Pi Capital
Date of publication: 13 October 2020
Today we will look at one debt securitiy as investment ideas for this week: Volkswagen

IDEA #1: Volkswagen

Against the background of Gazprom's plans to place indefinite term in the foreign market, we note that such Eurobonds are quite actively placed by companies in the real sector of the economy. For example, you can mark the "perpetual" Eurobonds of such issuers as General Electric, Electricite de France or Petroleos Mexicanos. Among our top picks in the single European currency segment is the perpetual issue of automotive giant Volkswagen AG.

I must say that Volkswagen AG is a fairly active issuer of "perpetual" securities. Currently, there are 11 issues in circulation, including the junior subordinated Eurobond, placed in June 2018 in the amount of 1.5 billion euros with a coupon of 4.625% per annum. The issuer is 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 finally guaranteed on a subordinated basis by the Volkswagen Group. Compared to senior debt, the "perpetual" issue has ratings two notches lower, which, however, still allows it to correspond to the "investment" category.

As might be expected, Q2 2020 proved to be difficult for the company amid the unfolding pandemic. However, analysts expect a fairly confident recovery in the financial performance of the auto concern in 2021, although it will not be possible to reach the level of 2019. However, the company's free cash flow is not expected to go into negative territory by the end of this year.

Although the company is actively increasing its debt, its net value remains in the negative zone (-18.8 billion euros in the second quarter of 2020). With annual interest payments of € 3.2 billion, the automaker's adjusted operating cash flow over the past 12 months amounted to € 25.3 billion as of June 30, 2020. In 2020-2021 VW has to pay off a debt of 28 billion euros, while as of June 30, 2020, the volume of cash and equivalents on its balance sheet amounted to 61.3 billion euros.

In the current crisis, which hit the auto industry in the first place, rating agencies have downgraded their forecasts for VW. However, the company's ratings remain at "investment" level with a certain margin. The probability of default by Volkswagen AG, calculated by Bloomberg, also slightly increased. For example, the probability of default has increased from 1.2% to 3.7% over the next 5 years. Nevertheless, even the increased value looks, in our opinion, quite moderate.

As with most Euro bonds, the coupon for this issue is paid once a year (June 27). The nearest call option on the security is scheduled for June 2028, further calls will follow once a year until 2168. If we estimate the probability of the next call option being exercised in 2028, then it is worth noting that the only "VW Eurobonds were withdrawn on the first call. According to the current repayment schedule, in 2028 the company will have to pay off a debt of 3.5 billion euros and the redemption of the "eternal" paper in the amount of 1.5 billion euros from this point of view should not create big problems.

Since the Eurobond is "perpetual", the main risk associated with it has to do with coupon payments. The fact is that this bond is "hybrid", that is, it has the qualities of both interest-bearing (debt) and equity securities. As a result, such bonds allow borrowers to defer interest payments without violating their obligations (in other words, non-payment of a coupon does not entail a technical default of the issuer). However, the deferred interest on the issue is cumulative. Note that unlike the "perpetual" Eurobonds issued by banks, the VW issue is not provided for write-off to compensate for losses.

Compared to late February levels, VW's current release price (perp) is 8 figures lower. Note that the issue looks quite competitive among the securities of the "investment" rating, denominated in euros.

Now the issue offers a yield to the next call in June 2028 at 3.6%, which is seen as an interesting level against the background of zero deposit rates in the single European currency.

The Eurobond is serviced by NSD and is available only to qualified investors. The minimum lot for paper is equal to the face value (100 thousand euros).

Alexey Shternshis
Joint Managing Director
Capital Pi 


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