Many bond investors do not like the idea of purchasing a premium bond, or a bond that is priced at more than its principal amount. They would rather buy a bond at a discount or at par value because it looks like the “better deal.” Contrary to popular opinion, premium bonds can actually be advantageous to the investor.

Although paying a premium for a bond at the time of the purchase may seem unattractive, that outflow of cash that was spent is recouped through higher coupon payments over time. Premium bonds are attractive for their high coupon rates that are greater than current market yields. In other words, the higher initial cost can be offset by the higher cash payments received throughout the life of the bond.

Let’s examine how a premium bond can be more beneficial than a discount bond. In this example, we have two 10-year bonds, each with a face value of $1,000. One bond is priced at a discount while the other is priced at a premium.

As we see in this example, although at first it may seem that we are getting a better deal with the discount bond due to its lower price, there is another important factor to consider. The discount bond’s coupon payments are lower than the premium bond’s payments, and as a result we are better off with the premium bond in this case. The premium bond’s net cash flow of $400 is derived from the 10 year cash flow, or $500, minus the premium paid on the bond which is $1100-$1000, or $100.  In contrast, the discount bond’s net cash flow was only $300. This was derived from the 10-year cash flow of $200 plus the amount we are saving through the discount which is $1000-$900, or $100. In this case, the higher cash flows earned over the life of the bond justify paying a premium for this bond.  If the bond is held to maturity, there is additional cash flow of $100, or $400-$300, with the premium bond.

In addition, these higher coupon payments make premium bonds more defensive against changes in interest rates. Higher coupons or cash flows from premium bonds may shield the investor against rising interest rates or inflation, making the bond’s price less volatile.  The higher coupon provides a cushion against price declines because the bond price has further to fall before it becomes a discount bond. Therefore, premium bonds with higher coupons should be less price sensitive to changes in interest rates than discount bonds with lower coupons. Also, if interest rates rise, these higher cash flows may be reinvested at the higher prevailing rates to your advantage.

Another possible advantage of premium bonds is that their yield to maturities can be higher than the yield to maturities of discount bonds of similar maturity and credit quality. In this example, the premium bond’s yield to maturity was 3. 78%, while the discount bond’s yield to maturity was 3.18%.  Therefore, in this specific case the premium bond is the better choice. It is always wise to consider the bond that is giving you the highest yield to maturity. The yield to maturity is a very important number as it shows your overall rate of return, taking into account the fixed coupon payments given over time and the price of the bond which can be variable.

Besides these main factors that affect yield to maturities, the yield to maturities for premium bonds may be higher than comparable discount bonds because many investors may be unwilling to own bonds that are priced very high. Not only that, but the fact that premium bonds will decline in price over time may also turn off investors to buying premium bonds.

The bond investor should realize that a bond bought at a premium will most likely not stay at that price during the length of its maturity. It is important to remember that the price of a bond tends to converge to its par value over time. In other words, although you may purchase bonds at a higher price than its par value, by the end of its maturity the price of the premium bond will most likely have decreased and returned to its par value. The size of the premium will decline as the bond approaches maturity, or its price will decline over time toward its par value. Similarly, the size of the discount on a bond will decline as the bond approaches maturity, hence increasing the discount bond’s price over time toward par.

Of course, there may be some disadvantages to premium bonds. One risk of callable premium bonds is that the higher coupons make them more susceptible to being called prior to maturity. Bonds may be called by the issuer when interest rates fall so that they may be reinvested at the lower rate. Since the value you earn from premium bonds is dependent on the receipt of higher coupon payments, if the bonds are called early then you won’t be receiving those payments any longer. Therefore, the investor may receive a price for the bond that is less than their original cost.

That is why it is important to remember that every bond is different and an astute investor should always check to see if there is an early call date. If this is the case, then the yield to call and yield to worst are important measures to use. The yield to call of a bond tells you what your rate of return is on your bond if it is called before its maturity. Similarly, the yield to worst of a bond is the lowest possible rate of return on your bond should it be called early or before its maturity date. For example, if your premium bond is called before its maturity date, then you lose some of the premium you paid and get a lower return as your interest payments are truncated. In this case your yield to call is lower than your yield to maturity and so you are at a disadvantage.

