Naftogaz, a 100% state-owned vertically integrated gas producer and operator of the oil & gas transportation system in Ukraine, is looking to issue a EUR500mn 5-year bond and a US$300mn 3-year bond. The IPT is in the 7.5% area for the EUR-denominated tranche and 7.75% for the US$-denominated tranche. We think both tranches are attractive in the 7.5% area.
Credit summary. We view Naftogaz as a derivative of the sovereign risk demanding a premium: 1) the company is burdened by significant social responsibilities resulting in high overdue gas receivables, 2) an economic relationship with the controlling shareholder is not formalised, 3) leverage is likely to increase due to ambitious capex and falling cash flows following the unbundling of the gas transit operations, and 4) the bonds’ lowest rank in the capital structure with all other debt of the company is represented by secured obligations. The unbundling of the gas transit operations is likely to reduce revenues by c30% and EBITDA by half. We estimate Naftogaz revenues on a pro-forma basis (post unbundling) at US$6.8bn, EBITDA at US$1.6bn and net leverage after issuance of bonds at 1x-1.5x, depending on the proportion of proceeds used to refinance short-term debt.
US$ tranche pricing considerations. Historically, if we look at the old NAFTO issue that was repaid in 2014, the median spread to the sovereign was c165bps over the life of the bonds or a ratio of 1.23x. Applying our findings to UKRAIN 22s indicated at 5.82%, we come to a 7.15%-7.45% range for the US$-denominated tranche. The recently issued bonds of another 100% state-owned company Ukrainian Railway (RAILUA) set a precedent for Naftogaz. We believe the IPT of 7.75% for the US$-denominated tranche is attractive, but if the pricing tightens below 7.5%, investors would be sacrificing a big chunk of the credit and new issue premia. Recently priced bonds of Ukrainian Railway (RAILUA 24s), another 100% state-owned company, were issued at 8.25% (+170bps over sovereign) and have since tightened to c115bps, suggesting that 7%-7.5% is a reasonable range for the US$-denominated bonds of a quasi-sovereign in Ukraine. We think that a new issue of a state-owned company with weakening credit profile should not yield below 7.5%.
EUR tranche pricing considerations. In the EUR space, the only available benchmark is UKRAIN 26s indicated at 5.91%. Adjusting the benchmark for the difference in tenors (through a midswaps) and applying the same spread as we used for the US$ tranche, produces a range of 7.15%-7.45% for the new Naftogaz EUR-denominated bonds. A scarcity of Ukraine risk in the EUR segment of the market could attract higher demand for the EUR-denominated tranche, and cause the IPT to tighten from the announced 7.5% level.