By
Randy
Durig
:
Recycle your way to higher income with these high yielding bonds
from Bio PAPPEL, S.A.B. de C.V.(CDURQ.PK) , the largest paper
producer in Mexico and the leader in the production of 100%
recycled, recyclable and biodegradable paper throughout Mexico and
Latin America. Each week, we screen thousands of corporate bond
listings to find what we believe to currently be the best corporate
bond for investors needing or seeking higher yields with the least
amount of risk as possible relative to its projected return. The
following is our review process that shows why we believe these
near 13% yielding US dollar short-term 4-year "step up" bonds from
Bio PAPPEL pass the stringent criteria for our clients, and why we
have selected them for addition to other high yielding
corporate bonds
in their investment portfolios.
Step 1 - Assessing the Yield Curve
The higher yield fixed income market continues to be driven by
money inflows, and remains resilient despite stock market action.
Along with declining fixed income yields are heightened concerns
for acquiring fixed income instruments that can outpace inflation
without adding excessive risks. With the 5-year treasuries still
trading near a low 0.75% yield and the official (but seemingly
flawed) CPI for all items (less food and energy) now reported at
2.1%, this one year shorter-term 13% bond might has the possibility
of taking a big stride towards improving cash flow and in
preserving wealth as long the underlying fundamentals of the
issuer, which we will review the major elements of here in this
article, remain sound.
Step 2 - A look at the issuer
Since itsfounding 25 years ago, Bio PAPPEL's vision of
sustainability is founded on competitiveness, environmental
protection, and social responsibility. The paper industry itself is
the largest consumer of wood and forests worldwide, since it uses
them as raw material for paper production. However, Bio PAPPEL has
replaced use of forest woods with the use of urban woods (paper
recycling), with investments of over 500 million US dollars in the
past 10 years and not cutting down trees for use in manufacturing
paper. This is the structural foundation of Bio PAPPEL's change of
corporate identity. In 2011, the company recycled 1.5 million
metric tons of paper, which is equivalent to saving 685 thousand
trees. Bio PAPPEL is the only Mexican company to obtain
"FSC-Certification 100% Recycled," which can be reproduced by the
users of its products.
Bio PAPPEL currently has 31 Industrial plants in the lower US
and (primarily) throughout Mexico, and about 7,500 employees. It
has a broad and diversified customer base in Mexico and the USA,
which includes most of Mexico's top 500 companies.
Step 3 - We like companies that are profitable
When first starting our review of Bio PAPPEL, we were naturally
inclined to think of it as just another troubled forest commodities
producer afflicted over the lastfour or five years by global
economic woes. Surprising us, was the relative consistency of its
net sales numbers over the last five years:
|
|
2011
|
2010
|
2009
|
2008
|
2007
|
|
net sales
(in millions of pesos)
|
11,008
|
11,322
|
10,288
|
10,217
|
10,126
|
|
operating income
(in millions of pesos)
|
406
|
675
|
568
|
(208)
|
634
|
|
deprec. and amort.
(in millions of pesos)
|
362
|
329
|
364
|
unavail
|
unavail
|
|
EBITDA
(in millions of pesos)
|
768
|
1004
|
932
|
|
|
Also somewhat surprising to us was the relatively stable
earnings (EBITDA) generation over the last three years.
Furthermore, after looking deeper into their income statements, it
confirmed to us that the risks to earnings and cash flow were not
likely to be big fluctuations in the demand for their products, but
rather, in currency exchange and production costs.
Fitch, which recently affirmed Bio PAPPEL's bond rating at "B",
expects somewhat higher EBITDA generation through the remainder of
this year. Given that Chinese purchasing demands for waste paper
supplies have recently fallen off, after considering the following
three key points, we think the comment is probably overly
conservative or too vague to draw much attention to the primary
reasons:
- The global recovery rates for waste paper appear to be
rising. They currently average about 44% in Latin America and
about 65% in North America. Along with a curtailed demand from
Chinese buyers for North America's waste paper, this is likely to
stabilize or perhaps even lower Bio PAPPEL's raw material
costs.
- Energy is Bio PAPPEL's second biggest production cost, and it
is primarily dependent on natural gas costs. Considering the
projected continued low prices for natural gas and the
integration of some savvy longer-term (2 ½ year) hedging in
January of 2012 when natural gas pricing was near 10-year lows,
there appears to be little doubt that this cost reduction will
continue to reflect in strong EBITDA number going forward.
- As a result of a majority of its costs being linked to
dollars, any appreciation of the Mexican peso relative to the US
dollar would result in additional costs savings. According to a
July 2012 Global Emerging Markets Equity Research report from JP
Morgan, Mexico was outperforming most other Latin American
countries primarily as a result of the sharply appreciating peso
from its lows in May. More significantly, the MXN was the only
currency in Latin America that appreciation was expected to be
seen in going forward.
Overall, it appears that Bio PAPPEL adjusted to and survived the
global economic whirlwinds of 2008 with remarkable ease, and is now
very well positioned to turn continued cost savings into solid
earnings and cash flow going forward.
Step 4 - Interest Coverage Ratios
Interest expenses for Q2 were reported at about $5.3 million,
while operating income was about $20.1 million, indicating
reasonably good 4 to 1 coverage ratio and a 90% year-over-year
improvement in 2Q 2011's operating income, which was $10.6 million.
