MARKET SIGNALS 06.02.2020
IDEA #1: Volkswagen AG
Against the background of near-zero deposit rates in euros, the segment of Eurobonds from highly reliable issuers is of natural interest. The so-called “eternal” issues offer the highest yield, however, if we exclude issuers from the banking sector, then the line of Eurobonds of one of the world's largest automakers, Volkswagen AG, is immediately in the focus of attention.
Volkswagen AG's stock market capitalization has been hit hard during the current crisis. On March 20, 2020, the concern’s share price fell to 100 euros apiece, whereas, for example, in January this year it amounted to 180 euros. However, by the current moment approximately half of the March losses have been recouped. Despite the current rebound, the company expects a very significant decline in its revenue performance due to the crisis. However, unlike, for example, American automakers and despite its wide presence in China, Volkswagen AG management does not expect the net operating cash flow to go into the negative area. Note that current market forecasts suggest a fairly active recovery in the financial performance of the auto concern in 2021 (see table below).
The company has negative net debt and very comfortable interest coverage - at the level of 4.2 - even taking into account the forecasted decline in operating profit due to the crisis in 2020 (from 14.6 billion to 7.9 billion euros). In 2020-2021 VW will have to pay off debt in the amount of 13.0 billion and 18.7 billion euros, respectively, while as of March 31, 2020, the amount of cash and cash equivalents on the balance sheet amounted to 44.9 billion euros. In addition, the volume of credit lines opened by the company reaches 11.9 billion euros.
However, in the midst of a pandemic, international lending agencies worsened their forecasts for company ratings, which nevertheless remain at the "investment" level (see table below). The default probability of Volkswagen AG, calculated by Bloomberg, also slightly increased. For example, the probability of default over the next 5 years increased from 1.2% to 3.2%. Nevertheless, even the increased value looks, in our opinion, quite moderate.
Volkswagen AG is an active issuer of eternal securities. Since 2013, the company placed 10 issues (all in euros), one of which was called back in 2018 by call. The total volume of VW eternal securities currently in circulation is 12.5 billion euros.
One of these securities is the junior subordinated Eurobonds, placed in June 2018 in the amount of 1.5 billion euros and a coupon of 4.625% per annum. The issuer was the concern's subsidiary, Volkswagen International Finance N.V. At the same time, it is stipulated that the bonds of the issue are unconditionally and definitively guaranteed on a subordinated basis by the Volkswagen Group. Compared with senior debt, the “eternal” issue has ratings two steps lower, which, however, still allows it to correspond to the “investment” category.
As with most Eurobonds, the coupon on this issue is paid once a year (June 27). The next paper call option is scheduled for June 2028, further calls will follow once a year until 2168. If you evaluate the likelihood of the next call option being realized in 2028, it’s worth noting that the only “eternal "VW Eurobonds was recalled on the very first call. According to the current repayment schedule, in 2028 the company will have to repay a debt of 2.0 billion euros (which is the lowest value since 2020) and also repay an “eternal” paper worth 1.5 billion euros from this point vision should not create any problems. Note that in case of non-recall of the paper on the first call option, the coupon level on it will be recalculated according to the formula = 10-year interest-rate swap in euros + margin (premium) of 398.2 bp. n. If the new coupon were recounted now, then it would be 3.87% per annum (now 4.625%).
As the Eurobond is “perpetual”, the main risk associated with it is directly related to the payment of coupons. The fact is that this bond is “hybrid,” that is, having the qualities of both interest-bearing (debt) and equity securities. As a result, such bonds allow borrowers to defer payment of interest without violating their obligations (in other words, non-payment of a coupon does not entail issuer's technical default). Deferred interest on the issue is cumulative. Note that in contrast to the “eternal” Eurobonds issued by banks, the issue of VW is not possible to write off to compensate for losses.
Now the Eurobond can be purchased with a yield of 4.2% to the nearest call in June 2028. Note that the current yield of the paper (the ratio of coupon payments over the next 12 months to the current price) is 4.5%.
Compared to late February levels, the current VW (perp) release price is about 10 lower. Note that the LBEATREU index (which tracks the Eurobonds of the "investment" rating, denominated in Euros) has fallen much less during the crisis and is recovering
Alexey Shternshis
Joint Managing Director
Capital Pi