Further Pressure on Qatar. Really?

When A Story Falls Through the Cracks, Who Catches It?

If you read Gulf News regularly, you’ll have seen their article on Fitch’s downgrade of Qatar’s long term sovereign risk rating to AA- “Qatar Faces Further Pressure as Fitch Downgrades Sovereign Rating”.  

Sounds grim, perhaps even "subdued" if we apply Indian standards. 

But when context is missing, AA is there to catch what’s fallen between the cracks or perhaps in this case deliberately dropped between the cracks given GN’s demonstrated past ability to quote press releases verbatim.

Fitch did indeed downgrade Qatar’s sovereign rating.

A couple of points.  

First, AA- is still investment grade. 

Second, within the GCC context, Qatar’s sovereign rating is certainly well within range of its neighbors.  Fitch ratings page here.

COUNTRY	RATING
Bahrain	BB+
Kuwait	AA
Oman	BBB
Qatar	AA-
Saudi Arabia	A+
UAE	AA

Earlier this year, Fitch downgraded KSA several notches in one go. The pressure must be intense if one applies GN standards.  As to Bahrain, if you don’t know, BB+ is non-investment grade.  

Third, regarding my comment about taking flawless dictation from press releases, here are some quotes that GN somehow omitted.  Fitch press release here.  AA comments in red boldface.  Other boldface to highlight key points.

At an expected 146% of GDP in 2017, Qatar's SNFA [sovereign net foreign assets] are well above the 'AA' median and are sufficient to finance two decades of fiscal deficits or to repay all the estimated external liabilities of GREs, banks, and the private sector (around 90% of GDP).  Qatar's SNFA are underpinned by the foreign assets held by the QIA. Specific figures on the size, returns and asset allocation of the QIA are not publicly disclosed, but we estimate that its foreign assets amounted to USD283 billion at end-2016. We expect QIA foreign assets to fall in 2017 as a result of draw-downs to support the banking sector, which may not be completely offset by the return on QIA assets.

And here's another.

Qatar has been able to restructure its supply chain and avoid major economic and social instability. We expect only a slight up-tick in inflation (to 4% in 2017 from 2.8% in 2016). Inflation was 0.2% yoy in July 2017 (4% for food). Imports dropped 40% in June, but we expect that this will be temporary. Ports in India and Oman have replaced Dubai's Jebel Ali as transhipment points for goods destined for Qatar. Significant stockpiles of construction materials are giving the government time to examine longer-term supply options even as deliveries from quarries in Iran and Oman continue. Qatar Airways' cargo capacity has been used to maintain supplies of food and other perishable goods.

When you factor all this in, and AA hopes you do, you may have a different view of Qatar’s current situation. (Note that caveat.)

Unwarranted Hubris on the Potomac

Some Countries Have Scary Clowns Others Have Happy Ones    

This week Rachel Sylvester at The Times published a rather unflattering article on the UK’s Foreign Secretary Boris Johnson, “Our Foreign Secretary is an International Joke”.

“According to diplomatic sources, even officials at the Trump White House “don’t want to go anywhere near Boris because they think he’s a joke”. 

A rather low blow, indeed. 

AA wonders--and wonders if you do too— if officials at the TWH are self-aware enough to realize that Boris is appropriate company. 

Matthew 7:3-5  is no doubt appropriate here. 

Dana Gas: A Closer Look at Pearl Petroleum Limited

This post takes a closer look at DG’s لؤلؤ of an investment, Pearl Petroleum Ltd. BVI which accounts for the lion’s share of DG’s bewhiskered Trade Receivables.  

What can we learn about how Pearl is doing from DG? In performing this exercise we’ll ignore for the moment that cash payment by the KRG has severely lagged billing.   If DG’s information is lacking (a question that might not really need to be asked), do we have alternative sources of information? How do we exploit that information?  

Why take a closer look? 

According to press reports, DG’s management has admitted that its Egyptian operation has generated only USD 60 million in net profit during the ten-year life of the sukuk and just this month advised that Zora field production was down some 49% from the “corresponding quarter” in its 1H2017 interim financial report.  With a track record like that, taking a look at DG’s “jewel” is well worth the effort.

