This week we look at a short 40 month Russian Ruble bond from RusHydro that currently indicates an over 9% yield to maturity. The high yield and short maturity of this ruble bond, compares very favorably with other high yielding instruments in our Foreign and World Fixed Income holdings. We believe the dollar’s longer term weakening trend against many world currencies remains a major concern for investors seeking protection against its devaluation and a further erosion of its buying power, and we view the recent weakness in the ruble as a great opportunity to increase our exposure to the Russian economy, which continues to appear as one of the better global economies in spite of nearby European financial concerns.
Wealth Preservation Concerns
Wealth preservation continues to be one of the biggest concerns among our clients. With US Ten Year yields pushing into new territory below 1.5%, it appears that little to nothing can be gained in against only marginally lower inflation (CPI) levels. Therefore, here at Durig Capital we continue to look to protect our client’s assets against this persistent destruction of wealth by scouring the globe in search of sound investments in a basket of the strongest global currencies, which is why we have chosen these high yielding RusHydo ruble notes as This Week’s Best Bond.
Russia has undergone significant changes since the collapse of the Soviet Union, moving from a globally-isolated, centrally-planned economy to a more market-based and globally-integrated economy. Economic reforms in the 1990s privatized most industries, with notable exceptions in the energy and defense-related sectors. The Russian export industry consists primarily of natural gas to the Euro zone, is the world’s second largest exporter of oil, and is the third largest exporter of steel and primary aluminum. This reliance on commodity exports makes Russia vulnerable to boom and bust cycles following the highly volatile swings in global commodity prices, and provides reason for the higher correlation of its currency to oil prices.
The economy had averaged 7% growth since the 1998 Russian financial crisis, resulting in a doubling of real disposable incomes and the emergence of a middle class. The Russian economy, however, was one of the hardest hit by the 2008-09 global economic crisis as oil prices plummeted and the foreign credits that Russian banks and firms relied on dried up. The economic decline bottomed out in mid-2009 and the economy began to grow in the first quarter of 2010. Growth for 2011 was 4.8%, and unemployment was at 6.6%. Capital markets are relatively small but growing and are dominated by energy companies.
Russia’s competitive flat income tax rate and low corporate tax rates support innovation, although private enterprises also must cope with “informal taxes” such as bureaucratic hassling and corruption. Other taxes include a value-added tax (VAT) and a regional property tax. Overall tax revenue as a percentage of GDP was 34.1 percent. In the most recent year, total government expenditures, including consumption and transfer payments, increased slightly to 34.1 percent of GDP. The state maintains a strong presence in such key sectors as energy and mining. Public debt is at under 10 percent of GDP in 2011, while inflation is 3.8%.
|Country||Debt to GDP||2011 GDP growth||Unemployment Rate|
|Russia||9.9 %||4.8 %||6.6%|
|United States||over 100 %||3.0 %||8.2 %|
About Open Joint Stock Company RusHydro (OJSC RusHydro)
Federal’naya gidrogeneriruyushchaya kompaniya RusGidro OAO (RusHydro), is a Russia-based company, which is engaged in the generation, transmission and distribution of electric energy on the wholesale market of the Russian Federation. The main activity of the Company is production of power from renewable energy sources, developing power generation using water flows, tidal, wind and geothermal energy. The Company operates through 20 branches and numerous subsidiaries, located domestically. While its stock primary trades on the Moscow Interbank Currency Exchange (MICEX) exchange, it trades as an ADR on the London and German exchanges as well as (RSHYY) on the OTC exchange here in the US.
As of December 31, 2011, the Russian Federation owned about 58% of the ordinary shares of the company, and the Group’s major customer base includes a large number of entities controlled by, or related to the government. Furthermore, the government controls contractors and suppliers, which provide the Group with electricity dispatch, transmission and distribution services, and a number of the Group’s fuel and other suppliers.
There are three primary areas that Durig Capital focuses upon for its bond reviews to help assure the return of our client’s capital. After reviewing their most recent (audited) 2011 annual financial statement, RusHydo passes all three categories with flying colors:
- Debt to Equity – about 40%, indicating good balance sheet flexibility.
- Debt to Cash - about 2.25 to 1. This is reasonable, and once again, quite acceptable.
- Cash Flow to Debt obligations – over 5x’s. A good coverage ratio.
In accordance with the Russian legislation the Group distributes profits as dividends on the basis of financial statements, and on June 30, 2011 the Group declared dividends for the year ended 2010 of RR 2,450 million, or 0.0086 per share (indicating a yield of about 1% based on its current share price.) In summary, this is a very profitably run company with reasonably low debt levels, ready options for additional funding if necessary, and a prudent use of existing cash flows.