In summary, investors should take note of the main benefits of purchasing premium bonds. Although premium bonds seem expensive, they may offer higher yield to maturities than discount bonds, and ultimately an investor wants to see a higher yield. This cost for the higher yield is reflected in the premium dollar price that is paid for the bond. Also, premium bonds have higher coupon cashflows than discount bonds which makes it an attractive investment. Another advantage of premium bonds is that the higher coupon payments result in a lower price sensitivity to changes in interest rates compared to discount bonds. Finally, these higher cashflows can be reinvested at higher rates if prevailing interest rates start to rise. Therefore, depending on the circumstance these benefits may make premium bonds a worthwhile investment.

Disclaimer:  The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

One of the most significant risks for bond investors to consider is credit risk. Credit risk, also known as default risk, is the risk that a bond issuer will default on their payments of interest and principal. When a bond issuer defaults on their payments, the holders of the bond may lose most of their principal. For the most part, bonds issued by the federal government are immune from default and therefore have no credit risk. However, bonds that are issued by corporations are much more likely to be defaulted on, since companies can go bankrupt. Therefore, credit risk is a very important factor to consider when investing in corporate bonds.

Corporate bonds tend to offer higher yields compared to other investments to compensate the bond investor for the credit risk. Corporations that issue high yield bonds can be small companies or even large companies that are experiencing a degree of financial distress. As high yield bonds are generally more risky than investment-grade bonds, investors expect to earn a higher yield to compensate them for that risk. In order to lessen the impact of the default risk, the buyers of the bond will demand yields that correspond to the issuer’s level of default risk. In other words, usually when the risk of default for a bond becomes higher, the yield of the bond will also grow.

A good measure to assess the default risk of a bond is its credit rating. Credit ratings are given out by rating agencies such as Moody’s and Standard & Poor’s Corporation. Bonds that are seen as less likely to default are given higher ratings which are usually accompanied by lower yields, while bonds that are more likely to default are given lower ratings, usually accompanied by higher yields. In other words, high-yield corporate bonds can carry a lot of credit risk. High-yield bonds that are poorly rated may also be called junk bonds.

When a bond issuer defaults on their payments, the bondholder may lose their principal. However, a bond issuer does not have to default for credit risk to affect investors. If one or more credit rating agency downgrades a bond issue, or the market has a perception this may happen, the price of a bond will drop. The rating agencies will change their ratings for many different reasons including a change in the bond issuer’s industry, the financial and competitive standing of the issuer, and anything that will impact the issuer’s ability to meet the financial obligation to bondholders including their ability to pay off their debt.

Positive changes can result in an issuer’s ratings being upgraded. Many bond traders speculate by buying bonds of issuers that they think may be on the verge of a ratings upgrade. A ratings downgrade does not necessarily mean an issuer is close to default, and a change of one level may not necessarily result in a significant price change for highly rated issuers. However, bondholders should view a downgrade as a warning sign and carefully monitor the company for possible further deterioration.

A downgrade that reduces an investment grade bond to non-investment grade can be particularly problematic. Many institutional investors are required to hold only investment grade bonds. If a bond that these institutions hold is no longer investment grade, they will be forced to sell that bond. Because of the large positions these institutions usually hold, this selling can cause significant downside pressure on the bond’s price. In addition, a rating downgrade of more than one level can have a significant impact on the bond’s price.

Another way to assess the credit risk of a bond is through the use of financial ratios. Some widely used metrics are the interest coverage ratio and capitalization ratios. The interest coverage-ratio is used to find how much money the company generates each year in order to fund the annual interest on its debt. The formula for this ratio is EBIT, or earnings before interest and taxes, divided by the annual interest expense. The higher the interest coverage ratio, the better the position of the company to pay off the interest on its debt. An interest coverage ratio below 1.0 indicates that the company is not generating sufficient revenues to satisfy interest expenses.