Dana Gas Information on PPL

As I posted earlier, DG’s disclosure regarding Pearl Petroleum Limited is rather limited.  For some reason no doubt well-reasoned and Shari’ah compliant, DG does not disclose its share of net income in PPL but only gross operating income. 

As regards Shari’ah, AA supposes that there has been evolving interpretation of what “selling” or “wet corn” means (Muslim/Abu Hurairah) or “selling without disclosing defects” (Ibn Majah/ Wasila bin el-Asqa). 

AA has trawled through DG’s audited financials note on joint operations and prepared the following summaries. 

Let’s start with the statement of condition aka “balance sheet”. 

DG Info: PPL Balance Sheet USD Millions
Year	CA	NCA	TA	LIABS	EQUITY
2016	2,117	726	2,843	194	2,649
2015	2,123	777	2,900	89	2,811
2014	1,950	790	2,740	100	2,640
2013	1,358	823	2,180	45	2,135
2012	1,088	848	1,935	25	1,910
2011	670	878	1,548	28	1,520
2010	343	908	1,250	58	1,193

Technical notes:  

• The joint operations note presents only DG's share of PPL's assets and income.   
• To get PPL level information, one must divide DG's share by 0.35 in 2016 and 2015 and by 0.40 for the earlier years shown.  Why the change in 2015?  DG sold an additional 5% to RWE in 2015.  
  

Comments:

• DG “consolidates” its share of PPL’s assets and liabilities in preparing its (DG’s) financial statements. When it does so, it eliminates intra-group (DG and PPL) transactions. Therefore, it’s possible that PPL’s balance sheet is larger than shown above. 
• What could such intergroup transactions be?  Intra-group company loans, accounts receivable payable by PPL, etc.

Now to the income statement.  

DG Info:  PPL Income Statement USD Millions
Year	NET REV	OPCOST	GPROF	CHGEQ	DOI/OCI
2016	223	100	123	-163	-286
2015	406	97	309	171	-137
2014	618	88	530	505	-25
2013	575	105	470	225	-245
2012	645	85	560	390	-170
2011	565	73	493	328	-165
2010	205	15	190	348	158

Technical notes:  

• Same methodology as with the balance sheet to convert the information DG presents on its share of income to the aggregate income for PPL. 
• As noted DG only presents PPL’s Operating Profit not Net Income. 
• Using the change in equity (CHGEQ) as a proxy for net comprehensive income, I have computed the amount required to plug the gap in CHGEQ.  This is labeled DOI/OCI.  Derived Other Income (including other expenses not in gross operating profit) and Other Comprehensive Income.  (AA's calculations are in red typeface.)
• Examples of OCI would be change in carrying value of PPL’s contractual rights, value of reserves, etc. 
• DOI would include the interest that PPL accrued on the unpaid KRG receivables.  Recall that when PPL reversed the interest at 9% DG’s share of the reversal was USD 121 million or roughly USD 346 million for PPL in aggregate.  However, the arbitral decision allowed PPL to charge interest at L+2%.  Looking at note 28 in both 2016 and 2015, the change in interest due is some USD 68 million, implying (note that word) that the net of the reversal of the 9% interest and the accrual of interest at 2% was USD 68 million or roughly USD 194 million for PPL.   

So with DG’s “wet corn” tucked under the “dry” corn, we’re left with questions about PPL’s balance sheet and its income performance before allocation of DG expenses to PPL. 

Other Sources of Information on PPL 

It would seem like we’re at a dead end. 

But there are other sources of information on PPL.  DG has four partners in PPL.  Crescent, OMV Austria, MOL Hungary and RWEST Germany.

Crescent is a private company and does not appear to disclose its financials.  You’ll find Crescent on the web at http://www.crescent.ae/home.html.  Note that the Chairman of Crescent is also the Chairman of DG. Other apparent members of the Chairman’s family are on DG’s board.  Crescent is DG’s largest shareholder and thus would have rights to seats on DG’s board.   

Having a bit to do at work, AA looked only at the financials of OMV and MOL.  Preparing info on PPL from RWEST is left as an exercise for the student. Expect an announcement soon on the opening of Arqala University!  It’s going to be a huge success more so than Arqala Steaks –also under formation. 

