S. state debt (including pension gaps) recently reported by Reuters. Yet, in spite of all of this, the appetite for “safe-haven” U.S. debt continues to be whetted by troubles more persistent than cockroaches in a dark pantry. 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, isn’t the United States’ role in international commerce, but rather, results from its oil trade monopoly. However, China recently arranged to trade oil and energy products with Russia in their own currencies. In another interesting move last Monday (10/24), 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. And while oil contracts may be a few months or years away, the Chinese may be quite content to have the Renminbi more slowly chip away at the USD’s coveted status as “world’s reserve currency.”
While the notion of a strong dollar may initially sound good or even invoke a sense of national pride, easier money and currency depreciation appears to be central banks latest weapon of choice to stimulate economies. Yesterday Japan sold the yen for the second time in less than three months, saying it intervened unilaterally to counter speculative moves that were hurting world's third-biggest economy. With Federal Reserve Chairman Bernanke likely to repeat his disappointment with the pace of economic recovery after this week’s Fed meeting, it now seems likely for the dollar to take its turn at bat. In short, what we are looking for here at Durig Capital, are the fundamentally soundest economies to diversify towards, and away from overweighted US assets that are likely to significantly depreciate should the much longer and broader term global confidence in the dollar continue to deteriorate.
Norway is one of the world’s most prosperous countries, and is ranked 16th in economic freedom out of 43 countries in the Europe region. In general, Norway's economy was shielded from the worst of the global credit crisis due primarily to its extensive oil wealth (world's sixth-largest oil exporter), a strong labor sector, a stable housing market and a mainland economy that is expected to continue expanding at a somewhat moderate pace. The country is richly endowed with numerous natural resources including hydropower, fish, forests, and minerals in addition to its already noted petroleum sector, which accounts for nearly half of exports and over one third of state revenue. In anticipation of eventual declines in oil and gas production, Norway saves state revenue from the petroleum sector in the world's second largest sovereign wealth fund, recently valued over $570 billion.
After solid GDP growth in 2004-07, the Norwegian economy slowed in 2008, and contracted in 2009 before returning to positive growth again in 2010. It features a combination of free market activity and government intervention, with the government controlling key areas, such as the vital petroleum sector, through large-scale state-majority-owned enterprises. Norway opted to stay out of the EU during a referendum in November 1994. However, as a member of the European Economic Area, it contributes sizably to the EU budget.Norwegian inflation accelerated last month as the central bank signaled it would delay planned interest rate increases amid a deepening European debt crisis. Oslo-based Statistics Norway recently reported that the underlying inflation rate, adjusted for taxes, fees and energy prices, climbed to 1.2 percent in September from 0.8 percent a month earlier. Headline inflation was 1.6 percent, also faster than the 1.3 percent estimated in a survey. The country’s central bank kept its overnight deposit rate unchanged at 2.25 percent this month and postponed its next rate increase into the second half of 2012, as policy makers tried to protect the economy from the fallout of Europe’s debt crisis. Norway’s government last week presented a 2012 budget plan that will increase the use of its oil money and stimulate the economy by 0.3 percentage point amid concern that the euro area debt crisis will sap exports.The mainland economy is projected to grow 2.8 percent for 2011, and expand to 3.1% growth in 2012. The unemployment rate in Norway has fallen to 3.3% as the economy has bounced back from a shallow recession in 2009, and with those hiring chasing fewer candidates, wages and therefore inflation could rise. The Norges Bank traditionally is a flexible inflation fighter, balancing inflation and growth. The three- month Norwegian interbank offered rate was at 3.13 percent on Oct. 28, compared with a low for the year of 2.53 percent in January. The kroner has risen about 8% versus the U.S. dollar over the past year, and a stuttering U.S. recovery has weakened expectations that the Federal Reserve will raise rates any time soon.
Fred.Olsen Energy ASA [FOE:OSL]
Fred.Olsen Energy ASA (The Company) is a leading provider of exploration and development services to the oil and gas industry, and operates nine rigs and vessels for firms such as BP (BP), Anadarko (APC) and Statoil (STO). From roots over 150 years earlier in the shipping industry and more than 35 years in international offshore drilling, the Company first listed on the Oslo Stock Exchange in 1997. In 2000, important steps were taken to position itself within the deep water segment of the offshore market and strengthen its position as a supplier of offshore drilling and floating production services. Operating activities of Fred.Olsen Energy ASA and its subsidiaries (The Group) currently consist of offshore drilling as well as engineering and fabrication services. The Company is headquartered in Oslo with offices in Norway, the UK, Singapore, Bermuda, Brazil, Mozambique, Hungary and South Africa.