The capitalization ratio assesses the company’s degree of financial leverage. It is used to find how much interest-bearing debt the company carries in relation to the value of its assets. The formula for this ratio is long-term debt divided by long-term debt plus shareholder’s equity. The lower the capitalization ratio, the better the company’s financial leverage.

Finally, the future economic outlook of a company is very important to take into account while considering the credit risk of a corporate bond. This is because bonds are a function of time due to the fixed coupon payment given to the bond investor every period for the entire maturity of the bond. Although high yielding bonds with a high coupon rate may look very attractive at first glance, ultimately they may not give you the high yield you desire if the coupon payments are cut short because of an early default. A corporation that is financially unstable is much more likely to default on their coupon payments. Even before this happens a rating agency may downgrade the bond, possibly resulting in a substantial decrease in its price.

However, high-yield bonds do have some advantages. High-yield bonds do not correlate exactly with either investment-grade bonds or stocks. Since their yields are typically higher than investment-grade bonds, they may be less vulnerable to interest rate shifts, especially at lower levels of credit quality, and are similar to stocks in relying on economic strength. Due to this low correlation, adding high-yield bonds to your portfolio can be a good way to reduce overall portfolio risk when considered within the classic framework of diversification and asset allocation.

It is also important to note that should the bond issuer go bankrupt, the bond holders have an advantage as they will be paid first during the liquidation process, followed by preferred stockholders, and lastly common stockholders. This feature can prove valuable in protecting a bondholder’s overall portfolio from significant losses.

Overall, higher-quality bonds tend to perform better than lower-quality bonds even during times of economic distress. This is because issuers of higher-quality bonds have sufficient financial strength to keep making their payments even under unfavorable conditions. However, the same cannot be said for lower-rated issuers, who may default on their payments.

In conclusion, investors of corporate bonds should know how to assess credit risk and its potential payoffs. Companies that issue high yield bonds entice the investor with this high yield, but at the end of the day it is important to remember that there can still be a lot of credit risk to account for. In addition, looking at credit ratings and financial ratios of different corporations can give us a glimpse of a company’s financial stability and credit worthiness. Although there are many other risks to consider, understanding credit risk and how it can affect the value of your bond is a significant step that should be taken before investing.

Disclaimer

The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Similar to yield to maturity, the yield to call uses a call date and call price instead of a maturity and face amount. In other words, the yield to call calculates the yield of a bond that would be earned if the bond were to be called at its call date, rather than at the date of its maturity. Also, like yield to maturity suffers from the assumption that the investor won’t sell his bond before the date of maturity, the yield to call suffers from the assumption that the investor won’t sell his bond before the call date.

So why is yield to call important? Yield to call is important because if the bond is called early, than the original yield to maturity will not matter to the investor anymore. Instead, the yield to call will be your new yield. The yield to call will be less than or greater than your yield to maturity depending on the circumstance.  If the bond is trading at a discount, or below its face value, then the yield to call is greater than the yield to maturity. Conversely, if the bond is trading at a premium, then the yield to call will be less than the yield to maturity.  Therefore, if there is a chance that the bond will be called, then there is a chance that as a holder of the bond you may receive that possibly unattractive or lower yield. For example, imagine that you have two 10-year bonds with an annual coupon rate. Notice that Bond A is priced at par and Bond B is priced at a premium.

Bond A: Issued On: 12/12/2012, Maturity Date: 12/12/2022, Face Value: $100, Price: $100, Coupon: 6%

This is what Bond A’s yield to calls would be:

Notice that because Bond A is priced at par, or its face value is equal to its price, the yield to calls are equal to the yield to maturity.

Bond B: Issued On: 12/12/2012, Maturity Date: 12/12/2022, Face Value: $100, Price: $110, Coupon: 6%

Now let’s look at what Bond B’s yield to calls would be:

As we can see from this example, since Bond B is priced at a premium, its yield to calls are less than its yield to maturity.  Its yield to worst, or its lowest possible yield, is -3.66%, as opposed to Bond A with a yield of 6%.  Although an investor may have been originally expecting a 4.54% yield on Bond B, the callable feature will most likely result in a rate of return equal to one of the yield to calls. If Bond B had been priced at $150 instead of at $110, then its yield to calls would have been even lower. In other words, the higher the premium is on your bond, the lower your yield to calls will be and the less attractive your return will be. Therefore, if you buy a callable bond at a premium, there is a much higher chance that you will receive this lower yield.