OMV Information on PPL 

Here’s the data compiled from OMV.

First, the balance sheet. 

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Technical notes: 

• Despite its 10% ownership share, OMV accounts for PPL as an equity investment because it has substantial control over PPL because as I noted earlier some PPL decisions require shareholder unanimity. 
• OMV reports data for PPL’s balance sheet and income statement so there is no need to adjust numbers. 
• OMV only began reporting separate data on PPL in 2014.  Before that PPL was aggregated with another equity accountee. 
• I’ve used year end spot exchange rates for the balance sheet (ECB) and averages for the year (IBRD) to convert OMV’s reporting currency (euros) to USD.   You’ll also find this info at the Deutsche Bundesbank with slight variations to the IBRD average rate, a cautionary note about the potential for “different” versions of the same data from well-regarded sources.  I used the IBRD average rate for HUF to convert MOL data so for consistency I used IBRD for OMV as well.  Where there was a lapse, e.g., 2016 average for the euro in the IBRD data, I used the Bundesbank data. 
• CA and NCA are current assets and non-current assets respectively.  The same C and NC prefixes are used for liabilities.

Comments:

• Three things of note from the OMV data.
• Noncurrent liabilities are disclosed.  Based on other information in both OMV and MOL’s financials, these amounts primarily consist of loans extended by shareholders to PPL.   The difference between NCLs and the derived loan balances may consist of accrued unpaid interest.
• Side Note:  The loans were extended at Libor plus 2% which both OMV and MOL describe as a “market” rate.  AA would like to borrow some money from a “market” that rates Kurdistan risk this low because AA could probably get a loan at Libor minus 2%.   
• In 2015 OMV restated PPL’s equity as of 2014 or more precisely marked it down roughly USD 1.5 billion.  There is no restatement of PPL’s equity in DG’s financials. 
• OMV’s calculation of equity is higher than DG’s for 2014-2016.

Now to the income statement.

OMV Info:  PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	OMV
2016	223	149	0	149	16
2015	357	-258	0	-258	-26
2014	618	-373	0	-373	-37
2013	575	169	0	169	17

Comments:

• As you’ll note OMV did not restate income in 2015 for 2014 which AA believes indicates 2014 restated equity reflects a change in reserves or contractual value of PPL’s rights in the KRG. 
• Also OMV’s operating profit differs from that of DG.  It’s not clear what’s causing this, but AA believes it is the difference between gross operating profit (net revenues less depreciation and operating costs) as reported by DG and net operating profit (which includes other expenses) as reported by OMV.
• Not a particularly “pretty” profit picture.

MOL Information on PPL

MOL Info:  PPL Balance Sheet  USD Millions
Year	CA	NCA	TA	CL	NCL	Equity
2016	2,345	658	3,003	138	1	2,864
2015	2,123	686	2,809	88	229	2,492
2014	2,038	690	2,728	98	248	2,382
2013	1,415	716	2,130	49	253	1,829
R2012	1,122	734	1,856	24	490	1,342
2012	1,122	3,556	4,678	24	490	4,163
2011	684	3,582	4,266	28	644	3,595
2010	345	3,607	3,952	61	782	3,108

Technical Notes:

• Like OMV, MOL uses the equity method to account for PPL. MOL’s reporting currency is Hungarian Forint (HUF).
• It reports PPL’s aggregate balance sheet and income statement except for 2010-2012 when it reported only its share of the balance sheet and income.  Figures for those years have been divided by 0.1 to calculate PPL’s aggregate balance sheet. 
• I used the same IBRD source mentioned above for average annual rates for the HUF and laboriously copied fiscal year end spot rates from NMB (Hungarian Central Bank) website. 

