Why Choose Corporate Bonds? Investment-grade corporate debt instruments were yielding on average a premium of nearly 5.75% over Treasuries with similar maturities in early December. This premiumis more than three times the 5-year average spread. At this level, the market is demanding depression-level spreads not seen since the 1930s.
It’s extremely unlikely that we will have the rate of default on corporate debt securities that experienced in that ear. But with the level of intervention of the Federal Reserve through TARP, the actions of the FOMC holding short-term rates near zero and the balloting of the Federal Reserve balance sheet, reserves are being stuffed into the banking system at an unprecedented rate. With this much liquidity being injected, corporations are likely to see borrowing costs come down
this year.
As a result, prices on high-yield corporate bonds are likely to increase substantially in 2009, narrowing the default premium over Treasuries currently being paid.
Within this sector, I have identified 5 corporate credits as my favorites for the year.
Bond #1: DaVita (DVA)
DaVita is the first of the health care-related companies whose debt I favor in 2009. Its primary business is in the operation of kidney dialysis centers throughout the U.S. and abroad. DaVita currently controls about one-third of the market and has
sufficient cash to take advantage of acquisition and other expansion opportunities as they arise.
As the new administration and Congress move to expand the federal role in health care, companies like DaVita will benefit from the likelihood of increased capacity of an individual with a need in this area to be able to access the needed treatment.
DaVita bonds are currently trading at a slight discount. Bonds maturing in 2013 carrying a 6.625% coupon are trading at about 96, producing a yield-to-maturity of 7.75%
Bond #2: Steel Dynamics (STLD)
Steel Dynamics is one of the most profitable steel companies operating in the U.S.
While most analysts forecast a difficult year for the steel industry, recent activity in this sector has shown signs of having reached a low point.
Steel Dynamics stock is trading at a level double its 52-week low. The company is in a strong cash position, with a current ratio of 1.54 compared to an industry average of 1.17 and interest coverage of 18.33 versus the industry average of 0.09.
Of even greater significance is the company’s 5-year average earnings information. Steel Dynamics has had an average return on assets of 13.44 while the industry has had a ROA of 6.82. An average operating margin of 18.24 compared with the industry’s margin of 12.75 is further testimonial to the quality of the company’s management.
Steel Dynamics bonds are rated BB+ by S&P and Ba2 by Moody’s. Recent trades of their 7.875% bonds maturing in 2012 have been at a price of 80, producing a yield to maturity of 14.33%. At this level, the bond is a bargain offering high current returns and the opportunity for capital gains as the economy improves.
Bond #3: Freeport McMoRan (FCX)
Freeport McMoRan Copper & Gold, Inc, the world’s largest publicly traded
copper company, has been the leading supplier of copper and is among the largest gold mining operations as well. Recent weakness in demand for copper has resulted in a steep decline in copper prices worldwide. As a result, the company has moved aggressively to reduce capital expenditures over the next two years and has revised its outlook for earnings downward.
The company is in a strong cash position and is not highly leveraged. Its current ratio of 1.82 and long-term debt-to-equity ratio of 35.88 compares favorably to the industry. In addition to the company’s liquid assets, Freeport has controlling
interest in high producing copper mines throughout the world.
Freeport’s debt is currently rated BB- by S&P, Ba2 by Moody’s and BB by Fitch. Bonds issued by the company are actively traded at a discount from par. Recent activity in the bond has trended up in price, with the 8.25% bond of
2015, for example, currently trading at 84.25 resulting in a yield-to-maturity of 11.86%. As recently as December 23, the bond was trading at 80, indicating that the market for the bond is significantly improving.
Bond #4: Church & Dwight (CHD)
Consumer household and over-the-counter health products continue to be reasonably immune to the changes in the economy. Church & Dwight is among the largest manufacturers and distributors of these kinds of products.
The company has delivered strong earnings throughout its history and most recently reported strong earnings in spite of the condition of the economy. CHD stock traded in a relatively narrow range in 2008, with a 52-week high of $65.54 and a low of $47.59.
The company’s bonds have also held their value. Bonds due in 2012 with a 6% coupon are trading at 97, yielding 6.877%. While the opportunity for capital gains in the trading of this bond is not significant, the current return offers reasonable
security and moderate cash flow.
Bond #5: Becton, Dickinson & Company (BDX)
Among the companies engaged in the manufacturing and sale of medical supplies, devices, laboratory equipment and diagnostic products, Becton, Dickinson & Company is one of the few to enjoy investment-grade status from the rating agencies. Rated AA- by S&P and A2 by Moody’s, Becton is able to tap the corporate debt market at very favorable rates.
With a long-term debt-to-equity ratio of under .24 and a current ratio of 2.67, the company is poised to grow with the likelihood of expanded availability of health care through the adoption of a national health care program.
Becton bonds are among the most actively traded corporate bonds in the market. Even with their well-deserved quality credit rating, however, the bonds are trading at a significant discount to par. Becton 4.90% bonds of 2018, for example, trade at around 94, producing a yield-to-maturity of 5.720%. The spread to the 10-year Treasury is nearly 400 basis points, well above historical averages for highly rated corporate bonds. The bond is quite cheap at this level and should be part of a balanced portfolio.
