This week we consider a medium term Jaguar Land Rover 8.125% coupon note denominated in pound sterling that will yield about 7.24% through maturity. Although the lower rating of this company, currently owned by Tata Motors (TTM), necessitated a higher 8.125% coupon yield when it was first issued almost one year ago, the strong and steadily improving performance while under the new management of Tata Motors has brought this lesser known "junk rated" issue to the forefront of our attention and careful scrutiny. Not always believing that the well known and more popular rating agency always get it right, here at Durig Capital we have developed our own strict criteria for evaluating unrated and/or high yield junk bonds. As a result of our research, as presented in more detail below, we believe that the slight premium for this high coupon bond is justified, and that it currently represents one of the best short to medium term "risk to reward" opportunities denominated in the Queen's currency. A further consideration of the most recent political and fiscal directions in the U.K. leads U.S. to believe the currency is well positioned against many other global currencies. Therefore, we are using this opportunity to add Jaguar Land Rover bonds to our Foreign and World Fixed Income holdings.
Wealth Preservation Concerns
Wealth preservation remains as one of the biggest concerns among our clients, and we continue to look for the most "intelligent risks" that are more likely to achieve reasonable returns that can simply outpace moderately rising inflation. With U.S. Five Year treasury yields still stuck near 1%, the Ten Year hovering around (often below) 2%, and with energy commodities (up over 6% year over year) threatening to push the CPI average back over 3% (the food index already at 4.4%), a certain degree of wealth destruction is virtually assured within these otherwise commonly considered "safe" U.S. government notes.
Part of our effort to protect our client's assets against the persistent destruction associated with an ever increasing supply of U.S. dollars is to lower overall portfolio risk by diversifying a portion of our fixed income investments into sound, high yielding instruments denominated in (or linked to) currencies outside of the U.S. dollar, and away from the U.S. economy.
United Kingdom's Economy
The UK, a leading trading power and financial center, is the third largest economy in Europe after Germany and France. Over the past two decades, the government has greatly reduced public ownership and contained the growth of social welfare programs. Agriculture is intensive, highly mechanized, and efficient by European standards, producing about 60% of food needs with less than 2% of the labor force. The U.K. has large coal, natural gas, and oil resources, but its oil and natural gas reserves are declining and the U.K. became a net importer of energy in 2005. Services, particularly banking, insurance, and business services, account by far for the largest proportion of GDP while industry continues to decline in importance.
Facing burgeoning public deficits and debt levels, in 2010 the CAMERON-led coalition government (between Conservatives and Liberal Democrats) initiated a five-year austerity program, which aims to lower London's budget deficit from over 10% of GDP in 2010 to nearly 1% by 2015. In November 2011, Chancellor of the Exchequer George OSBORNE announced additional austerity measures through 2017 because of slower-than-expected economic growth and the impact of the euro-zone debt crisis. The CAMERON government raised the value added tax from 17.5% to 20% in 2011. It has pledged to reduce the corporation tax rate to 23% by 2015. The Bank of England (BOE) implemented an asset purchase program of up to £325 billion (approximately $525 billion) as of February 2011. During times of economic crisis, the BoE coordinates interest rate moves with the European Central Bank, but Britain remains outside the European Economic and Monetary Union (EMU).
Public debt to GDP
United Kingdom in £
£ 120 Billion
United States in USD
|102.8%||US$ 1.29 Trillion||1.474 Trillion||2.239 Trillion|
Stanford University has rated the U.K. economy number # 9 on its global Sovereign Fiscal Responsibility Index. This recognition highlights how much stronger the U.K.'s financial condition is compared to the # 28 ranked (out of 34) United States, which came in only four points above a defaulted Iceland.
