Yesterday Oman came to the market with a multi-tranche USD5bn bond issue that was close to four times covered but with the 30 year issuing at a generous yield of 6.549%, even for a Baa1 rated credit (Moody’s), it is easy to see why investors were keen to get exposure, ourselves included. That said, we still see the greatest valuation upside in the quasi-sovereign space.
Most quasi sovereign bonds trade at wider spreads than their own governments and globally quasi sovereigns pay roughly 0.9% more than their sovereign owners. That is a lot of extra compensation for the modest additional risk. This is why quasi sovereigns have been a focus of ours for many years. Although the issues are usually not explicitly guaranteed by the government, the strategic importance of quasi sovereigns means that the government is highly likely to stand behind these credits.
Pemex, the world’s eighth largest oil producer, 100 percent owned by the Mexican government, remains a favoured holding of ours: For example, the US dollar denominated Pemex 6.625% 2035 issue trades on a yield of 6.51 percent and is trading ~5.5 credit notches cheap on our valuation models which compares with a yield of 5% on the longer dated US dollar denominated Mexican States 4.6% 2046 which is trading ~2.5 notches cheap on our models. Pemex’s debt is not explicitly guaranteed by the Mexican government but the producer is of strategic importance and the government has a track record of supporting and injecting capital into the business when required. For example, the government injected USD1.5bn in equity in 2016 to plug a gap in its pension liabilities and the Ministry of Finance has recently made public statements supporting Pemex. It comes as little surprise that Moody’s view Pemex as having a ‘very high likelihood of extraordinary support’.
Pemex has been heavily criticised for being inefficient and badly run which has manifested in a much weaker stand-alone credit profile and financial metrics. However, under the leadership of the new CEO Jose Antonio Gonzalez Anaya, Pemex seems to be gaining some traction with a cost cutting program and efficiency drive targeting profitability along the entire value chain. The company remained loss-making at the net income level in 2016 (MXN -296bn) but shifted to profit at the operating income level (MXN 364bn), a considerable improvement over 2015, and which supports 2017 as an inflexion point. The CEO expects the Pemex to return to profitability in 2019 or 2020. While the company has high debt levels and a weak liquidity position Pemex has successfully been able to access the debt markets, diversifying the funding base and lengthening the average term of the debt. The company expects to bring net debt down to MXN150bn in 2017 down from MXN232bn in 2016; this is important as rising leverage was one of the concerns cited by the rating agencies.
Encouragingly, for the first time in five years the company exceeded their production target producing 2,154,000 barrels per day in 2016. That said, there is still much work to be done to address a declining production profile; mainly due to the decline in the major Cantarell field. In terms of exploration and capex its strategy is to form joint-ventures to develop new fields and upgrade existing facilities. For example, a farm-out agreement was signed with BHP Billiton in December 2016 for the development of the Trion field, an USD11bn project. The Trion field is expected to produce 120,000 barrels per day by 2025 although it will not begin operating until 2023. BHP bring expertise in deep-water subsalt exploration and drilling and the farm-in structure reduces Pemex’s capex requirements on a go it alone basis.