However, keep in mind that you are being compensated for this premium through the higher fixed cash payments or coupons you are receiving. In this example, we are receiving a 6% coupon every year, which is much greater than our yield to calls and our yield to maturity. Also, in this example we notice that the sooner the premium bond is called, the lower its yield to call. If we call the bond in December 2015, we receive a yield of 2.42% which is much less than if we call the bond in December 2017 with a yield of 3.63%. This is because you are receiving less coupon payments if your bond is called sooner than later, which explains why your yield to call is lower than your original yield to maturity.

These various call dates show us that the issuer of the bond has a lot of flexibility because he can call the bond at any time.  The main reason why the issuer would call the bond is because of a decline in interest rates. If a company issues a bond and interest rates decline during its maturity, the company will likely want to refinance the bond at a lower rate of interest. The company would proceed to call its current bonds and reissue them at a lower rate of interest. Also, it is important to keep in mind that premium bonds are more likely to be called than discount bonds. This is because usually bonds will become discounts after a rise in interest rates as bond prices decrease. Overall, it is advantageous for the company to issue callable bonds in the first place, even though the issuer has to pay more than the face amount to call in a bond.

Callable bonds can be tricky to navigate through for bond investors. Since the callable feature of a bond is so common in the bond market, it is important to know the different parts to a callable bond that could ultimately affect your yield in the future. Looking at the yield to call and yield to worst of a bond can help you decide which bond has a higher chance of giving you a successful return.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Community Health Systems (CUSIP 12543DAL4)

8.00% Fixed Coupon Paid Semi-Annual basis

November 15, 2019 Maturity Date

November 15, 2015 Next Call Date at $104.00 Dollar Price

Current Market: Offered at $109.375, Yield to Worst of 5.72% according to Trade Monster’s Bond Trading Center

+535 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 3-Year)

$108.88 Dollar Price, 5.89% Yield to Worst at time of Inclusion of Bondsquawk’s High Yield Portfolio

‘B’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

Community Health Systems, Inc. (Ticker: CYH) is a nonurban operator of acute-care hospitals located throughout the United States. The company has 135 hospitals in 29 states and is the second largest publically traded hospital company behind HCA. This broad presence gives it the most diversified geographic footprint among its competitors.

Key Drivers

Improving Profitability and Free Cash Flow: CYH reported EBITDA of $469.8 million in the Third Quarter of 2012, an improvement of 5.5% from a year ago and a 7.8% from a year ago. In addition, the company’s Free Cash Flow for the past year stands at $418 million, an increase from $292 million in the Third Quarter of 2011.

Deleveraging Potential: The Company has $9.6 billion in total debt as of the Third Quarter. Using the last twelve months of data, CYH has a Total Debt to EBITDA ratio of 5.0x which is higher than some of its peers in the industry. Healthcare reform coupled with improvements in profit margins of recently acquired hospitals is expected to be some of the catalyst for continued profitability next year. Based off of consensus estimates, EBITDA is expected to grow to $2.01 billion for 2013. If the company meets or surpasses expectations, this in turn should lower the company’s leverage and improve its credit profile which should be a positive for bond holders.

Relative Value: The bond is callable on and anytime after the following dates at the following prices:

November 15, 2015         $104.00 5.72%

November 15, 2016         $102.00 5.74%

November 15, 2017         $100.00 5.77%

At a current price of $109.375, the bond has a Yield to Worst of 5.72% assuming the bonds are called in 2015.  Yield to Worst takes the lowest of the Yields (including Yield to Maturity of 7.02%) for a “worst-case” scenario.

