This week we also look at a very short term Petroleos de Venezuela S.A. (PDVSA) bond, in US dollars, that currently indicates an 11.4% yield to maturity in October of 2014. Although this unrated issue may lack some appeal because of the greater geopolitical risk associated with the unpopularity of Venezuela's current socialistic government among many foreign investors, it does represent the senior unsecured debt of one of the most highly prized and crucial state owned company in the country's most valuable industry. 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 discounted price of this 4.9% coupon bond represents one of the best short term "risk to reward" opportunities denominated in US dollars. A further consideration of recent developments and the upcoming elections in Venezuela leads us to believe the window of opportunity to acquire these bonds at such a significant discount may be shrinking, and we are therefore using this opportunity to add these very high yielding PDVSA Yankee 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 US Ten Year treasury yields dipping close to 1.5% and the official CPI still at 3.0%, a certain degree of wealth destruction is virtually assured within these otherwise commonly considered "safe" US government notes.
Part of our effort to protect our client's assets against the persistent destruction associated with an ever increasing supply of US dollars is to lower overall portfolio risk by diversifying into a variety of higher yielding instruments denominated in US and foreign currencies both within and away from the US economy.
Venezuela remains highly dependent on oil revenues, which account for roughly 95% of export earnings, about 40% of federal budget revenues, and around 12% of GDP. Fueled by high oil prices, record government spending helped to boost GDP growth by 4.2% in 2011, after a sharp drop in oil prices caused an economic contraction in 2009-10. Government spending, minimum wage hikes, and improved access to domestic credit created an increase in consumption which combined with supply problems to cause higher inflation - roughly 28% in 2011. President Hugo Chavez's efforts to increase the government's control of the economy by nationalizing firms in the agribusiness, financial, construction, oil, and steel sectors have hurt the private investment environment, reduced productive capacity, and slowed non-petroleum exports.
In the first half of 2010 Venezuela faced the prospect of lengthy nationwide blackouts when its main hydroelectric power plant - which provides more than 35% of the country's electricity - nearly shut down. In May 2010, Chavez closed the unofficial foreign exchange market - the "parallel market" - in an effort to stem inflation and slow the currency's depreciation. In June 2010, the government created the "Transaction System for Foreign Currency Denominated Securities" to replace the "parallel" market. In December 2010, Chavez eliminated the dual exchange rate system and unified the exchange rate at 4.3 bolivars per dollar. In January 2011, Chavez announced the second devaluation of the bolivar within twelve months. In December 2010, the National Assembly passed a package of five organic laws designed to complete the transformation of the Venezuelan economy in line with Chavez's vision of 21st century socialism. In 2011, Venezuela continued to wrestle with a housing crisis, higher inflation, an electricity crisis, and rolling food and goods shortages - all of which were fallout from the government's unorthodox economic policies.
Public debt to GDP
|36.3% *||US$ 15.4 Billion|
|102.8%||US$ 1.29 Trillion||1.474 Trillion||2.239 Trillion|
*Included in the public debt for Venezuela is the debt of the state-owned oil company PDVSA.
Petroleos de Venezuela S.A. (PDVSA)
Petróleos de Venezuela S.A., the state-owned corporation of the Bolivarian Republic of Venezuela, is responsible for the efficient, profitable, and dependable exploration, production, refining, transport and commerce of hydrocarbons. Its main objectives are to foster the harmonic development of the country, to guarantee sovereignty of national resources, to increase endogenous development and to serve and benefit the Venezuelan people, who correspond to their share of the country's national wealth. PDVSA is constitutionally the owner of the country's oil reserves. The State of Venezuela is PDVSA's sole stockholder under the provisions of the Constitution of the Bolivarian Republic of Venezuela and represents the economic and political sovereignty exerted by the Venezuelan people over oil, their major energy resource.
Therefore, PDVSA's actions must follow the Ministry of Energy and Petroleum's guidelines, plans and strategies, as well as the norms issued by the National Development Plans for the hydrocarbon sector. Transparency and clear control of accounts is stated as being a fundamental value for PDVSA. The average export price of oil rose 39% in 2011, and 2011 revenues of US$ 124.75 billion represent a 31.4% increase of revenues of US$ 94.93 billion for 2010. Costs and expenses for 2011 were US$ 89.52 billion compared to US$ 80.34 billion in 2010. Total assets for PDVSA are stated as being US$ 182.16 billion (an increase of over 30 billion recorded in 2010), however the actual amount of debt PDVSA may be responsible for is not as clearly communicated. On one hand, US$108.27 billion is stated as being "mirrored in liabilities" and up from US$76.45 billion in 2010. On the other hand, a "thorough review" states it as being only US$ 32.49 billion. Reuters has reported it as being US$ 32.50 billion, and most recently was reported by El Universal as having just increased to US$ 43.3 billion.
It is worth mentioning that PDVSA is using the lending in US dollars to bring in equipment and technology, while Asdrúbal Oliveros, an economist and director of economic research firm Ecoanalítica, commented that these bond issues are mainly made to maintain the exchange rate policy. "PDVSA is borrowing money at expensive rates to grant the private sector access to foreign currency," he remarked.
Recent weakness in the bond prices of PDVSA may be a result of Chavez's lead in the polls to successfully be re-elected in October. However, lurking in the background is Chavez's cancer diagnosis, about which no further details of it, his treatment, or his prognosis have been revealed since first disclosed one year ago. If he remains tethered to chemotherapeutic regimen and the unconfirmed (nor denied) reports of rhabdomyosarcoma are correct, he may be fortunate to survive to run in the October elections. Much less likely would be his chances of surviving another term as Venezuela's President.
One of the key metrics that we examined when reviewing this issue was cash flow and profitability. While the investment spending by the company's growth and expansion strategy, are more concerning to from a long term perspective, the very short to near term prospects for a return of capital appear to us to be quite favorable, and it is why we have chose to include this very short term PDVSA Yankee 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 PDVSA's ability to perform. Given the importance of the state-owned company's oil export business to economy of Venezuela, we do not believe the performance risk differs significantly from lower yielding sovereign debt of similar maturity. Therefore, we see higher yield of this bond is an intelligent reward opportunity relative to its performance risk.
These bonds do carry geopolitical risk associated with the policies and actions of the sovereign government of Venezuela.
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), Netflix (NFLX), or Tutor Perini Corporation (TPC).
Accessibility and Liquidity
PDVSA has numerous outstanding US dollar denominated bonds with maturities ranging out to 2037. 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.
Given the savvy high reward to risk opportunity we see these bonds represent, we are recommending these short term PDVSA Yankee bonds for our clients looking for both greater cash flow and diversification away from overweighted US economy based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Yield to Maturity: 11.43%
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.