Citigroup’s 10%-11% autocallables tied to Halliburton, Schlumberger offer short-term value play

By Emma Trincal

New York, Sept. 13 – Citigroup Global Markets Holdings Inc.’s autocallable equity-linked securities due Sept. 16, 2022 linked to the lesser performing of the common stocks of Halliburton Co. and Schlumberger NV (Schlumberger Ltd.) provide an attractive opportunity to earn a double-digit fixed rate for contrarian investors happy to take a chance with a deeply depressed oil sector, a portfolio manager said.

The interest rate is expected to be 10% to 11% per year and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Interest will be payable quarterly.

Beginning March 13, 2020, the notes will be automatically called at par if the lesser-performing stock closes at or above its initial share price on any quarterly valuation date other than the final one.

The payout will be par unless the lesser-performing stock’s final share price is less than its downside threshold price, or 50% of its initial price, in which case investors will lose 1% for every 1% that the lesser-performing stock declines from its initial share price.

Six-month trade

The notes are however likely to have a six-month duration rather than a three-year term, said Steven Jon Kaplan, founder and portfolio manager at TrueContrarian Investments, who liked the timing of the trade.

“I think it’s more likely to be a very short-term bet, although it’s possible in theory that the notes would not get called during the three-year timeframe. But it’s very unlikely,” he said.

Kaplan always look at the timeframe first, but valuations are just as important.

“There’s an autocall if both stocks are up in March. Even though we just had a big rebound in energy, the sector remains very cheap, which makes me think it’s the most-likely scenario. You hold the notes for six months and collect your 5% to 5.5% coupon.”

Very depressed

Both Halliburton and Schlumberger have seen their share prices collapse.

Halliburton is down 48% for the past year, and Schlumberger’s share price has dropped 39% over the same period.

More importantly for Kaplan is how far the stocks are from their previous lows.

“Halliburton is near its early 2009 low. Schlumberger is actually lower than its 2009 low. You have to go all the way back to the beginning of the century, late 1990s to find similar bargains,” he said.

Not a bond

The note offers a fixed coupon, unlike the ever-so-common contingent coupon deals, he noted.

But just because the coupon is guaranteed does not mean investors should consider buying the notes as a form of fixed-income replacement, he said.

“This is a very attractive reward for investors looking for a target return,” he said.

“But it’s not a fixed-income security. Your principal is at risk. You could still lose 100% of your investment,” he said.

Risk-reducing features

That said, the note was structured in such a way that the inherent volatility of the underlying stocks was balanced by a number of positive factors that mitigated the downside risk.

He mentioned some of them: the 50% barrier, which he liked given the already low prices of the underlying shares; the high likelihood of a call within the first year; and the fixed coupon, which could be used as a cushion at maturity.

Even the worst-of dispersion risk was attenuated given the correlation of the two underlying stocks.

The worst-of payout had been introduced to stretch the coupon. Kaplan did not find it too risky.

“Those stocks are closely correlated with each other, which is a good thing because for that type of product based on the worst of two assets you don’t want these things to behave very differently,” he said.

In conclusion, the note was not a bond. But for an equity-linked structured note tied to two volatile stocks, the issuer did a relatively good job at mitigating risk, he said.

Not for bulls

Another thing the note was not is a bullish bet on energy.

“It’s not a replacement for investing in the sector,” he said.

“I’m very bullish on energy, so I wouldn’t buy this note if I expect to make more than 10% a year.”

Both Halliburton and Schlumberger are among the largest players in the energy sector, he said.

“They’re not as big as Exxon and Chevron, but they’re pretty big in the oil services industry. They’re both very diversified. They’re both global franchises. They’ve been around for a very long time. And they’re both unpopular.”

Unloved underliers

That last characteristic was perhaps what made Kaplan more interested in this note than in any S&P 500 index-based product.

His mission is to discover unpopular sectors with good prospects and low valuations that insiders are in the process of buying.

Both stocks made his buying list.

“The sector has had a very bad year. You had negative article after negative article to a point where the news media stopped writing about those stocks altogether,” he said.

“Now that they’re at their lowest since the financial crisis, you’d think there would be some serious coverage.

“But that’s not how it works. Once those stocks double, it will be all over the news. ‘Buy this now; it’s at all-time highs.’ Ridiculous but true.

“The time to buy is when something is low, not high.”

Smart money

Insiders, however, understand valuation. Kaplan follows their lead when it comes to buying a particular sector.

“Insiders buy when they think a sector or a stock is going up. They have to hold for at least six-months. They’re sophisticated and pay attention to value.”

Apparently, they have noticed the opportunities offered by the sector.

“I have never seen that much insider buying in energy ever before.”

The bid on an already beaten-up sector bodes well for investors in the notes.

“Of course, things could go wrong in the sector. But it’s unlikely. The 50% barrier is a generous barrier. But prices are already so low. It’s just some sort of insurance, in case we have a total collapse,” he said.

The volatility of the two stocks is what allowed the issuer to offer the double-digit interest rate.

“When you see prices down in the 40%, nearly 50%, people are scared. Option premiums go up.

“The coupon is a way of capitalizing on the high volatility.”

Economics, not geopolitics

Oil headlines spread even more fear when the focus is on geopolitics, according to this portfolio manager.

“You get those reports about Iran. If Trump eases the sanctions, if there is less risk of tensions or war in the Middle East, then oil prices are going to drop,” he said.

“I don’t give any credit to the analysts who interpret, predict the prices of oil based only on geopolitics.

“Their forecasts will stick for one day; the next day, they’ll predict the opposite.

“What really defines the price of oil is the economic environment, nothing but supply and demand.”

At the moment, the laws of supply and demand are bullish for oil stocks, he said.

Another factor making the bears speak louder about oil prices is the constant talk of an upcoming recession, he added.

“People hear it constantly. We’re going to have a recession ... in six months, one year. When growth decelerates, oil prices will come down. But we don’t know if we’ll have a recession during that period and what will be the magnitude of it,” he said.

What investors should know is that the supply and demand fundamentals for oil are bullish, he said.

“There’s an increasing demand for oil around the world. Population is growing worldwide. This is not going to change,” he said.

“With prices so low, supply has been crushed. Oil companies have had to cut their production because it’s no longer cost-efficient for them to invest and produce as much as before, so demand is increasing and supply is constrained. The bullish case is pretty clear to me.”

Again, the notes are not designed for an extremely bullish investor.

“You have to be moderately bullish and be happy with a return capped at 10% to 11% a year,” he said.

“This note is intended for someone who wants a high chance of success. You may not participate in the next rally, but you are very likely to meet your 10%-a-year target.”

The notes will be guaranteed by Citigroup Inc.

Citigroup Global Markets Inc. is the underwriter.

The notes will settle Sept. 18.

The Cusip number is 17327TFR2.

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