Comparatively, this bond provides a yield advantage to investors. Lower rated (‘B-‘ by S&P) HCA 8.0% 10-1-2018 is offered at $117.25 for a Yield to Worst of 4.56%. HMA 7.375 1-15-2020 which also has a lower rating (rated ‘B-‘ by S&P ) has a Yield to Worst of 5.27%, given that it can be purchased at $109.00. So investors can pick up 116 and 45 basis points, respectively by investing in CYH 8.0% 11-15-2019 which is rated one notch higher by S&P at ‘B’.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Updated on December 19, 2012 to include analysis on DISH 7.875% 9-1-2019. High Yield Bond Portfolio originally posted on December 10, 2012.

In last week’s post, we covered why it makes sense to invest in individual bonds versus using a fund. A fund’s “one-size fits-all” approach can be convenient but may not be suitable for an individual who is looking for a tailored solution toward reaching their investment goals. By choosing to own individual bonds, you will have greater control that could lead to better performance. Furthermore, you should have a better grasp of your investments and where you stand today in reaching your goals.

Below is Bondsquawk’s High Yield Bond Portfolio which consists of 12 bonds, one from each diverse sector.  The model is used to illustrate an active High Yield portfolio that has bonds rated from BB+ or lower. The goal of this model portfolio is total return so both income and price changes are considered in determining the allocation.

* Yield shown is the Yield to Worst measure which is calculated by using the lower of either the Yield to Maturity or the Yield to Call on every possible call date.

Notes

• CYH 8.0% 11-15-19 is currently callable. The next call date is 11-15-15 at 104.00
• SD 8.75% 1-15-20 is currently callable. The next call date is 1-15-15 at 104.375
• OSK 8.5% 3-1-20 is currently callable. The next call date is 3-1-15 at 104.25
• TEX 6.5% 3-1-20 is currently callable. The next call date is 4-1-16 at 103.25
• STX 7.0% 11-1-21 is currently callable. The next call date is 5-1-16 at 103.50
• WYNN 5.375% 3-15-22 is currently callable. The next call date is 3-15-17 at 102.688

Information and market quotes on the bond investments are provided by Trade Monster’s Bond Trading Center.

The portfolio can change at any time. Bonds can be removed if price targets are achieved or original thesis is no longer valid. Analysis on current bonds will be posted along with changes to the portfolio on Bondsquawk.com. Be sure to visit Bondsquawk.com and subscribe with your email (on the side bar of the home page) to receive updates as well as other bond portfolio strategies and insights.

Guidelines

High Yield Ratings (BB+ to C- ratings by Standard & Poor’s Ratings Services at time of inclusion)

1 to 30 Years Maturity

Taxable Bonds

Fixed Rate Coupon

U.S. Dollar Denominated Only

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

DISH Network Corporation (CUSIP 25470XAB1)

7.875% Fixed Coupon Paid Semi-Annual basis

September 1, 2019 Maturity Date

Current Market: Offered at $120.38, Yield to Worst of 4.33% according to Trade Monster’s Bond Trading Center

+251 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 10-Year)

$118.50 Dollar Price, 4.64% Yield to Worst at time of Inclusion of Bondsquawk’s High Yield Portfolio

‘BB-’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

DISH Network Corp (Ticker: DISH) is an American satellite broadcaster, providing direct broadcast service to more than 14 million subscribers across the United States. The company is the nation’s third largest pay-TV provider and second-largest direct broadcast satellite TV provider behind DIRECTV. DISH offers 280 basic video channels, 60 Sirius radio channels, 30 premium movie channels, 35 regional sports channels, 2,500 local channels (offered in each sub’s respective market), and 50 channels of pay-per-view content. The DISH Network has more than 34,000 employees and is headquartered in Meridian, Colorado.

Key Drivers

Low Leverage: While total debt for DISH increased by $2.0 billion from a year ago to $10.4 billion as of the Third Quarter 2012, the company’s leverage when accounting for its cash on hand, has declined. The Net Debt, which is Total Debt less Cash Balances, to its EBITDA ratio has fallen from 1.40x in Third Quarter 2011 to 1.26 as of the latest statements.

This low level of leverage compares favorably to DISH’s competitors in the Media & Entertainment sector which is significantly higher. The Net Debt to EBITDA ratio for Cablevision Systems (Ticker: CVC, rated ‘BB+’) and Charter Communications (Ticker: CHTR, rated ‘BB-) stands at 4.87x and 4.86x, respectively.

