Diamonds or Debt ?
5 April 2017 by Gary Kirk
Diamonds or debt collectors? This seems like a fairly straightforward question and expect that most people would gravitate towards the rare and precious stones as an investment opportunity, rather than venture into the often misconstrued sector of debt collection.
When looking at relative value in fixed income however, it isn’t quite as straightforward as it first seems. This morning as we were going through the latest news and new issuance detail, two stories stimulated some discussion on the desk.
In the new issue market, Petra Diamonds announced it is intending to launch a US$600m transaction, maturing in May 2022, with a call in 2019. The price talk is circa. 7.5% for the B1 (positive)/B+ (stable) rated South African entity. On the face of it, given the current market conditions, a yield of this level for a relatively short-dated bond looks potentially interesting, but there were a number of issues that we couldn’t get comfortable enough to warrant making an investment. The current political uncertainty in South Africa is an obvious concern, which has the potential to disrupt the performance of any domestic credit. That withstanding, a single-focused commodity group is also highly reliant on the price of the underlying mineral being produced and the price of diamonds are no different. Now, diamonds have generally been considered to be ever increasing in value, but recent technological breakthroughs may put this to the test. For over 50 years scientists have tried to make gemstone-quality diamonds with only limited success (after all the real thing is produced within the Earth’s core under extreme heat and pressure), but recently, a new technique developed in California can produce diamonds up to 5 carats in size that are more pure than the natural product (and can be made bespoke in terms of both shape and colour). At the moment this ‘artificial process’ costs more than mining, but like most new technologies it is only a matter of time before costs are reduced, and when this happens, it is likely that it will have a detrimental impact on the price of the commodity, however strong the demand for the genuine product. This is a risk for any business that has just one product and that alone usually is enough to deter us from investing.
Switching industries to the slightly less glamourous world of debt collection, we took note of the FY-2016 results released by GFKL (Garfunkelux) this morning; which recorded another substantial increase in cash EBITDA with management additionally guiding leverage slightly down for the coming year. To us this has been a very interesting sector over the past few years and will continue to remain so as banks in particular are encouraged to recognise and shed non performing loans, leaving the specialist credit management groups to take advantage (as per our earlier blog on this subject Value in Debt Collecting). Currently the whole sector sits in the high yield universe, but as it grows we think it would benefit substantially from sitting on investment grade balance sheets. Yields are attractive, and it’s one of the few sectors where real capital gain possibilities still exist. Needless to say the GFKLDE 8.5% 22 were again better bid following the news.
Now there is obviously a wide comparison between these two sectors, and to my wife, diamonds will always be a girl’s best friend, but it does illustrate to us that not everything that glitters is necessary worth chasing.
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