Georgia Capital — Successful bond refinancing improves risk profile

On 1 August 2023, GCAP announced that it has successfully priced a US$150m, five-year sustainability-linked bond in the Georgian market. GCAP highlighted that it was the largest ever corporate bond offering in the local market, and attracted significant interest from local investors. While high-profile international financial institutions (European Bank for Reconstruction and Development, Asian Infrastructure Investment Bank, Asian Development Bank and International Finance Corporation) committed to a US$110m investment in GCAP’s bonds, their tranche was scaled back to US$67m to allow local investors to acquire the remaining US$83m. It is also worth noting that holders of US$23m of the existing Eurobond transitioned their holdings to the new bond.

The bond bears a fixed coupon of 8.50% and was issued at par, which compares to a 6.125% fixed coupon for the previous bond (issued in March 2018). GCAP secured a quite attractive rate when compared to the local interest rates in Georgia (the current central bank refinancing rate is 10.25%), and the rate on GCAP’s bonds is also close to the US corporate high yield bonds (the effective yield of the ICE BofA High Yield Index at 1 August 2023 was 8.23%). Importantly, given the lower volume of the new bonds versus the US$300m Eurobonds, GCAP will reduce its overall interest expenses. The new bonds were rated ‘BB-’ by S&P, which represents a one-notch upgrade compared to the previous Eurobonds.

Key financial covenants embedded in the bond include: 1) net debt to total equity must be less than 45%; 2) payments such as dividends or capital stock redemptions will be restricted to 50% of end-2022 retained earnings and 50% of consolidated net profit thereafter; 3) interest coverage should be at least 100%; and 4) dividend payments and other distributions from material subsidiaries can be restricted only up to 50% of net profit of the material subsidiary. The sustainability-linked target embedded in the bond terms involves a 20% reduction in scope 1, 2 and 3 emissions versus the 2022 baseline of 22,829 tonnes of carbon dioxide equivalent by 2027 (scope 3 emissions represent aggregate scope 1 and 2 emissions of GCAP’s portfolio). This reduction will be an important milestone on GCAP’s agenda to become net zero in terms of carbon emissions by 2050.

The issue proceeds, together with GCAP’s liquidity already available before the bond placement, will allow the company to fully redeem its existing US$300m Eurobond (which was due to mature in March 2024). Following the pricing of the new bond, GCAP bought back Eurobonds with a principal amount of US$176.5m through a tender offer, which expired on 8 August 2023. The company intends to cancel these together with the US$106.9m bonds already held in treasury, leaving just US$16.6m outstanding (to be redeemed through a ‘Make Whole Call’ option in Q323).

At end-June 2023, GCAP’s NCC ratio reached 17.4% (see front-page chart), slightly down from 19.7% at end-March 2023 and lower than the 27.0% at end-June 2022. The Q223 improvement was driven by a solid dividend income and an increase in portfolio value. This means that GCAP is gradually approaching its NCC target (through the cycle) of below 15%. Once this is achieved, GCAP is likely to expand its buyback programme (in line with its capital management policy).

Following the full redemption of the previous Eurobonds, GCAP estimates its net debt balance will be c US$110m (or c 8.6% of GCAP’s total portfolio value at end-June 2023) versus US$124.1m at end-June 2023. We believe that the bond refinancing meaningfully reduces GCAP’s risk profile, warranting a narrowing of the discount to NAV (currently 58% of its ‘live’ NAV estimate). Importantly, the bond is callable after two years, providing GCAP with the flexibility to pursue its recently reiterated target of reducing the holdinglevel balance of net debt and guarantees issued close to zero over the short-to-medium term. In this context, we note that GCAP’s put option on the remaining 20% stake in its water utility business granted by FCC Aqualia (see our January 2022 note for details) will be exercisable in 2025 or 2026 (the stake was valued at GEL159m at end-June 2023 using an option valuation method). GCAP plans to continue pursuing on-market buybacks as part of its deleveraging strategy, which will also enhance liquidity in the local bonds.

GCAP’s holding-level net debt reduction is also being assisted by continued solid income streams from GCAP’s portfolio holdings. It received GEL148m in H123, with Bank of Georgia’s (BoG’s) cash dividend and buyback ‘dividend’ being the major contributor (GEL114.4m), followed by the one-off dividend from the retail (pharmacy) business of GEL20.1m, as well as regular dividends from the P&C insurance (GEL8.4m) and renewable energy (GEL5.2m) businesses. Management expects FY23 recurring income to reach GEL150–160m, which together with additional one-off inflows should bring the full-year income to c GEL205–215m (or c US$62–65m). GCAP’s management remains confident in the dividend outlook beyond 2023, which across its private holdings should be particularly driven by the insurance, renewable energy and retail (pharmacy) businesses.