Increasing Cash and Free Cash Flow: DISH’s Cash Balance increased during that time from $1.0 billion to just under $3.1 billion. Furthermore, the company’s Free Cash Flow for the past 12 months increased by 8% to $1.7 billion from a year ago.

Profitable and Current: DISH is easily able to stay current and pay its interest payment obligations from its debt as evident by its Interest Coverage ratio. While it has fallen from the 6.5x posted a year ago, the EBITDA to Interest Expense ratio using the past year’s worth of data for DISH remains at a healthy 5.8x. A higher Interest Coverage Ratio implies better credit health since it is making enough money to stay current with their debt interest obligations. Conversely, a red flag is raised when this ratio approaches 1.5 or lower since its ability to pay the interest on their debt is questionable.

Comparatively, competitor CHTR has an Interest Coverage ratio of just 2.8x while CVC’s stands at just under 3.0x.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

SandRidge Energy (CUSIP 80007PAL3)

8.75% Fixed Coupon Paid Semi-Annual basis

January 15, 2020 Maturity Date

January 15, 2015 Next Call Date at $104.375 Dollar Price

Current Market: Offered at $109.50, Yield to Worst of 5.83% according to Trade Monster’s Bond Trading Center

+547 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 3-Year)

$108.56 Dollar Price, 6.30% Yield to Worst at time of Inclusion of Bondsquawk’s High Yield Portfolio

‘B’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

SandRidge Energy, Inc. (Ticker: SD) was founded in 1984 and is an oil and natural gas exploration company with a focus in the U.S. The company’s core drilling operations are on its oil properties located in West Texas (Permian Basin) and the Mid-Continent area (Mississippian) of Oklahoma and Kansas. Furthermore and as a result of the Dynamic Offshore Resources acquisition, the company has sizable assets in the Gulf of Mexico. The company is headquartered in Oklahoma City and has over two thousand employees.

Key Drivers

Growth: SandRidge reported Third Quarter EBITDA of $297 million which was higher than the consensus estimate of $281 million. 2012 Third Quarter EBITDA is up 74% from a year ago and 11% from the previous quarter due to strong Mississippian production. Management is guiding continuing production growth of 18% in 2013 while expecting only 10% growth coming from oil production.

Sale of Assets to Pay Down Debt: The company is looking into a sale of assets in its Permian Basin due to its high-margin production. Street analyst estimates range anywhere from $1.7 billion to $2.6 billion for the Permian sale given market pricing. While total debt has grown by $1.5 billion in the past year to $4.3 billion, the monetization of assets will be used to pay down debt and help fund Mississippian operations.

Growing Cash: According to JP Morgan analyst, Joseph Allman, the company should be cash flow positive by the end of 2017 (not accounting for the potential Permian sale). JP Morgan expects the company to outspend their cash inflows for a total of $2.7 billion during this time period. SD has enough access to liquidity to cover this shortfall. As of the Third Quarter, the company has $674 million in cash (up from $325 million posted a year ago). Furthermore, the company has access to credit facility for a total of about $745. In total, SD has $1.4 billion in total liquidity which coupled with inflows, should be enough as the company reaches a positive cash flow balance in the years ahead.

Relative Value versus Peers: The bond is callable on and anytime after the following dates with minimum 30 days notice and at the following prices:

January 1, 2015 $104.375 Dollar Price       5.83% Yield to Call

January 1, 2016 $102.917 Dollar Price       6.18% Yield to Call

January 1, 2017 $101.458 Dollar Price       6.38% Yield to Call

January 1, 2018 $100.000 Dollar Price       6.52% Yield to Call

At a current price of $109.50, the bond has a Yield to Worst of 5.83% assuming the bonds are called in 2015.  Yield to Worst takes the lowest of the Yields (including Yield to Maturity of 7.02%) for a “worst-case” scenario.