Gross revenues for the Group in 2010 was NOK 6,019 million, and earnings before depreciation and amortization, financial expenses and taxes (EBITDA) were NOK 3,401 million. The net interest bearing debt at 31 December 2010 was NOK 4,041 million. The number of tenders and fixtures within the offshore drilling market increased in 2010, resulting in a trend of shorter term contracts and decreasing lead-times, with rate levels remaining relatively stable. Oil prices fluctuated at levels between USD 70-90 per barrel during 2010.
Geographically, the Group currently operates in Norway, the UK, Mozambique and Brazil. At year-end 2010, the Group’s offshore units had an average contract length of 21 months. The current contract backlog is approximately USD 1.9 billion. At mid-end June 2011, the Group had consolidated assets of NOK 14,182 million. The ratio of net interest bearing debt to total assets about 41.5% and the book value of the equity was NOK 7,381 million. Net cash from operating activities for the first half of 2011 was NOK 1,182 million (compared to 1,066 a year ago) and cash and cash equivalents were NOK 2,268 million.
In April of this year Fred.Olsen Energy ASA ordered a new ultra-deepwater drillship from Hyundai Heavy Industries Co. for delivery in 2013 at an estimated cost of USD 615 million and in the following month successfully completed a five year NOK 1,400 senior unsecured bond issue, with a maturity date of 12 May 2016. The floating rate for this note is reset quarterly, at NIBOR (Norwegian Interbank Offered Rate) + 4.25%, which currently equates to 7.32% after 12 August 2011. The interest is paid in arrears quarterly.
There are three primary areas that Durig Capital focuses upon for its bond reviews to help assure the return of our client’s capital. After reviewing their most recent 2Q 2011 statements, Fred.Olsen Energy scores passes all three categories with flying colors:
- Debt to Equity - about 50%. Higher than we normally prefer, but still quite acceptable.
- Debt to Cash - about 2.5 to 1. This is reasonable, and once again, quite acceptable.
- Cash Flow to Debt obligations - over 10 x’s. An excellent coverage ratio.
In 2007 the Company distributed dividends for the first time since listing in 1997, and stated that the Company would pursue a yearly strategy to pay a dividend of NOK 10 per share. This they have not only done, but an additional NOK 10 extraordinary dividend brought the total to NOK 20 per share for the year 2010. In summary, this is a well financed company with reasonably low debt, ready options for additional funding if necessary, and a prudent use of existing cash flows.
The default risk is Fred.Olsen’s ability to perform. Considering their historical and recent performance, their flexible balance sheet, their sound cash position, and the excellent cash flow to service their 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.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Norwegian economy.
The Norwegian kroner has gained about 6 % against the euro from a year ago, but because 80 percent of Norway’s exports go to the European Union, the kroner remains connected to the euro and would be affected in the advent of a Greek default. Though Norway’s banks hold little in the way of Greek debt, the fallout of a Greek default on banks in Germany and France would pass through the whole region and hit even Europe’s richest economies.
Accessibility and Liquidity
Fred.Olsen Energy ASA trades on both the Oslo exchange and here in the U.S. as the symbol FOEAF. The most recently indicated dividend yield for the stock is 10.54%. However, we prefer their recent debt issue of 1.4bn NOK. Rather that owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail and typically have no “maturity certain” date, we prefer our clients hold individual bonds with a specific maturity date. At times broker/dealers may require an institutional-sized single bond purchase, however, it is also possible for a number of smaller 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 $5,000 US Dollars.
Indications of a slow or modest US economic recovery remain very fragile and sensitive to oil prices. Considering that higher oil prices will likely correlate into an added boost to the krone's strength relative to the US dollar and numerous other global currencies, there may be significant potential for a longer term capital gains advantage residing in the currency exchange for the Norwegian kroner. Therefore, we view the both the currency risk of this leading European economy and the integral strength of a growing and profitable Norwegian oil services company like Fred.Olsen Energy as an intelligent risk choice that we have recommend our clients take in their continued effort to diversify away from overweighted US dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Coupon: 0 Floating
S&P rating: NA
Disclosure: Some Durig Capital clients currently own these bonds.