Whats in vogue with the Engro group these days? Corporate debt instruments it seems. Engro Chemicals raised around Rs7 billion in 2008 through TFCs while Engro Fertilizers attracted approximately Rs1.5 billion earlier this year through the same instrument.
The latest in the series of the debt instruments fad is Engro Corps TFC issue for Rs4 billion with a greenshoe option of Rs2 billion. Unlike the previous issues that offered a profit rate tied to the Kibor, the profit rate on these TFCs has been fixed at 14.5 percent for a tenor of 3 years.
However, given the fragile macroeconomic environment surrounding the country, and the consequent escalation of the discount rate, a return of 14.5 percent doesn seem like a very lucrative option, especially bearing in mind that further monetary tightening is expected.
Though the maturity risk with a three-year tenure is low, given that 6-month Kibor is currently at 13.21 percent amid prophecies of further hikes in the discount rate, a 14.5 percent rate of return will not be lucrative for long.
Those, betting on a fall in discount rate next year, should note that the timing of monetary relaxation over a short span of 3 years can be estimated with certainty just as yet.
Add to it the rates of return from risk-free instruments such as the PIBs at 13.83 percent over 3 years, the risk premium offered by Engro is not a figure to brag about.
"The risk premium shouldve been at least 2.5-2.75 percent over and above what is offered by the risk-free instruments," said a fund manager speaking to BR Research, while warning of the caveat of TFCs being generally considered illiquid instruments.
Engros highly-leveraged position currently does not bode well for fund managers either. One of them claimed that the soaring debt-to-equity ratio also puts forth the possibility of a credit default risk.
An analyst speaking to BR Research also alluded towards a default risk, albeit in softer words. "They have a very good past record, theyve never defaulted on previous loans, but then again, you can never be sure," he said.
Representatives of Engro Corp, however, defended all allegations saying that the target market for these TFCs are retail investors, starved of better alternatives since bank deposits and National Saving Scheme (NSS) bonds offer a lower rate.
This so-called ingenuity actually seems like a necessity since institutional investors and fund managers are wary of Engros debt instruments because of their high debt ratios. The unimpressive rate of return doesn do much good either.
And wait a minute, the Behbood certificates that are also bought largely by retail investors offer 14.64 percent.. So where exactly is the competitive edge in the rates offered by Engro?
"Even mutual funds (which also target retail investors by the way) will remain averse to this issue especially since money will be locked in for 3 years. Banks are already heavily exposed to the company so theyd be reluctant to invest as well," said a renowned investment veteran.
With all options exhausted, retail investors are the obvious call for Engro. But then again, reaching out to retail investors and distribution might be a predicament the company will have to deal with.
No one wants to invest in fixed instruments at a time when interest rates are on a rising trajectory, as is witnessed by low participation in the PIB auctions. This makes the latest issue of TFCs by Engro Corp a very ambitious step.
"You can assess how desperate they are for cash flows from the frequency of debt instrument issues," a fund manager dealing in TFCs confined. And given the situation at hand, there is a stronger than strong chance that he is right.
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