This bond has a better yield to worst than some of its Energy Exploration and Production sector peers with similar rating and call date. Oasis Petroleum (OAS) 7.25% Coupon Maturing 2-1-2019 with a Call Date in 2015 is yielding just 5.32%. OAS is rated ‘B’ by S&P. Similarly, Plains Exploration Co (PXP) 6.55% Coupon, Maturing 11-15-2020 with a Call Date in 2015 has a Yield to Worst of 4.30%. S&P has ESL rated ‘B.’ Furthermore, Wells Fargo Credit Research reported that the average Yield to Worst of the sector which comprises of 54 High Yield issuers is 5.63%.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Oshkosh Corporation Senior Notes (CUSIP 688225AD3)

8.5% Fixed Semi-Annual Coupon

March 1, 2020 Maturity Date

March 1, 2015 Next Call Date at 104.25 Dollar Price

Current Market: Offered at $111.56, Yield to Worst of 4.75%

+442 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 5-Year)

$111.13 Dollar Price, 4.97% Yield to Maturity at time of Inclusion of Bondsquawk’s High Yield Portfolio

‘BB’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

Oshkoch Corporation (Ticker: OSK) which was founded in 2017 designs, manufactures, and markets through its various segments fire and emergency apparatuses and specialty commercial and military trucks. The Company provides products such as pumpers, aerial and ladder trucks, tankers, rescue vehicles, snow removal vehicles, refuse truck bodies, and concrete mixers. The company employs over 12 thousand people around the world and is headquartered in Oshkosh, Wisconsin.

Key Drivers

Trend of Debt Reduction: Oshkosh Corporation has a strong history of deleveraging. Over the past two years, the company has reduced their total debt load by more than 33%. In the past year, OSK total debt has fallen by $156.7 million to $955.0 million as of the Third Quarter 2012. Total Debt to Equity stands at 54.6 from 82.9 in the Third Quarter of 2010.

Improving Interest Coverage Ratio: The company has improved its ability to service its debt and interest payments. The Interest Coverage Ratio which is EBITDA divided by Interest Expenese has increased from 7.6x from a year ago to 8.4x. Using data from the past twelve months, the Interest Coverage Ratio stands at 6.2x.

A higher Interest Coverage Ratio implies better credit health since it is making enough money to stay current with their debt interest obligations. Conversely, a red flag is raised when this ratio approaches 1.5 or lower since its ability to pay the interest on their debt is questionable.

High Cash Balance: OSK has $390.7 million in Cash. In addition, the company has a Revolver line of credit available of $517.3 million. With no short term liabilities, the company has just over $900 million in liquidity. Furthermore, the company produced $122 million in Free Cash Flow in the past 12 months. Compared to their debt totals of $955.0 with a Market Capitalization of $2.6 billion, the company has ample cash.

Yield Advantage Over Peers: The bond is callable on and anytime after the following dates and at the following prices:

March 1, 2015    $104.250 Dollar Price       4.75% Yield to Call

March 1, 2016    $102.833 Dollar Price       5.34% Yield to Call

March 1, 2017    $101.417 Dollar Price       5.67% Yield to Call

March 1, 2018    $100.000 Dollar Price       5.88% Yield to Call

At a current price of $111.56, the bond has a Yield to Worst of 4.75%.  Yield to Worst takes the lowest of the Yields (including Yield to Maturity of 6.46%) for a “worst-case” scenario.

This bond has a better Yield to Worst than some of its Aerospace & Defense sector peers with the same rating and call date. B/E Aerospace Inc (BEAV) 6.875% Coupon Maturing 10-1-2020 with a Call Date in 2015 is yielding just 3.56%. BEAV is rated ‘BB’. Similarly, Esterline Technology Corp (ESL) 7.000% Coupon, Maturing 8-1-2020 with a Call Date in 2015 has a Yield to Worst of 3.96%. S&P has ESL rated ‘BB.’ So, this bond by OSK has a yield advantage of 119 and 79 basis points, respectively.