Combined, these financial ratios are some of best that we have reviewed for unrated or less than investment grade issuers, and it is why we have chose to include this Russian ruble denominated RusHydro Bond in our offshore bank income investment opportunities that include issuers such as JP Morgan (JPM)’s, Bank of America (BAC), Lloyds Bank (LYG) or UBS (UBS).
The default risk is RusHydo’s ability to perform. Given the majority government and the company’s expanding asset base, improved balance sheet and strong performance last year, it is our opinion that the default risk for this short term bond is minimal relative to the currency risk of the Russian ruble.
The currency risk of the Russian ruble could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Russian economy. The Russian Federation displays certain characteristics of an emerging market that includes relatively high inflation and high interest rates. The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Russian government, together with tax, legal, regulatory and political developments. While higher oil prices could help Russia reduce the budget deficit inherited from the lean years of 2008-09, lower oil prices would impede progress in this area.
Accessibility and Liquidity
RusHydro currently has over $3.8 billion of outstanding debt, mainly in short to medium term notes denominated in Russian rubles. Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual, maturity definite RusHydro ruble bonds. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and advisor’s assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as US $10,000.
We hope NOT to see any further destruction of wealth resulting from a decline in the US dollar relative other global currencies, and we acknowledge that a strengthening of the US dollar would directly reduce the total returns of this Russian ruble denominated bond. On the other hand, should the US dollar return to its longer term path of devaluation that it was on prior to recent interruptions in confidence in global economic and financial systems, this alone could add quite significantly to the already highly positive accruing returns of this bond.
While acknowledging that every investment vehicle involves varying elements of risk, we believe that this recent strengthening of the US dollar relative to the Russian ruble represents an extremely attractive opportunity for increasing exposure to the Russian economy, at a very attractive yield. Therefore, we recommend it to those looking to diversify away from overweighted US dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Yield to Maturity: 9.11%
Disclosure: Some Durig Capital clients may currently own these bonds.
Durig Capital clients may currently own these bonds.
Contact our fixed Income analyst for questions at 971-327-8847.
JP Morgan News:
- Dimon clings to JPMorgan chairman title, after fight - Reuters
- JPMorgan Seen to Defeat Effort to Split Top 2 Jobs at Bank - New York Times
- JPMorgan Chase Shareholders Vote To Let Jamie Dimon Keep Both Chairman ... - Huffington Post
- Wall Street advances as Home Depot, JPMorgan buoy Dow - Reuters
- BofA, JPMorgan say they have fulfilled mortgage settlement terms - Los Angeles Times
- Stocks: Apple and Carnival may make waves - CNNMoney
- Stocks: Focus on Apple, Carnival and JPMorgan - CNN
- Stockholder Power Faces Test at JPMorgan - New York Times
- Deutsche Bank Cut by JPMorgan on Concern Over Capital - Bloomberg
- JPMorgan Shareholders Consider Splitting CEO, Chairman Jobs - NPR
Russian Economy News:
- Ex-Finance Minister Kudrin directly responsible for current state of Russian ... - Russia Beyond The Headlines
- Medvedev doesn't find state of Russian economy dramatic - Kyiv Post - Kyiv Post
- Russia's Economy Could Be Next Big Underperformer - CNBC.com - CNBC.com
- Ulyukayev Dismisses Monetary Easing to Reverse Russian Slowdown - Bloomberg
- Russia's economic growth in 1Q 2013 the slowest since 2009 - RT
- Russia GDP cheers investors - Financial Times (blog)
- Russian Economy Probably Grew at Weakest Pace Since 2009 - Bloomberg
- Russia Economy Minister Sees GDP Growth above 3% in 2nd Half - Fox Business
- Putin's Economic Advisers: Time for Big Change in Russia - Businessweek
- Russian economy expands by 1.6pc in Q1 - Business Recorder - Business Recorder (blog)
Russian Ruble News:
- Russian Ruble Leads Emerging-Market Currency Rally - Wall Street Journal
- Sberbank Sees Yandex Extending Advance: Russia Overnight - Bloomberg
- Ruble Rises Most in Three Weeks to Dollar as Companies Pay Taxes - Bloomberg
- Most Emerging Stocks Rise as Solar Shares Rally; ICBC Declines - Bloomberg
- Russian shares ignore Rosbank's woes; rouble weakens on oil - Reuters
- Asia's Currency War - the Diplomat
- Mechel Slips as Output Dims Sales View: Russia Overnight - Bloomberg
- Market force - The Lawyer
- Emerging stocks rise to one-week high - Post (subscription)
- What the Papers Say, May 21, 2013 - The Moscow Times