Comments: 

• Both MOL and OMV report very similar balance sheets for 2014-2016 which AA takes as indicating that this exercise has produced a fairly accurate picture of PPL’s balance sheet for those years. 
• Note that their equity numbers are equal for the period 2014-2016 and different (higher) than DG’s. 
• But there is a significant difference between MOL and OMV regarding the restatement of PPL’s equity.  At MOL the restatement occurs in 2013 for fiscal 2012 and is a much larger amount USD 2.8 billion versus USD 1.5 billion at OMV for fiscal 2014.   It is unclear what caused this timing difference. 
• NCLs as reported by MOL track those reported by OMV.  With the longer data period at MOL we can see the shareholder loans have declined to next to nothing from roughly USD 782 million in 2010.  
• Looking at the change from 2015 to 2016 in NCLs, at a 35% share, DG received roughly USD 80 million in repayments from PPL in 2016.  Because these are intergroup transactions, they would not be reflected in DG’s consolidated statement of cashflows. 
• The USD 80 million was likely reflected in consolidated cash as DG’s 35% share of PPL’s total cash. Once payment to DG was made DG’s consolidated cash balance would not change.  If DG prepared and disclosed parent only financials, we should see the USD 80 million as a separate transaction there.   

Now let’s turn to MOL’s version of PPL’s income statement. 

MOL Info PPL Income Statement USD Millions
Year	Rev	Op Prof	OCI	NI	MOL
2016	223	235	154	388	0
2015	357	-188	293	106	11
2014	618	524	28	553	55
2013	575	470	17	487	84
2012	645	564	5	570	57
2011	565	494	-8	486	49
2010	205	192	5	197	20

Comments: 

• Similar to OMV, MOL’s restatement of PPL’s equity did not result in a restatement of net income which seems to bolster AA’s theory that this is a valuation change of contractual rights or reserve values. 
• But OMV and MOL part company on income. 
• MOL’s calculation of net income tracks closely the change in equity and is much large and more consistently positive than OMV’s.  OMV does not appear to consider OCI. Yet the difference between the two is apparently not solely the result of OCI. 
• Based on MOL’s calculation, PPL appears to be a highly profitable investment. 
• But there is a wrinkle here.  Despite recognizing larger net income, in 2016 MOL stopped accruing income on PPL shifting to a “cash basis”.    That is not a vote of faith in PPL’s prospects or the ability of the KRG to settle the trade receivables. 

Summary 

• We’ve been able to recreate PPL’s balance sheet in more detail than DG has provided.  This can serve as a basis for further analysis by other interested parties, e.g., sukuk holders’ advisors, equity analysts, and equity holders. 
• However, this exercise has not resulted in a completely identical set of financials.  As regards the balance sheet, there is an approximate 10% of so difference between DG’s value of equity and that reported by OMV and MOL.  
• More importantly for a meaningful analysis, there are striking differences in PPL’s income as reported by DG, OMV, and MOL. 
• DG only provides gross operating profit not net income or net comprehensive income.  The above mentioned “interested parties” may wish to push DG to provide additional information.  For starters, to disclose its calculation of PPL net comprehensive income before and after allocation of DG expenses. 
• OMV and MOL have very different net income figures for PPL. While PPL is a small fish in OMV’s and MOL’s operations, parties interested in those companies may also wish to understand more about PPL’s performance. 
• As noted, this does not seem to be solely the result of MOL considering OCI while OMV does not as OCI does not equal the difference between OMV and MOL’s figures.
• Interestingly, DG, OMV, and MOL are all audited by Ernst and Young, though it's important to note that each of the firms are legally separate partnerships within the global E&Y “family”.
• Differences among these companies' accounting for PPL is the result of differences in accounting practices. DG “consolidates” its share of PPL.   OMV and MOL use the equity method to account for their respective holdings in PPL. But, as noted above, OMV and MOL have remarkably different results for net income. 
• Finally, this approach to reconstructing/estimating undisclosed information by using other sources might be useful to bankers, investors, and other interested parties for a range of other transactions and obligors.  Where there is more than one partner in a venture and that partner is listed in a reasonably well regulated market, there may be disclosures available.  One can also look to counterparties to a transaction who may disclose details in their public disclosures that their counterparty does not. 
• Side Note: On that topic, early in AA’s career, a dearly respected white-haired mentor told AA how a colleague of his had recreated a rudimentary set of Aramco financials from SEC-mandated disclosures by the listed US oil companies who were Aramco shareholders at the time.  This chap later off-handedly discussed key elements of Aramco’s financials with the company, much to the consternation of Aramco officials who were concerned about the reaction of the “new” Saudi shareholder.