The Islamic Republic of Pakistan and India's UPL Corp took advantage of China's golden week holiday on Wednesday to raise $1.5 billion in a muted week for Asian G3 bond supply.
Pakistan's $1 billion five-year Reg S/144a deal was particularly noteworthy, not least because its 5.5% profit rate means the sovereign has finally been able to pierce its previous record low borrowing cost set in 1997.
Almost two decades ago, the then-B+/B2 rated credit raised $150 million in five-year money on a 6% coupon.
It has never been able to achieve it again, until now.
In the intervening period, international borrowing costs spiralled to as high as 12% during 2010 and 2011 as the country seesawed in and out of IMF programmes and its credit rating dropped into CCC territory.
The government is currently exiting its latest $6.6 billion three-year IMF facility and clearly hopes it will be its last, although some analysts are sceptical whether its reform commitment will last given elections are looming in 2018.
During roadshows, officials pointed to the country's recent MSCI inclusion as evidence that Pakistan is entering a new stage of development and more importantly, the $46 billion China is ploughing into the country as part of the China Pakistan Economic Corridor (CPEC), which will link the People's Republic to the Indian Ocean and potentially transform the economy.
Investors responded relatively positively to the message with the deal building up a $2.3 billion peak order book, notwithstanding the fact that pricing came through fair value on a Z-spread basis according to syndicate bankers.
Pakistan certainly appears to have timed its new sukuk a lot better than its last conventional dollar deal, which came in September 2015 at a time of heightened global volatility. The sovereign, nevertheless, managed to get the deal away after halving the issue size to $500 million on the back of a $1 billion order book.
That deal offered a generous 69bp new issue premium and also has traded extremely well in the intervening year. On Wednesday, it was trading around the 109.5% mark, up from 99.99% at issue.
This time round, the B3/B/B- rated sovereign initially set out with price guidance in the high 5% area before final pricing was fixed at par on a profit rate of 5.5%, or Z-spread of 420bp according to syndicate bankers.
The issuance vehicle was Third Pakistan International Sukuk Company and is based on an Al-Ijarah structure.
Pricing benchmarks
The closest comparable is the country's last $1 billion sukuk from November 2014.
This 6.75% December 2019 deal has also traded very well so far this year, rising from a low of 100.25% on January 22 to a high of 106.89% on September 23, when the government announced the new issue.
Since then it has dropped off just over a point-and-a-half and on Wednesday was trading around the 106% mark, equating to a yield of 4.94% or Z-spread of 385bp.
The sovereign also has an 8.25% April 2024 conventional bond outstanding. This was trading Wednesday on a yield of about 6.62% and Z-spread of 530bp.
On this measure, fair value for a new five-year comes out around the 445bp mark on a Z-spread basis, 20bp to 25bp wider than where it priced.
JP Morgan embraces sukuks
Bankers said distribution was similar to recent Pakistan bonds, which tend to have a very even geographical appeal.
They added that while the deal’s forthcoming inclusion in JP Morgan’s emerging market indices is a positive move, it did not have too much bearing on demand.
This August, the US bank announced that sukuk issues from Pakistan, Malaysia, Indonesia and Turkey will be included in its indices from October 31, potentially bringing a whole new investor base into a bond sector traditionally dominated by Islamic buy and hold investors.
“It’s a great step forwards,” said one banker. “But sukuks will have a small weighting so this is something that will have greater impact over time.”
Reform commitment?
The finance ministry says proceeds from the new sukuk offering will be used to top up foreign exchange reserves at a time of declining export revenues. The government also has a $750 million Eurobond maturing next June to contend with too.
At the end of September, FX reserves stood at $23.41 billion, or five months of import cover.
Key for investors will be whether the government is able to continue pushing ahead with structural reforms now it no longer has the IMF looking over its shoulder and when faced with the temptation of shoring up political support through electoral give-aways.
Earlier this summer, the central bank noted that the tax base had still not really expanded despite a tax amnesty scheme and penalties for non-filers.
On the plus side, Chinese investment remains extremely strong given Pakistan’s pivotal geo-political position within the former’s One Belt One Road project.
For example, the 1,320MW Chinese funded and constructed Bin Qasim power project should solve almost one quarter of Pakistan’s power shortages by the time it is operational towards the end of 2017.
Joint global co-ordinators for Pakistan's sukuk were its usual troika of Citi, Deutsche Bank and Standard Chartered, with the addition of Dubai Islamic Bank and Noor Bank.
UPL Corp
Wednesday also marked the debut of a five-year Reg S/144a deal from India’s UPL Corp.
The Indian agro-chemicals company is currently one of equity analysts top picks given its growth trajectory, which appears to be mirroring the highly successful path the country’s pharma companies have trodden on the world stage.
And the syndicate also offered a global comparable, NYSE-listed FMC Corp, to benchmark the $500 million deal against.
Indicative pricing was initially pitched around 220bp over Treasuries, with the order book topping out at $1.4 billion before the deal was priced at 200bp over on an issue price of 99.963% and coupon of 3.25% to yield 3.258%.
At this level, UPL Corp has come through domestic peers such as Bharti Airtel and Adani Ports, which have the same Baa3/BBB- rating.
Adani has a 3.5% July 2020 bond, which was trading on a G-spread of 205bp according to one broker on Wednesday. Bharti, meanwhile, has a 5.125% 2023 bond, which was trading wider still at 218bp.
However, syndicate bankers added that both bonds are trading wide for technical and credit reasons, particularly Bharti which has recently been hit after S&P warned that revenues could halve now Reliance Jio has been launched.
The other main comparable from the Indian universe is Reliance, which has a one to two notch higher Baa2/BBB+ rating and is a much bigger and better known brand.
Its 5.4% February 2022 bond was trading around the 160bp level on a G-spread basis on Wednesday.
Instead, the syndicate guided investors to Baa2/BBB rated FMC Corp’s 3.95% February 2022 bond, which was trading on a G-spread of 175bp.
This means UPL has offered 25bp premium in exchange for a four-month shorter maturity and one-notch rating differential in FMC Corp’s favour.
Investors need to decide whether that is enough given Indian credits also typically command an Asian premium over their US peers.
Mizuho calculated fair value around 200bp over Treasuries.
One factor in UPL Corp’s favour are better debt metrics than FMC Corp, which reported a gross debt to Ebitda ratio of 3.2 times in June according to S&P data.
By contrast, the agency said UPL Corp recorded a 2.1 times level and forecasts it will drop and remain below two times for the next two years.
UPL is about half FMC Corp’s size in terms of Ebitda, but reports the second highest margin of the world’s five main comparable agro-chemical companies behind NYSE-listed Mosaic Corp.
According to S&P, this averaged 20.1% over the past three years, compared to FMC’s 19.7% level.
UPL Corp derives the majority of its revenues from overseas and particularly Latin America, which accounts for about 40% (Brazil being the biggest component).
In a research note, S&P said the group is well placed to take advantage of depleting global arable land and the ongoing need to increase crop yields to meet population growth.
Morgan Stanley is one of the most positive brokers on the stock, which is up 55.31% year-to-date. It recently said it saw “parallels between UPL’s growth potential in the global generic CP industry and India pharma’s move into global generic drugs, which led to a major industry re-rating.”
It added that unlike other generic peers, UPL is well placed because it focuses on “branding, manufacturing presence and global supply chain efficiencies.”
Proceeds from the bond deal are being used to re-pay short-term debt.
Joint global co-ordinators were Citi and JP Morgan, with ANZ, Credit Suisse and Deutsche on joint books.
