At the end of last week Standard and Poor's downgraded the Sultanate of Oman’s sovereign rating one notch to BB+, citing a reduction in the nation’s net external asset position; as a result of falling oil prices. Oman is still rated investment grade (IG) by the other two main rating agencies, Baa1 (stable) by Moody’s and BBB (stable) by Fitch. As IG indices require a minimum of two IG ratings (from the three main agencies) for bond inclusion, coupled with the fact that Oman’s sovereign curve already trades relatively wide on a rating basis, our positions saw limited price action. Please note however, that we do not look to the IG indices for guidance on holdings, in fact a number of our holdings across the portfolios are not included in such indices; rather we look for relative value, spread cushion and ownership strength.
As such, we currently hold the likes of Oman Government 5.375% 2027 and 6.5% 2047 issues, which are amongst some of the highest yielding IG bonds, at 4.9% and 6%. Rated Baa1 by Moody’s, these bonds in turn offer very attractive risk-adjusted expected returns around 10% and 20% respectively, and more importantly have ~3.5 notches of credit cushion. Aside from these holdings we also have a position in the state-owned funding vehicle for the country’s electricity transmission network, Lamar Funding 3.958% 2025, which was also downgraded one notch to BB+, but maintains its Baa1 rating through Moody's. On this basis the bond trades on a spread above +255bps over US Treasuries, while similar bonds trade around 135bps; this suggests that the bond could potentially see roughly 10 points of capital appreciation to reach what we calculate is ‘fair value’.
Another bond we like is a new issue from the same quasi-sovereign issuer; the Oman Electricity 5.196% 2027. Rated Baa1 by Moody’s and unrated by Standard and Poors and Fitch, this bond would not be included in the IG indices, however we hear from the banks who brokered the deal that the bond, which sits at the belly of the curve, has a huge amount of GCC bank support. Since issue, a week ago, the bond has tightened 10bps to a yield of 5.06%, and as with our other holdings trades over 3.5 notches cheap.
As is well known, Oman’s economy is highly dependant on the hydrocarbon sector, where oil accounts for ~60% of exports. However, as with other Middle Eastern economies the Sultanate continues its drive towards diversifying its economy away from the hydrocarbon sector, after collaborating with the Malaysian Government last year, with an aim to use Malaysia’s ‘successful’ economic diversification blueprint. The first phase of the ‘9th Five-Year Plan’, which is underway, includes a boost to tourism and manufacturing industries, investment in transportation and logistics; with the second phase focused on the fishing and mining sectors. As such we expect further issuance from the Sultanate, with a USD 7-year tenor sukuk issue due by the end of the month; potentially followed by a 12-year sukuk tranche.
At Stratton Street we currently assign the high-income country, Oman with a 4 star rating as it has net foreign liabilities (NFL) less than 25% of GDP; using current IMF estimates, we forecast Oman could potentially break through to a 3 star country by 2019. Despite this, at these levels of attractiveness, we remain comfortable with our exposure to the sovereign and its electricity network as their bonds currently more than compensate any potential downside. However, as always we continue to monitor all of our positions and look to switch into higher value and cushioned credits which we feel can effectively deliver the best performance.