Fixed Income Boutique

Wrestling income and yield from emerging market corporate bonds

Emerging Markets

Market inefficiencies are the prime reason to invest in emerging market corporate bonds. By seeking out inefficiencies caused by, for example, overreaction to short-term news and benchmark-hugging investors, an active investor can find bonds where the credit fundamentals are solid yet the yield and income are generous.

Emerging market corporations are familiar to most investors through equity markets. However, emerging corporate bonds offer a far broader opportunity set than equities by giving investors exposure to high-growth emerging markets companies. Since bondholders are paid before shareholders, investing in these companies through bonds is a less risky proposition than a direct equity investment. Furthermore, bonds pay a coupon, whereas equities may or may not pay a dividend. Therefore, emerging market corporate bonds can provide investors with steady income – often at a higher yield than their developed market peers.

With emerging market corporate bonds, it’s important to do a thorough analysis, both bottom-up and top-down, to ensure that the underlying company is able to service its debts, as well as confirm that it is operating in an favorable economic environment.

To demonstrate how an active investor can go about finding individual bonds, we will look at an issuer that many investors might overlook, but what we believe, based on our analysis, offers a solid investment.

Trans Oil

Trans Oil is based in Moldova, a nation of 3.5 million inhabitants, nestled between Romania and Ukraine. Moldova is a nation where the national sport is trynta, a form of wrestling. So let’s have a look at how an active investor can go about grappling an emerging market corporate bond and pinning one that will deliver returns.

The name Trans Oil would indicate a petroleum company, however, the company is not in the business of crude oil. Rather, it is in agricultural oils and grains. An apt company for Moldova, where grain is highly regarded. For example, in trynta, the traditional award for a winner of a fight is a loaf of bread.

Top down

Moldova is known for its fertile black soil and favorable climate with a low likelihood of natural disasters. Although a small country with a GDP of 11 billion US dollars, Moldova has grown rapidly in the global and EU context, with average annual real GDP growth of 4.5% in the past three years.

The country had a severe banking crisis in 2014 due to corruption, but since then the banking sector has been cleaned up and consolidated. Currently, its banking industry is effectively controlled by international banks (including the EBRD). Moldova is in 47th place in the World Bank’s Ease of Doing Business ranking, which is decent for a frontier economy.

All in all, Moldova is a typical small emerging market country with some historical legacy issues, but a fast growing economy with improving governance and leaning toward a pro-European direction (for example, in the first round of the recent presidential elections, the pro-EU candidate received 35% of the vote vs. 32% for the pro-Russia candidate).

This type of environment makes for a fertile hunting ground for bond investors, who can venture into frontier markets.

Bottom up

Trans Oil grows crops (sunflower seeds [SFS], corn, and wheat) as well as buys them from third-party companies and farmers, processes them, and bottles (sunflower oil) and exports via its own port terminals, including the only seagoing terminal in the country. It also has 13 inland silos and more than 100 railcars.

Half of Trans Oil’s revenues come from the European Union, with which Moldova has a free-trade agreement since 2014, the rest is exported to the Black Sea region, Turkey (re-export to the US), and the Middle East and Africa region. All revenues are in US dollars, while about 70% of costs are in local currency (lei). Thus benefitting from a strong US dollar.

Trans Oil dominates its sector in the country, controlling some 80% of SFS origination and 95% of crushing capacity, as well as 60% of all agricultural exports in Moldova. In addition, the company is one of the largest employers in the country with 1770 employees.

Founded in the 1990s, it was acquired by the current majority owner – Moldovan Vazha Jhashi in the mid-2000s and, recently, a US-based private equity giant OakTree has joined as a strategic partner. The company continues to grow organically and develop its assets. Most recently, in 2019, it acquired a crushing plant in neighboring Romania, a sound business acquisition, in our view.

Of the company’s revenues, SFS is about 40%, wheat 20%, and corn 20%. The top ten clients represent about 70% of turnover, making their customer base well diversified. Most of Trans Oil’s customers are direct buyers in the countries of export rather than so called ABCD (four largest agricultural commodity traders, like Bunge or Cargill).

As a dominant player in the country, it also manages to improve margins by supporting its suppliers with working capital credit lines, which is a positive social function, in our view.

The company has 800 million US dollars in revenues, almost 100 million earnings before interest, taxes, depreciation, and amortization (2020). Net leverage is 1.9 and has decreased from 4.8x in 2016. Importantly, the net leverage includes 75% of its readily marketable inventory (RMI), in line with ratings agencies’ methodology, whereas de facto 95% of its RMI is actually pre-sold.

The company does not pay and is not expected to pay any dividends. However, their medium-term target is, after reaching 100 million EBITDA, to go public and then it would likely adopt some kind of dividend policy.

Trans Oil’s nearest competitor is Ukraine’s Kernel (rated B/B+) whose January 2027 bond trades at 6.7% yield which is tighter than the sovereign curve in Ukraine. Thus, at around 10% yield, Trans Oil gives a very decent premium, mainly because the name/country is quite exotic for many large investors. This is exactly the kind of inefficiency that creates a yield premium that an active investor should seek.

Be active

Thanks to its sheer size of more than 2 trillion US dollars, the emerging corporate bond universe offers investors fertile ground to plough for return-generating bonds. The key is to take an active approach. This is no different to wrestling: in a tight match between equally matched opponents, it is the one who is more active whose hand is raised in victory… and awarded a loaf of bread.

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