Historically, from 1972 until 2012 the GBPUSD exchange averaged 1.75 reaching an historical high of 2.62 in May of 1972 and a record low of 1.05 in February of 1985
U.S. Dollars per British pounds (GBP) -
Jaguar Land Rover
Jaguar Land Rover is a business built around two great British car brands that design, engineer and manufacture in the U.K. Jaguar Land Rover is currently part of Tata Motors, India's largest automobile company, who acquired it from Ford Motor Co. (F) in 2008 for a mere 2.3 billion dollars. Having survived the global downturn (which hurt the market for many luxury vehicles), Jaguar Land Rover's most recently released results for the period ending Dec 2011 are demonstrating remarkable success and profitability under Tata's management. While Moody's credit rating of B1 for this debt issue reflects Jaguar Land Rover's small scale as a niche player with a limited product line and materially less financial strength than other premium car manufacturers, it is evidently much more difficult to assess the value of its rapidly growing (at 17%) Chinese market versus the potential R&D expenditures of its envisioned model expansion and limited track record.
One of the key metrics that we examined when reviewing this issue was profitability. Even with the higher level of investment required by the company's growth strategy, it continues to be fully funded from operating cash flow and the overall free cash flow remained positive in the most recent nine month period at £619.0m. The nine months revenue was increased by 31% to £9,367.5 million compared to 9M FY11. Retail volumes for Q3 FY12 were 13,006 units for Jaguar and 65,287 for Land Rover. Land Rover's growth, compared to the equivalent quarter in the prior year was 41% whilst Jaguar's volume increased by 9%.
Another key consideration is the amount of available free cash flow relative to the level of debt interest obligation. Their combined short and long term debt total at the end of nine months (Dec 31, 2011) was £1,583.7m. While their interest costs for this same period are listed at £71.4m, when their additional activities are added in it ends up closer to £100m. Nine month cash flow from operations came in at £1,567.5m and net income before taxes at £976.3m, providing debt interest coverage ratios of over 15x's and nearly 10x's, both of which are superb.
We prefer companies with a low debt to cash ratio. Considering that the cash balance of their investment and financial products is £1,815.5, which is higher that their debt level, means that they could now pay off the debt entirely if necessary.
Finally, we like companies that have flexible balance sheets. Although currently a subsidiary of Tata Motors, the company has recently been valued by outside analysts surveyed by Bloomberg at more than $14 Billion (USD), which is more than either Fiat or Suzuki. With this new valuation, analysts are suggesting/expecting Tata to put JLR on the public market. Given its relatively low debt (less than $2.6B in USD), we view their debt as being about 18.5% of the value of the company, a debt to equity level that most bank lenders would gladly welcome.
Combined, these financial ratios are among the strongest that we have reviewed, and it is why we have chose to include this British pound sterling denominated Jaguar Land Rover Bond in our offshore bank income investment opportunities that include issuers such as JP Morgan (JPM)'s, Bank of America (BAC), Lloyds Bank (LYG) or UBS (UBS).
The default risk is Jaguar Land Rover's ability to perform. Given their significantly improved performance and greatly strengthened equity position since being under the umbrella of Tata Motors, we consider the higher yield of this bond as an intelligent reward opportunity relative to its performance risk.
There is currency risk, as this bond exposes the investor to the valuation changes in British pound sterling, which is affected by certain economic conditions of the United Kingdom and fiscal policies of the Bank of England.
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 Georgian Railway, Neo Material Technologies (NEMFF.PK), Netflix (NFLX), or Tutor Perini Corporation (TPC).
Accessibility and Liquidity
Jaguar Land Rover has several outstanding bonds issued in May of last year, the largest being £500m. We prefer the larger, shorter maturity issue, which is currently available in the secondary markets. 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 U.S. $10,000.
We hope NOT to see any further destruction of wealth resulting from a constant decline in the U.S. dollar relative to other global currencies (as forecast by the Congressional Budget Office), and we acknowledge that a strengthening of the U.S. dollar would directly reduce the total returns of this British pound sterling denominated bond. On the other hand, should the U.S. dollar continue on the long term path of devaluation that it has been on, this alone could add quite significantly to the already positively accruing returns of this bond, not to mention the possible stellar returns that would result should the U.S. dollar ever lose its domineering status as the world's reserve currency and collapse against a basket of other stronger currencies.
Therefore, we are recommended this medium term Jaguar Land Rover pound sterling bond for our clients looking for both greater cash flow and diversification away from overweighted U.S. dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Yield to Maturity: ~7.24%
Disclosure: Some Durig Capital clients currently own these bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.