In light of the recent noise out surrounding Saudi Arabia and neighbouring geopolitics, as holders of the country’s strategically important electricity company we’d like to discuss our thoughts.
As regular readers are aware, we manage the portfolios with the Net Foreign Asset (NFA) as the first level of investment guidelines. For inclusion of any credit at first they must be domiciled in a ‘Wealthy Nation’ as defined by the NFA calculation; Saudi Arabia more than qualifies having a NFA to GDP of 178% (7 stars). Although there are concerns over the country’s forecast budget, we view the recent 2016 budget as credit positive; it is evident that policymakers have taken positive proactive steps in the face of further declining oil prices (of their own making). According to the budget, subsidies (which have been a fiscal drag) will be cut and expenditure is expected to fall by ~14% yoy. Ratings agency Fitch echoed our sentiment stating that the country is showing a “commitment to reform” adding that the budget was “positive”. Saudi’s 5-year CDS currently trades around 190 basis points which is fairly low when you consider one of the largest holding within EM indices i.e. Brazil’s at around 300bps higher.
We hold two issues by Saudi Arabia’s dominant utility company, Saudi Electricity (SECO). Rated A1/A+/AA-, the SECO 5.06% 2043 and 5.5% 2044 issues are backed by the sovereign’s Aa3/A+/AA ratings; as SECO, the Gulf’s largest utility firm is 81% owned by the Saudi government. These bonds currently offer some of the most attractive risk-adjusted expected returns of ~32%, with a yield over 6.2%. By way of comparison, similarly rated Korea Gas Corp 6.25% 2042 has an expected return of just 3.2% and yield less than 4% and trades at a spread of +110bps, where SECO 2043 trades at an impressive 340bps spread over Treasuries. We also calculate that the market is pricing the SECO bonds as Baa2/Baa3 rated bonds; in other words these bonds provide plenty of cushion, currently ~5.5 notches, against unexpected events such as the current geopolitical climate.
Whilst the SECO bonds have underperformed, due to exaggerated market reactions, there has neither been a change in the fundamentals of the company, nor an increased threat in default; we therefore will not be looking to either cut or add to our current exposure in the short-term. We do not believe that current geopolitical tensions with Iran will have a material impact on SECO, the country’s exclusive electrical provider. If there is a scenario where the company suffers any kind of financial distress, the government will no doubt remain supportive as SECO is strategically important to the state. In fact the company has been taking pre-emptive steps in loan structuring, just yesterday SECO, announced that it had signed a three-year USD 1.4bn credit line with seven international banks, so important was the announcement that the country’s Capital Market Authority (CMA) temporarily halted trading on SECO’s shares!
Whilst it is clear there is a widening budget deficit in Saudi Arabia, recent tightening measures will further help the country’s strong position in weathering lower oil prices and weaker growth. In fact we see plenty of room for further tightening, if necessary, especially if we consider that one litre of high-grade petrol costs only $0.24 in Saudi versus UK supermarket “discounted” petrol priced at £0.997 ($1.45)! The Kingdom also boasts huge fx reserves of ~USD65bn, as at October 2015 and very little debt within international debt markets; word on the street is that the country is due to issue ~USD 5bn at some point this year.