The Evil Twins of Emerging Market Debt
Emerging Markets: Sizing Up Debt’s Evil Twins — Barron’s
By Craig Mellow (Jan. 26, 2015)
Petroleo Brasilieiro, better known as Petrobras, and Gazprom are terribly managed companies at the heart of the less-than-brilliantly-run economies of Brazil and Russia, respectively. Both have huge debts, which have become tougher to repay, thanks to diving energy prices and internal factors — a corruption scandal that is paralyzing Petrobras, and international sanctions that are keeping Gazprom out of bond markets.
But could either of these national champions actually default? Not likely, and that may spell opportunity for fixed-income investors who can hold their governance noses. “These credits are priced at distressed levels, while we foresee that they will repay,” says Max Wolman, senior investment manager at Aberdeen Asset Management in Scotland. “We are buying selectively.”
With foreign debt of close to $130 billion between them, Petrobras (ticker: PBR) and Gazprom (OGZPY) were avatars of a credit spree that saw bond placement by emerging-market corporations grow eightfold since 2009, to about $1.7 trillion. The oil crash and expected U.S. interest-rate rises have induced a vicious hangover. The Pimco Emerging Markets Corporate Bond fund (PEMIX) is down 9% since mid-November, an extreme move by fixed-income standards. Spreads on both companies’ bonds have ballooned by about two percentage points, with five-year Petrobras paper yielding more than 6.5%, and Gazprom’s about 8.5%. Emerging-market pros think these levels may be too high. Though many view Gazprom as an agent for Vladimir Putin’s adventures in Ukraine, the company is conservative financially. It owes $5.4 billion to foreign creditors this year, but generated $7 billion in free cash flow last year, figures Maxim Edelson of Fitch Ratings in Moscow. Russia’s state oil flagship, Rosneft, is in much direr straits, but most of its debt is in syndicated bank loans, he reports.
Petrobras’ balance sheet is genuinely stressed, with long-term debt at a vertiginous 5.3 times earnings before interest, taxes, depreciation, and amortization, says Michael Roche, an analyst at New York fixed-income boutique Seaport Group. Kickback investigations by Brazilian prosecutors and U.S. regulators will keep the company from issuing new bonds until this summer, he predicts. But Petrobras can release cash by curtailing expensive investments in offshore drilling, while its existing wells are profitable, even if oil dives into the mid-$20s, says Roberto Sanchez-Dahl, a portfolio manager for John Hancock Asset Management in Boston. (Benchmark Brent crude currently trades around $48 a barrel.) Brazil’s government, which still has $350 billion in currency reserves, is also expected to defend Petrobras’ investment-grade credit ratings via direct loans or by guaranteeing a bond issue. “Petrobras is a core holding in our portfolio,” Sanchez-Dahl observes.
Petrobras and Gazprom will sacrifice future investment to debt if energy prices don’t rise and, in the latter’s case, sanctions on Russia aren’t lifted. Gazprom and its majority shareholder, Russia’s government, will be particularly challenged to finance a $55 billion pipeline to China, Putin’s anti-sanctions linchpin.
In any case, accessing emerging-market corporate credit is tough for retail investors. The Pimco fund requires a minimum bet of $1 million. The competing WisdomTree Emerging Markets Corporate Bond fund (EMCB) is open to all and reasonably liquid with $100 million in assets. And two others in the category, iShares Emerging Markets Corporate Bond (CEMB) and the SPDR BofA Merrill Lynch Emerging Markets Corporate Bond (EMCD), have assets of $24 million and $22 million, respectively.