This will be the not this first time we have found strong reasons to revisit and feast upon these high yielding US dollar bonds from Transportadora de Gas Del Sur (TGS). However, the recent strengthening and rise of Transportadora’s stock price (up over 50% year to date) has greatly improved the metrics of its balance sheet and diminished the overall risks that we see in its bonds. When lower rated or unrated bond issuers continue to execute well or improve significantly, we see the risks to its bondholders as being reduced. If certain inefficiencies in the market appear to allow the yields of a bond to stubbornly remain much higher than what we think is more commonly associated with markedly reduced risk, then we see it as a very compelling reason to increase its position in our FX1 and FX2 fixed income portfolios. Consequently, while it may be difficult to still acquire these Yankee bonds at yields to maturity over 10% given the rising trend of its bond price, we believe the combination of lowered risks, slightly lower (but still high) yields and the organically laddered call structure of Transportadora’s sinking bond (which is explained below) qualify it as the winner of this week’s best bond.
The first bond that we strongly recommended a second time, when three months after our first review of it still offered a double digit yield to maturity, was Mexican based Bio Pappel (CDURQ.PK) 11.5 % bonds. Since that time, some of these Bio Pappel bonds have been called (returning over 16% for clients holding it about a year) and its outstanding bonds now indicate a price above par. The organically lattered call structure inherent within Transportadora’s sinking bond, couponed at 7.785%, means that 25% of the bonds are to be redeemed at slightly over par in May of 2014, another 25% are to be redeemed at par the following year, the next 25% at par in 2016, and the remaining fourth at maturity in May of 2017. Therefore, the average redemption length of this issue is a very short 25 months. If purchased at a discounted price of 95, the yield to worst (maturity in 2017) would be about 9.4%. However, yields are actually enhanced as a result of the mandated early call dates. The yield to redemption in May of 2014 for this purchase would be about 18.8%, while the yield to redemption in May of 2015 would be nearly 11.1%. Stated another way, we anticipate the average yield to the average redemption (which is 25 months) to be near 11%.
Transportadora de Gas del Sur S.A., updated
We first reviewed Transportadora de Gas del Sur S.A. in January this year after finding very few professional articles detailing their products and services. After diving deeper into the details, we found this monopolistic company to be a largely misunderstood business intimately entangled in the highly regulated natural gas industry of Argentina. In brief, Transportadora de Gas del Sur (Gas Transporter of the South) is the largest natural gas extractor in Argentina. The company was established in 1992, after the privatization of Gas del Estado, the state owned company that maintained the pipelines. Considering certain concerns that may have resulted from Argentina’s seizure over a year ago of the local business (YPF) of Spanish oil firm Repsol (REPYY), it seemed fitting remind investors that TGS is an Argentina based company that resulted from a move to denationalize the pipelines. The company transports about 61% of the total Natural gas consumed in Argentina, and supplies distributors, electric generators and industries. It owns about 7.635km of the 9,127km pipeline system it utilizes in 7 Argentine provinces.
It also bears repeating in this updated review of TGS that natural gas is considered to be one of the more environmentally friendly sources of guaranteed energy, and that it provides one of the lowest costs for electrical power generation. Therefore, natural gas power plants are projected as a top means of providing new guaranteed energy in the near future. TGS is also one of the leading natural gas liquids (NGL) producers and traders, and also renders telecommunications services through its subsidiary, Telcosur, S.A.
1) Liquids, 71% of Revenues
TSA’s largest and fast growing business segment is its liquids sales. Over 40% these sales go to world markets, where 90% of it is settled in US dollars. Liquid petroleum, which it exports, provides over 30% percent of total sales for the company. Thus, a major profit hub for Transportadora’s overall business model involves processing and commercializing natural gas liquids, and then selling it at spot prices to the rest of the world.
2) Gas Transportation, 24% of Revenues
TGS pipelines (see map insert below) transport about 61% of all of Argentina’s natural gas, and Argentina is currently recognized as the largest gas producer in South America. Argentina also uses natural gas for over 50% of its own energy needs. All of its non-interruptibility gas contracts with TGS are regulated and performed at a fixed rate, similar to a real estate rent, and consequently this portion of TGS revenues are not sensitive to the price the price of gas, volumes and other such factors. All guaranteed Gas (not-interruptible) clients pay connection fees that do not fluctuate with gas prices or actual usage. TGS provides a wholesale pipeline transportation business, primarily to reselling natural gas companies, as TGS is restricted from having their own retail gas business. TGS has one major pipeline competitor and doesn’t foresee any new direct competitors, which puts it in the dominant and very desirable position of an oligopoly. Thus, the second major segment of TGS’s business is relatively stable, as revenues are fairly immune to natural gas price fluctuations and should not be directly correlated to natural gas prices. The Natural Gas Transportation business segment represented approximately 24% and 31% of TGS’ total revenues in 2012 and 2011, respectively.