In terms of the deleveraging of its portfolio holdings, we note that the retail (pharmacy) and renewable energy businesses had adjusted net debt to EBITDA ratios of 1.7x and 7.1x at end-June 2023 (slightly above their over-the-cycle targets of up to 1.5x and up to 6.0x, respectively). The education business had a ratio of 1.0x (within its target of up to 2.5x), while hospitals had leverage of 4.1x, with clinics and diagnostics at 7.1x (above their targets of up to 2.5x). In terms of the maturity profile, we note that 12% and 35% of total gross debt across GCAP’s private portfolio companies matures in 2023 and 2024, respectively. The debt maturing in 2024 includes in particular GEL112m for the hospitals business (c 53% of total gross debt of the hospital business) and a US$35m bond issued by the housing development business. We note that the hospitals and clinics and diagnostics businesses have been affected by the return to normal, post-COVID-19 operations since Q122, but GCAP’s management highlighted that the revenues and earnings of these businesses started rebounding in Q223 (hospitals up 8.3% and 9.2% y-o-y, respectively, clinics and diagnostics up 18.7% and 38.1% y-o-y, respectively), suggesting a possible inflection point in performance.

GCAP posted an 8.2% NAV TR in Q223 in Georgian lari terms (3.3% in sterling terms), mostly on the back of the continued share price appreciation of BoG, which, together with a minor revaluation of the minority stake in the water utility business, resulted in a 5.2% increase in GCAP’s NAV during the quarter (see Exhibit 2).

BoG’s share price was up c 6.4% in Q223 and appreciated further by c 17% since end-June 2023 on the back of its strong Q223 results published on 17 August. The company achieved a healthy annualised return on equity (ROE) of 34.6% during the quarter (bringing the H123 ROE to 31.3%), with a net interest margin of 6.6% (vs 5.3% in Q222) and an adjusted cost-income ratio of 26.9% (vs 32.5% in Q222). BoG also saw a solid increase in loan book of 7.6% during Q223 (or 6.4% on a constant currency basis) and in deposits of 7.3% (5.9% on a constant currency basis). The company booked cost of risk at 80bp (slightly up from 60bp in Q222), and its non-performing loan ratio stood at a moderate 2.4% at end-June 2023 (vs 2.6% at end-June 2022). Its CET-1 ratio and total capital ratio were 18.7% and 22.6% at end-June 2023, respectively (well above the regulatory requirements of 14.6% and 19.8%, respectively).

BoG continues to pursue its policy of distributions to shareholders, targeting a 30–50% dividend and share buyback payout ratio in the medium term. It paid a final dividend for 2022 of GEL5.80 and declared an interim dividend for H123 of GEL3.06 per share (or GEL134m), which on a last 12-month basis represents a c 8% dividend yield. On top of this, BoG spent GEL62m on share buybacks in H123, with a further GEL62m programme approved by the board (to be commenced later this year).

We note that, despite the recent share price rally, BoG’s market valuation does not look very demanding based on the Refinitiv FY23 consensus ROE (c 28% currently) and book value per share (now implying a P/BV of 1.0x) compared to local peers (see below).

Within GCAP’s private holdings (whose revaluation raised GCAP’s NAV by 1.9% in Q223), the major positive contributor was the insurance business, consisting of P&C and medical insurance businesses and making up c 9% of GCAP’s end-June 2023 total portfolio value. The business was revalued by 19.2% in Q223, with revenue growth of 22.6% y-o-y assisted by a wide range of business lines, including motor, credit life, agricultural and border motor third-party liability. Despite a higher combined ratio in the P&C business (84.3% in Q223 versus 79.8% in Q222), the net income of the entire insurance business rose strongly by 28.0% y-o-y. The higher fair value also reflects a c GEL40m one-time positive effect from the introduction of the Estonian Taxation Model from January 2024, following which GCAP’s insurance businesses will no longer be subject to the corporate income tax payment (given that GCAP is a domestic legal entity).

GCAP’s education business also contributed positively, as it was revalued by 5.1% versus endMarch 2023 on the back of a continued strong operating performance, with revenues up by 27.5% yo-y in Q223 fuelled by a strong intake and utilisation ramp-up. EBITDA was up just 1.5% yoy due to the negative impact of the shift in academic days in the midscale schools, as well as a 44% yoy rise in operating expenses due to business expansion and cost inflation. Its valuation was assisted by a net debt decline to GEL13.4m at end-June 2023 from GEL17.9m at end-March 2023.

The above positive valuation effects were partly offset by a 3.6% reduction in the fair value of the retail (pharmacy) business based on higher net debt. The latter was due to a one-off dividend distribution to GCAP, as well as the buyout of the 20.6% minority stake concluded during the quarter (bringing GCAP’s total stake to 97.6%). The retail (pharmacy) business posted Q223 revenue and EBITDA growth of 5.3% and 11.7% y-o-y, respectively amid the expansion of pharmacy chain and franchise stores, but with the top line somewhat dampened by lower product prices (due to Georgian lari appreciation) and the implementation of the External Reference Pricing model (still, same store sales were up 2.8% y-o-y in Q223). GCAP’s NAV TR was further supported by its ongoing share buyback programme (translating into 2.1pp NAV accretion in Q223).