The full year for 2011 (ended Dec. 2011) showed interest expenses
at Ps 284.5 million ($20.8 million), while operating income was
reported as Ps 406.3 million ($29.7 million.) Earnings before
taxes, depreciation and amortization (EBITDA) was Ps 768 million
($56.3 million), giving about a 3 to 1 coverage ration of the
interest expenses. Years 2009 and 2010 both indicated higher cash
flows than 2011 against lower interest expenses, with significant
variations evidently resulting from or magnified by USD-MXN
currency exchange rates.
Given Bio PAPPEL's recently reported strong cash flow and
rapidly rising EBITDA, it would truly be no surprise to us to see
the bond called next year prior to the interest coupon payment
increase to 10%. Furthermore, should the Mexican peso continue to
strengthen against the dollar, it will likely bode very well for
this company and we would be quite surprised to see these bonds
left outstanding.
Step 5 - We like companies with lower debt to cash
ratio
The consolidated debt of Bio PAPPEL at the end of Q2 2012 was
$261.8 million, primarily attributed to the 2016 Notes. Cash and
cash equivalents at end of Q2 had increased to $80.1 million from
the 2011 year end amount of $70.8 million, giving it a quite
reasonable debt to cash ratio of about 3.25 to 1.
Step 6 - We like companies that have good balance
sheets
Bio PAPPEL's current debt appears to be about 60% of its
currently indicated enterprise value of about $425 million. This
plainly shows the valuation currently given to it by the capital
markets, but what it doesn't reveal is how low this valuation is
relative to its much higher book value of over $880 million. So,
while there may be reduced opportunity from the equity markets
should additional capital need to be raised, the strong property,
plant and equipment valuation it holds on its books does provide
sound and tangible assurance for its bondholders.
Step 7 - We like higher yields
This US dollar denominated debt of Bio PAPPEL was issued in
August of 2009 at the coupon rate of 6% for the first year, 7% for
the following three years, and 10% for the last three years,
payable quarterly. Its principal amount of $250 million is
callable, and it maintains certain restrictions affecting the
ability of Bio PAPPEL or its subsidiaries to such things as (but
not limited to): incurring new debt; paying dividends; becoming
involved in a lines of business not allowed; mergers, leases or
sales of all or substantially all of the company's assets; or
repurchasing the 2016 Notes in case of a change of control.
At its current discounted price of 87.50, the indicated yield to
maturity in 2016 is about 13%, or if it were to be called next
August, about 20%. Although the credit ratings are widely
different, when set in comparison to longer five-year U.S.
Treasuries yielding a paltry 0.75%, we believe this greater than
12% difference in yield is stunning given the level of risks that
we can identify.
Step 8 - Risks Considerations
Bio PAPEL is relatively small compared to other paper and
packaging products manufactures and their subsidiaries, such as
International Paper Company (
IP
), Domtar Corporation (
UFS
), Weyerhaeuser (
WY
), and MeadWestvaco Corporation (
MWV
), and may face increasing competition from substantially larger
and better financed companies for the raw materials that are
needed.
The cost of recycled fiber (OCC and ONP) is directly affected by
trends in international and domestic prices, as well as by the
exchange rate of the Mexican peso. Fluctuations in the price and
supply of energy are also unpredictable, but recently implemented
commodities hedging should help alleviate some of these
uncertainties going forward. Considering that most of its revenues
are generated in pesos, it is our opinion that Bio PAPPEL's
vulnerability to a sharp devaluation of the peso may be the most
significant risk.
We believe that these Bio PAPPEL bonds have similar risks,
similar maturities, or similar yields to the StoneMor (
STON
), KEMET Corporation (KEM), Tutor Perini (TPC), or Georgian Railway
bonds reviewed previously on our
Bond-Yields.com
blog.
Summary and Conclusion
Although Bio PAPPEL's bonds are only rated as B from Fitch and
are unrated by other agencies, we see the overly conservative view
from Fitch as a blinder that hides this unusual opportunity from
the peripheral vision of those seeking high yields for the least
amount of risk. In fact, this is such an unusually high yield
relative to its risks that we are inclined to think of it more as
an anomaly, especially when the likelihood of being tendered in
2013 is added to it. In light of this, we suspect that there may
not be much liquidity in this particular bond issue at its current
price levels.
It is our opinion that Bio PAPPEL has not only positioned
themselves well for the future as a "green" 100% Recycled materials
company, but they are the largest in all of Latin America. They
have a good cash position, sound interest coverage, and a sound
balance sheet, which is why we have chosen to add them to our other
Offshore Bank,
Foreign and World Fixed Income
holdings.
Coupon:
7.0, stepping up to 10.0 in year 2013 and after
Ratings:
NR/NR/B
CUSIP:
P7448MAH2
Maturity:
08/27/2016
Price:
88.25
Yield to Maturity:
12.96%
Yield to Call in 2013:
~20.75%
Disclosure:
Durig Capital and certain clients may have a position in PAPPEL
2016 bonds. I wrote this article myself, and it expresses my own
opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
Please note that all yield and price indications are shown
from the time of our research. Our reports are never an offer to
buy or sell any security. We are not a broker/dealer, and reports
are intended for distribution to our clients. As a result of our
institutional association, we frequently obtain better
yield/price executions for our clients than may be initially
indicated in our reports.
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