The Upside Potential for TGS
Within a national scope, in 2012 natural gas supply showed a slight increase with respect to the previous year. As far as domestic supply is concerned, production continued its downward trend, mainly as a result of the marked drop in Neuquen basin reserves. However, there are high expectations regarding the future exploitation of non-conventional natural gas in this basin, based on recent announcements by YPF with reference to investment and associations agreements with other oil companies that will contribute to the project with both technology and capital. Partnering with state-owned YPF, the world’s largest oil and gas producer ExxonMobil (XOM) drilled five exploration wells last year, and has plans to dirll five more wells this year. Another mega cap producer, Chevron (CVX), said earlier in the year that it hopes to invest up to $15 billion, along with partner YPF, in Vaca Muerta. Adding to the bustle of activity, Apache Corporation (APA) plans to invest $200 million, and earlier this year the Argentine Supreme Court lifted an embargo on $19 billion-worth of assets held by Chevron’s subsidiary in the Latin American country, paving the way for the final agreement with state-owned YPF to develop the Vaca Muerta super-field, the second largest shale oil reservoir in the world according to the American energy company. Argentina’s very large new gas discovery, according to the US Energy Information Agency (EIA), gives Argentina a total of 774 trillion cubic feet (TCF) of technically recoverable shale gas resource. That’s double the size of Canada’s resource estimate, and is the world’s third-largest assessment behind only the US and China.
The great interest in pointing out these large discoveries and production developments that are in or in close proximity to the Neuquén Basin is simply that this is where TGS already has a major pipeline for country wide distribution. TGS appears to be in a rather envious position of having nearly a monopoly and the largest established footprint in front of this hydrocarbon resource tidal wave.
We like companies that are profitable
Based on its annual reports and first six months of 2013, TGS shows excellent gains in revenues and operating income. and net income over the last 3 years. Most of this growth has come from the very profitable production and commercialization of Natural Gas Liquids business segment, which also explains its stronger margins. This positive effect was partially offset by a higher foreign exchange loss as the Argentine peso’s devaluation was greater than in 2011.
In millions of ARS pesos (one ARS peso = about $0.186 in US dollars end of June, 2013.)
1H 2013
1H 2012
2012
2011
2010
Sales
1,300.9
1,181.40
2,575.0
1,853.9
1,653.0
Operating income
365.2
274.2
705.7
552.5
363.4
Net Income before tax
147.7
152.2
369.6
359.5
201.4
Interest Coverage Ratios
Interest expense for the first six months of 2013 was about 99.1 million pesos ($18.4 million), so the operating income of 365.2 million pesos ($67.9 million) appears to be about 3.7x’s interest expenses.
We like companies with lower debt to cash ratio
Even though cash flow from operating activities in the six month period ending June 30, 2013 increased by 61.6 million pesos over the same period last year, it cash position declined by 189.2 million pesos, mainly because of dividend payments totalling about 334.5 million pesos. Still, its cash and cash reserves at the end of June 2013 was at 715 million pesos ($133 million), putting TGS’s total debt to cash ratio well under 3x’s. The Company is subject to certain restrictive covenants under its outstanding debt obligations which include, among others, some restrictions to incur new debt, dividend payments, the granting of guarantees, assets sales and transactions with related companies. Among these new debt restrictions are an earnings (EBITDA) to interest expense ratio greater than 2 to 1, and a debt to earnings equal to or less than 3.75 to 1. TGS’s loan debt at the end of the 2012 totaled about 1,853 million pesos, or about $380 million using end of 2012 fx rates. At the end of the first six months of 2013, TGS’s long term loan debt declined to about 1,523 million pesos, or about $283 million dollars using end of June fx rates. This 25% shift of loan debt from long term to short term is actually an indication in TGS’s accounting for the pending redemption next May (2014) of 25% the outstanding 2017 bonds at the premium price of 100.984.
