Each week, we screen thousands of corporate bond listings to find what we believe to currently be the best corporate bonds for investors needing or seeking higher yields with the least amount of risk as possible relative to its projected return. This week we look at BB/Ba2 rated, medium-term Vedanta Resources (OTCPK:VDNRF) Yankee bonds that currently indicate about 7.7% yield to maturity in July of 2018. The following is our review process that shows why we believe these high-yielding, 69-month U.S. dollar bonds from Vedanta Resources pass the stringent criteria for our clients, and why we have selected it for addition to other high-yielding corporate bonds in their fixed income investments portfolio.
Step 1 - Assessing The Yield Curve
Wealth preservation continues to be one of the biggest concerns among our clients. In other words, the focus for many people is not necessarily towards making more money, but to preserve the wealth they have already accumulated by achieving returns that can simply outpace moderately rising inflation. While speculation still abounds over what affect the latest QE3 efforts of the Fed might have, there appears to be little doubt among most pundits that "safe" U.S. Treasury yields will remain in the basement until the Fed is satisfied that its efforts to "reflate" the economy have taken root. Along with declining fixed income yields are heightened concerns for acquiring fixed income instruments that can outpace inflation without adding excessive risks. Compounding the difficulty in assessing a yield curve that might actually do this is the fact that the way that government calculates inflation has changed more than 20 times since 1978. Evidently, the government is constantly looking for ways that inflation might appear to be lower than it would be if reported on the same basis as measured previously. According to John Williams of shadowstats.com, if inflation was measured the same way that it was in 1990, the inflation rate would be about 5 percent right now (and much higher than that if reported by earlier standards.)
Regardless of who or what agency considers inflation to be hovering near 2% or not, it seems that most Americans simply are not buying into the story that there is barely any inflation right now. According to the American Institute of Economic Research, the real rate of inflation was about 8 percent last year, and some analysts are projecting that we could see food prices rise by 14 percent or more over the next year. Achieving yields high enough to outpace inflation is therefore, not only a matter of intelligently assimilating as little risk as possible in order to achieve higher rewards, but it also requires each investor to consider the enigma of how high is high enough. We believe this medium term, 5 ½ year bond yielding about 7.7% provides an excellent balance between risk and reward, and offers a savvy solution to preserving one's wealth, as long as the underlying fundamentals of the issuer, of which we will review the major elements in this article, remain sound.
Step 2 - A Look At The Issuer
Founded in 1976 and headquartered in London, UK, Vedanta Resources PLC is a globally diversified natural resources group with wide-ranging interests in aluminum, copper, zinc, lead, silver, iron ore, oil and gas, and power. It currently operates in the high growth markets of India, Zambia, Namibia, South Africa, Liberia, Ireland, and Australia, and has a workforce of over 31,000 people worldwide. Having experienced significant growth in recent years through various expansion projects, Group Revenue for the fiscal year ending March 31, 2012 was $14.01 billion. Vedanta Resources was the first Indian manufacturing company to be listed on the London Stock Exchange, and continues to be a part of the FTSE 100 Index.
Step 3 - We Like Companies That Are Profitable
For the full year ending March 31, 2012, Vedanta's Financial Highlights included:
• Revenue of $14 billion, up 23%
• EBITDA of $4.0 billion, up 13%; EBITDA margin of 29%
• Underlying EPS of $1.42, down 46%, due to lower attributable profit from subsidiaries
• Final dividend of $0.35 per share, up 8%
• Free cash flow of $2.5 billion before growth capex
• Invested $2.4 billion in organic growth program during the year
• Strong balance sheet with cash and liquid Investments of $6.9 billion
For the half year ending September 30, 2012, Vedanta's highlights include:
• Record Q2 and H1 gross Oil & Gas Production, with Rajasthan output up 37% and 35%, respectively
• Record Q2 and H1 integrated production at Copper Zambia, up 42% and 23%, respectively
• Strong H1 integrated production of Silver and Lead at Zinc India, up 66% and 59%, respectively
• Record Power sales in Q2 and H1
• State-wide temporary restriction on iron ore extraction announced in Goa
Despite its iron ore operations being restricted, we see these increases in its other divisions as adding significantly to Vedanta Resources' overall growth in revenues and profitability.
Step 4 - Interest Coverage Ratios
Net interest expenses for 2012 were reported at $420.3 million, while EBITDA income was about $4,026.3 million, indicating a greater than 9.5 to 1 coverage ratio and a 22.6% year over year improvement from fiscal year 2011's income. In line with Vedanta Resources' policy to progressively increase its dividend payment to shareholders, its total declared dividends for the year were $0.55/share, or about $144.1 million.
Step 5 - We Like Companies With Lower Debt To Cash Ratio
The net debt of Vedanta Resources at fiscal year ending March 31, 2012 rose to $10.1 billion, reflecting the investment of $8.67 billion in Cairn India Limited (Cairn India). Cash and cash equivalents totaled $6.89 billion, while total debt was $16.97 billion, giving it a very good debt to cash ratio of less than 2.5 to 1.
Step 6 - We Like Companies That Have Good Balance Sheets
Vedanta's current debt appears to be about 10% higher than its currently indicated enterprise value of about $14.67 billion. Although its current market capitalization value of about $4.58 billion may not give as clear an indication in and of itself of the capital markets probable receptivity of an equity offering should the company need or decide to raise capital reserves, its debt to total capital ratio is about 47.91%, and the strong property, plant and equipment valuation it holds on its books provides sound and tangible assurance for its bondholders.
Step 7 - We Like Higher Yields
This $750 million bond was issued in 2008 at the coupon rate of 9.5%, and pays semi-annually in January and July. We think the credit ratings of Ba2, BB, and BB+, respectively from Moody's, S&P, and Fitch appear to be very conservative, and given the risks that we can identify we see the premium price and indicated yield to maturity of 7.7% that the bond is currently trading as being very attractive.
Step 8 - Risks Considerations
Vedanta Resources has engaged in very aggressive growth, and the difficulties that are frequently encountered in such rapid growth and integrating new acquisitions present unique challenges to any management team. We see no changes that to its current pattern or plans for growth and expansion, and expect that it will continue to have major capital expenditures.
Mining companies are subject to certain regulatory risks, such as evidenced in the recent mining ban in Karnataka, a temporary restriction on iron ore extraction in Goa, and transportation restrictions in South Goa during the monsoons. If the mining suspension extends for a long time, it would be negative for Vedanta's iron ore earnings. Although iron ore generated nearly 18% of its earnings in the previous year, we expect it to be much less significant given the higher contributions going forward from the oil and gas earnings from Cairn India.
We believe that these Vedanta Resources bonds may have similar risks, maturities, or similar yields to the StoneMor (NYSE:STON), KEMET Corporation (NYSE:KEM), Tutor Perini (NYSE:TPC), or Georgian Railway bonds reviewed previously on our Bond-Yields.com blog.
Summary and Conclusion
Although Vedanta Resource bonds are rated just below investment grade paper, we see these as being very conservative and regard this as a good opportunity for those seeking better yields for the least amount of risk. It is our opinion that Vedanta's management team has acquired an excellent portfolio of fundamental resource assets for the company, and has positioned it well for strong future growth. Vedanta has a good cash position, sound interest coverage, and a reasonable solid balance sheet, which is why we have chosen to add it to our Offshore and Foreign Corporate Fixed Income holdings.
Yield to Maturity: 7.7 %
Disclosure: Durig Capital and certain clients may have a position in Vedanta Resources 2018 bonds.
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.