Bond investors’ fervor for new U.S. dollar-denominated corporate bond sales and emerging market assets ratcheted up a notch Tuesday, with Saudi Arabian Oil Company’s (Saudi Aramco) debut debt deal.
Oil giant Saudi Aramco entered the U.S. primary market with a multi-part note offering, which was said to have fetched more than US$100bn in orders.
According to Bloomberg, the US$12bn, five-part issuance met with a groundswell of interest – notably for its longer-dated maturities – with spreads having compressed by roughly 15bps to 20bps from initial price talk through final terms.
Some of the deal’s tranches had been set at higher levels than Saudi Arabia’s government bonds, with the 5-year notes, for example, priced to yield 2.875% at maturity compared to around 2.994% for the sovereign debt.
The inaugural note sale, comprised of tenors ranging from 3- to 30-years, was offered to qualified institutional buyers under the SEC’s Rule 144A and Regulation S. The issuance was being joint lead-managed by Citigroup, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and NCB Capital Markets.
Risk appetite for EM resurfaces
The recent course of monetary policy in the U.S. has generally reignited investors’ willingness to purchase riskier assets.
The Federal Reserve’s decisions to maintain the target range for the federal funds rate at 2.25-2.5%, with no plans in 2019 to hike interest rates further, as well as cease other quantitative tightening measures, had spurred a plunge in government bond yields, which effectively spurred issuers to take advantage of still ultra-low borrowing costs, amid ongoing demand for yield.
For the week ended April 3, Thomson Reuters/Lipper U.S. Fund Flows reported a net inflow of roughly US$135m into emerging market equity funds, contributing to a whopping total of around US$18bn this year, while at the end of March, more than US$1bn worth of inflows reportedly made their way into EM debt funds year-to-date.
Saudi Arabian stocks have been no exception, with the iShares MSCI Saudi Arabia ETF (NYSEARCA: KSA), which has among its top holdings Saudi Basic Industries Corporation (SABIC - TADAWUL: 2010) and Saudi Telecom (TADAWUL: 7010), having risen by nearly 25% from its most recent 52-week low set in mid-October 2018.
While Saudi Aramco is officially headquartered in Dhahran, Saudi Arabia – deemed by the global financial markets as emerging market territory – the firm itself appears to hold little credit risk to bond investors.
Moody’s Investors Service analyst Rehan Akbar recently noted that the firm has “many characteristics of a Aaa-rated corporate, with minimal debt relative to cash flows, large scale of production, market leadership and access in Saudi Arabia to one of the world's largest hydrocarbon reserves.”
The ratings agency assigned an ‘A1’ credit rating to Saudi Aramco’s Global Medium-Term Note (GMTN) program announced at the start of April, with a stable outlook.
Moody’s said the company's balance sheet leverage has been “conservatively managed,” with debt/book capitalization of 14.7% as of year-end 2018 – comparing “favorably” to industry peers such as Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), which each had ratios in that same period of 18.4%, while Royal Dutch Shell (NYSE: RDS.A) and Total (NYSE: TOT) had debt-to-capital ratios of 33.5% and 43.2%, respectively, for the last twelve months ending September 30, 2018.
Furthermore, Moody’s said that Saudi Aramco has “a long-standing track record of maintaining minimal leverage and high profitability,” and as of year-end 2018, debt/EBITDA stood at 0.2x while EBITDA margin was 63.7%.
Also, as of year-end 2018, the company held nearly US$49bn of cash compared to US$27bn of group debt. In 2018, when the average Brent price was a little more than US$70 per barrel, the firm recorded cash flow from operations of US$121bn, undertook just north of US$35bn in capital expenditures and paid over US$58bn in dividends.
The cost of crude oil has recently been climbing and was last trading at around US$64, up over 46.5% from its latest 52-week low set December 24, 2018.
Ron Quigley, head of fixed income syndicate at Mischler Financial, noted that unlike in the U.S., where “hundreds of companies generate our daily production or in Russia where that number dwindles down to dozens of corporations, Saudi Arabian Oil Company produces all its oil itself.”
Saudi Aramco’s oil production amounts to more than 10-12 million barrels per day.
Quigley touted the company as “the single largest and most profitable” globally, accounting for an estimated 13% of the world’s oil production. “By holding back on 3 or 4 million barrels a day, Saudi Arabia can single-handedly catapult global oil prices to four times their current value, thereby throwing the world into a global recession,” he continued.
He added that, what may be more important for the Kingdom is that “the last vestiges of the Khashoggi incident seem to have been put aside or forgotten with this transaction that was previously postponed as a result.”
Saudi Aramco‘s debt sale follows the postponement of its initial public offering, which had been slated for 2018 and pushed to around 2021, after Saudi Arabia’s royal family was thrust into the center of a scandal, and alleged involvement, according to reports, of the murder of journalist Jamal Khashoggi in October.
Saudi Aramco’s note sale also follows hot on the heels of its acquisition in late March of a 70% majority stake in SABIC from the Public Investment Fund of Saudi Arabia for roughly US$69bn.
The deal, conducted as a private transaction, was aimed at bolstering Saudi Aramco’s integrated refining and petrochemicals business, given the combined entities’ production capacity of 79 million tons per year.
Saudi Aramco and SABIC have petrochemicals production capacity of 17 and 62 million tons per annum, respectively.
In 2018, SABIC’s consolidated production volume across its various business units was 75 million metric tons, with recorded net income of US$5.7bn, annual sales of US$45bn, and total assets of US$85bn.
In the meantime, given the ongoing, low rate environment, the Fed’s dovish policy stance, and continued investor appetite for high quality corporate debt, the U.S. investment-grade primary market is likely to continue to churn out deals.
Syndicate managers generally expect a total of around US$90bn worth of new U.S. dollar-denominated corporate bonds in April (of which almost 32% has priced) while, to date in 2019, issuers sold around US$350bn.
Potential deals in the pipeline include issuers such as Walgreens Boots Alliance (NASDAQ: WBA) and Apple (NASDAQ: AAPL) – each of which recently registered debt securities-related automatic shelf filings with the SEC – as well as emerging market sovereign debt from South Africa.
Note: This material was originally published on IBKR Traders' Insight on April 9, 2019.
The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: I am receiving compensation from my employer to produce this material.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.