Bondholders powered up
Eskom is not very good at keeping the lights on, but it’s providing excellent profits for bondholders. Eskom’s dollar bonds due in 2028 – which don’t have an explicit government guarantee – have handed investors a total return of 10% this year, more than three times that of the emerging-market benchmark. Securities due in 2025 and 2027 are also among the best performers in the 2 100-member Bloomberg Emerging Markets Hard Currency Aggregate Index.
Bondholders are confident National Treasury will make good any debts Eskom can’t pay – even those it doesn’t backstop – meaning the bonds offer a yield pickup over the sovereign, without additional risk.
They’re also betting South Africa will pay a premium when it takes over as much as two-thirds of Eskom’s debt this year, a deal which may be announced in the annual budget on 22 February.
“We would encourage investors to add ahead of the February budget announcement in which the government will provide details on Eskom debt assumption,” said Zafar Nazim, a credit analyst at JPMorgan Chase Bank, in a note to clients.
The company added Eskom bonds at the end of last year, according to filings data compiled by Bloomberg.
“Eskom should now be considered an extension of the sovereign, and bonds should trade as such,” Nazim said.
Most emerging-market debt is having a banner start to the year amid bets the Federal Reserve will slow or halt interest rate increases, and China’s reopening will mitigate a global growth slowdown. But still Eskom’s notes have outperformed.
Yields on Eskom dollar securities due 2028 have dropped 220 basis points (bps) since the start of the year to 9.3% as of Wednesday. That’s a premium of more than 300 bps over similar maturity government dollar notes. Yields on 2025 securities have plummeted 297 bps to 9.21%, offering a spread of nearly 400 bps.
About 80% of Eskom’s bonds come with an explicit government guarantee, and President Cyril Ramaphosa has said the company is “too big to fail”, implying the state would back the company.
The state is now considering a takeover of some of its $22.8 billion (about R388.9 billion) in liabilities as it seeks to restructure the utility and restore financial sustainability.
Some investors are steering clear. Eskom’s challenges are not just financial, and the hurdles to overcoming them are steep, said Manuel Mondia, a Zurich-based analyst at Aquila Asset Management.
The power company’s troubles have led to 13 consecutive months of rolling power cuts. The cash-strapped utility already relies on government support to run its operations and service its debt. Its CEO André de Ruyter also recently resigned.
Goldman Sachs Group has described it as the biggest threat to the economy.
Transferring Eskom’s debt to the state would require modifications to bond agreements, a complex and uncertain process needing approval from holders of the securities, said Mondia.
But Nazim said: “Creditors should not get too hung up on record rolling blackouts and the resignation of [its] CEO.”