Thursday, November 6, 2014

BILT Paper perpetuals with 12.3% yield offers good investment opportunity

Disclosure: We own this instrument in our portfolio.

BILT Paper, the subsidiary of Ballarpur Industries, India's largest manufacturer of paper, has a US$ denominated perpetual bond that offers 12.3% yield based on Bloomberg offers (coupon: 9.75%, Price: 92.5 cents. Bloomberg ticker: BILTIN 9 3/4 08/28/49 Corp, ISIN: USN08328AA95).

The discussion below summarizes the events that led to a distress in the bonds and argues that the situation is now on a mend, resulting in a potential investment opportunity for buy-and-hold investors looking for yield. 

Largest Paper Company in India and Malaysia...
Member of the Gautam Thapar led Avantha Group, Ballarpur Industries is the manufacturer of writing & printing paper in India and Malaysia, with a market share of 25% and 30% respectively. BILT Paper BV is the subsidiary of Ballarpur Industries that owns the pulp and paper manufacturing and forestry assets (where as rest of the more 'consumer' businesses such as specialty paper, branded stationery and hygiene business are owned directly by Ballarpur Industries). The group is the only vertically integrated manufacturer in India, controlling the entire chain from plantations to pulp to paper. It also has captive power plants at all its locations.

Ballarpur Industries is listed in India (TIcker: BILT IN) and BILT Paper also intends to get listed in an overseas stock exchange (likely Singapore).

...with ambitious expansion plans...
Malaysian operations were acquired in 2007. Following the financial crisis, BILT Paper went on a massive expansion spree. It increased the paper capacity from 780,000 tons to 1million tons and expanded the pulp capacity from 462,00 tons to 752,000 tons. The expansion aimed to increase vertical integration and reduce costs.

...but poor execution...
However, the execution was bad. The expansions were delayed, there were cost overruns, Indian rupee tanked and the cost (and value) of its US$ debt sky-rocketed. Its balance sheet took further toll when it bought two captive power plant units from Avantha Power for US$103mm. With economic slowdown India in 2013, paper prices also suffered, affecting the profitability. Plans to list BILT Paper were indefinitely postponed.

...resulting in stretched balance sheet...
Though BILT Paper is not listed, it has published its annual report for 2013 (presumably because it is preparing for an IPO). The following analysis is based on its June 2013 Annual Report. (FY14 annual report is not available yet. My guess is that FY14 balance sheet is slightly worse)

BILT Paper had FY13 revenues of US$722mm and EBITDA of US$98mm. Interest payment, including the distribution on perpetuals, was US$68mm. That results in interest coverage of 1.44.

Unlike the company's auditors, I do not see perpetuals as an equity (it requires servicing and though coupon deferrals are possible, it is construed almost like an event of default). Assuming that perpetuals is a debt, the company has total equity (Book Value) of US$509mm and net debt of US$870mm. That translates to a gearing (net debt to equity) of 1.7x and Debt to EBITDA of 8.7x. These are highly stretched debt levels - Debt to EBITDA of 3-4x are considered more 'normal.'

...and rumors of a likely default
In 2H 2013, when the rumors were rife that BILT Paper is going to default on the coupon payments, the bonds hit a low of 60cents to a dollar. Later, the rating agency Fitch downgraded the perpetuals to B+.   

Though the bonds have since recovered and now at 92.5 cents, are well above their distressed levels, but we believe they still offer an attractive risk-reward. 

1. Capex has peaked: Between 2010 to 2013, BILT Paper embarked upon a massive capex of over US$400mm. With the pulp mill in Sabah commissioned in FY13 and in India earlier this year, the last leg of capex is finally over, and the the Chairman Mr. Thapar declared so in his address to shareholders in FY13 annual report. Going forward, I expect only the maintenance capex of about US$20-30mm per year. BILT Paper should generate positive cashflow, which should go towards reducing the debt and improving the balance sheet.

2. Profitability to improve going forward: With the new pulp mills stabilized and operating optimally, BILT Paper would be totally self-reliant on pulp. Vertical integration should reduce pulp costs and improve the profitability going forward, which will be further enhanced as its plantation in Sabah is also expanded.

3. Investment by IFC improves the balance sheet and credit profile: Last month, IFC announced plans to invest US$100million in equity and provide up to US$150mm in loans to BILT Paper. The equity investment has already come through giving IFC a 14.3% stake, according to the announcement on 4th November (IFC's investment puts the equity value of BILT Paper  at US$600mm). BILT's press release earlier mentioned that IFC loan would be used to refinance some of the highest cost debt. The effect is to increase the equity, reduce the debt and gearing and the finance costs. Having IFC as an equity and debt investor in the company provides comfort for other investors. This could improve chances of BILT Paper's successful IPO and also open up other sources of funds.

4. Yield pick-up if the bonds are called: There is a likelihood that the perpetuals will be called at the next call date. Perpetuals come with a step-up clause in the coupons. At the next call date in 2016, the coupon steps up to 5yr US Treasury note + 8.57%. For instance, the current yield on 5yr US Treasury note of 1.63% would put the new coupon at 10.3% (and will fluctuate according to yield on Treasury note at each coupon date). Between now and 2016, the Treasury yield is likely to only increase, resulting in even higher coupons and creating even more incentive for the company to call the bonds. If the bonds are called, the yield to next call works out to 14.75%

If they are not called in 2016, the next call date after 2016 is in 2021, when the coupon steps up by another 1%.

1. Interest rates: Almost all of BILT Paper's debt is floating. Inability to quickly deleverage before the rates start rising could stress the cashflow .

2. Macro slowdown: Paper prices are highly susceptible to economic slowdown, as witnessed in India last year. Declining paper prices could put pressure on profitability.

3. Corporate Governance: Decision to acquire captive power plant from Avantha Group when BILT Paper's balance sheet was already stretched, was untimely and creates corporate governance red flags in my opinion. Similar transactions in future may create unexpected capex outlay and jeopardize the balance sheet.

We own BILT Paper perpetuals in our portfolio. With improving macro conditions in India, increased access to funding by the company and a lack of capex, I believe that with 12.3% yield, the bonds offer excellent investment opportunity for buy-and-hold investors seeking yield (Minimum ticket for the bonds is US$200,000 in face value).

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