We like companies that have sound balance sheets
Considering that all the financials of TGS are reported in Argentine pesos, which have devalued significantly over the last ten years, its equity value is difficult to assess. Over 51% of TGS stock is held by Compañía de Inversiones de Energía S.A. (“CIESA”), which we view as more restrictive on any possibilities for raising capital through additional stock offerings. However, all other basic aspects of its balance sheet remain very sound, and total shareholder equity at the end of Q2 2013 is reported at 2.034 billion pesos ($378 million.)
We like higher yields
This $500 million debt note (in US dollars) was issued by TGS in March of 2007 at the coupon rate of 7.875%, payable semi-annually. At the current discounted price of about 95, it not only provides excellent cash flow from a high coupon rate, its average yield to average redemption (25 months) is projected to be about 11%!
Risks Considerations
The default risk is Transportadora’s ability to perform. Considering its historical and recent performance, its flexible balance sheet, its sound cash position, and the excellent cash flow that is projected to service its 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 potential.
The hardest risk by far for us to identify is the geopolitical risk. In spite of investor concerns over nationalization of YPF last year, the investment climate has evidently improved enough that Chevron (and a number of other companies) has increased its presence in Argentina. Furthermore, we find it increasingly difficult to understand many of the political changes within even in our own country, as it sometimes hard to fathom why the US Government appears to have significantly delayed (if not outright canceled) the approval of TransCanada Corp. (TRP)’s multi-billion dollar development of the Keystone pipeline. Therefore, speculation towards any future Argentine efforts to regulate natural gas or petroleum development might seem rather pretentious. Another turn of events appears to be the lack of popular support for Argentina’s current president, Christina Kirchner. Primary elections in August seemed to confirm Mrs. Kirchner’s status as a lame duck. With that said, it is our opinion that diversification into many other countries, locations, and industries often serves to reduce overall portfolio risk. Our strategy is, as with other Yankee bonds, to focus on unique or required (and in this case somewhat monopolistic) services that can be seen as adding economic prosperity to the society it’s associated with. Considering that Argentina’s population is very dependent on natural gas for a major part of its basic cooking and heating functions and that natural gas accounts for 55% of Argentina’s total energy consumption, we view TGS’s natural gas pipelines and services as an essential part of the Argentinean society.
TGS is relatively small from a global perspective, and it may face increasing competition from substantially larger and better financed companies attempting to gain in massive natural gas expansion. However, it is by far still the largest pipeline company in Argentina and it’s part of the Public Utilities sector, which includes competitive companies such as Enterprise Products Partners L.P. (EPD) and National Grid Transco, PLC (NGG).
TGS is directly affected by prices in Natural Gas both internationally and domestically, as well as by the exchange rate of the Argentine Peso. Further development of the Neuquén Basin and the greatly increased production that is forecast, combined with TGS’s already embedded low cost pipe transportation hub, should help alleviate some of these uncertainties going forward.
We believe that these TGS bonds have similar risks and maturities to other high yielding Yankees bonds from Argentina and Latin America such as 9.5 % yields from short 44 month, high yield Yankee (US dollar) bonds from Alto Palermo SA (APSA), 11.22 % Yields From Aeropuertos Argentina 2000’s 7+ Year Bonds, and 9% Yield from Petroleos de Venezuela’s 4½ year Yankee bonds, maturing Feb. 2017, which are selected from some of our previous reviews.
Summary and Conclusion
Given the dominant monopolistic positioning of its pipelines and its highly profitability GTL operations, Transportadora de Gas del Sur appears to be very well situated as for the future as a key player within the Argentine economy. It has a fair cash position, excellent profit margins and 3 years of solid bottom line growth, and a healthy balance sheet even after incorporating its most recently announced dividend. Therefore, we think these short term TGS Yankee bonds offer an extremely high yield relative to the financial risks that we can identify, and we see them as a strong addition to our FX1 and FX2 fixed income portfolios.
Issuer: Transportadora de Gas del Sur S.A
Coupon: 7.875%
Maturity: 5/14/2017 (laddered call, 25 month average redemption)
CUSIP: P9308RAX1
Ratings: B3/B-
Pays: Semi-annually
Price: 95.5
Yield to Call (5/14/14): ~18.8 % (call price is 100.984)
Yield to Call (5/14/15): ~11.1 % (at par)
Yield to Call (5/14/16): ~10% (at par)
Yield to Maturity: ~9.4 %
Disclosure: Durig Capital and certain clients may have positions in TGS 2017 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. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this 10% US Dollar Yankee bond call our fixed income specialist at 971-327-8847
On a scale of A+ to F
Reason for Durig’s Highest A+ Rating
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