Terex Corporation Senior Notes (CUSIP 880779AX1)

6.5% Fixed Semi-Annual Coupon

April 1, 2020 Maturity Date

April 1, 2016 Next Call Date at $103.25 Dollar Price

Current Market: Offered at $106.75, Yield to Worst of 5.03%

+434 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 5-Year)

$106.88 Dollar Price, 5.01% Yield to Maturity at time of Inclusion of High Yield Portfolio

‘B+’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

Terex Corp. (Ticker: TEX) is a diversified global manufacturer of capital equipment operating in five business segments—Aerial Work Platforms (AWP), Construction, Cranes, Material Handling & Port Solutions, and Materials Processing. The company manufactures a wide range of equipment for use in industries such as construction, infrastructure, quarrying, shipping, transportation, power and energy. Terex also offers a complete line of financial products and services for the purchase of Terex equipment through Terex Financial Services. The company which is headquartered in Westport, Connecticut has more than 15 thousand employees with facilities in the Americas, Europe, Asia, and Australia.

Key Reasons

Deleveraging Balance Sheet: Total Debt for TEX declined $253 million from a year ago to $2.06 billion through the Third Quarter of 2012. As a result, the company is better able to service its debt as evident by its improving Interest Coverage ratio. The EBITDA to Interest Expense ratio using the trailing 12 months of data improved from 1.3x last year to 3.2x.

Better Profitability: Despite lackluster revenue growth of one percent over the past year, profitability for TEX improved significantly. EBITDA grew by $98.3 million over the past year to $167.6 million in the Third Quarter of 2012.

Cash is King: For the past 12 months, TEX has produced just under $200 million in free cash flow. As of the Third Quarter, the company has $543 million in Cash. Given the amount of debt and the total size of the company (Equity as of Third Quarter is $2.5 billion), TEX has ample liquidity.

Excellent Yield Despite Call Risk: The bond is callable on and anytime after the following dates and at the following prices:

April 1, 2016        $103.250 Dollar Price       5.16% Yield to Call

April 1, 2017        $101.625 Dollar Price       5.07% Yield to Call

April 1, 2018        $100.000 Dollar Price      5.03% Yield to Call

At a current price of $106.75, the bond is trading well over all of the call prices. Don’t let this scare you. Despite this drop in price should the issuer call the bonds at any of these dates, the investor is able to capture coupon payments from now until that call date to more than offset the decline in price. This is evident in the positive Yield to Call calculations for each of the call dates. Yield to Worst takes the lowest of the Yields (including Yield to Maturity of 5.37%) for a “worst-case” scenario which for this bond is 5.03%. As a comparison, the average Yield to Worst of the Industrial Goods sector is 4.86% according to Wells Fargo High Yield research report, Industrial Goods Relative Value Analysis, dated December 10, 2012.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.

Due to slower U.S. economic growth coupled with the shift to natural gas, the coal industry has been beaten down recently. While it is unclear if the turn is underway, there are some signs that suggest the coal industry may rebound. Improvement in exports and a slowing shift toward natural gas may fuel the focus back on coal companies. If that is indeed the case, bonds in the sector may perform.

Below are details of a High Yield bond issued by coal industry leader, Peabody Energy Corp. As part of Bondsquawk’s High Yield Portfolio released last week, this bond offers an investor an opportunity to capture yields along with the potential for price appreciation.

Peabody Energy Corp (CUSIP 704549AK0)

6.0% Fixed Semi-Annual Coupon

November 15, 2018 Maturity Date

Current Market: Offered at $108.38, Yield to Worst of 4.38%

+372 basis points Yield Advantage over comparable maturity U.S. Treasury (On the run 5-Year)

$105.25 Dollar Price, 4.97% Yield to Maturity at time of Inclusion of High Yield Portfolio

‘BB+’ Rating by Standard & Poor’s which falls on the High Yield spectrum

Company Profile

Peabody Energy (Ticker: BTU) is the world’s largest private sector coal company, with majority interests in 30 coal mining operations in the U.S. and Australia. The coal that is purchased is used in electricity generation and steelmaking. In 2011, BTU produced 227.5 million tons of coal and sold 250.6 million tons of coal, resulting in total revenues close to eight billion. BTU conducts business through its four principal operating segments: Western U.S. Mining, Midwestern U.S. Mining, Australian Mining and Trading and Brokerage. The company has approximately 8,300 employees around the globe and is headquartered in St Louis, Missouri.

Key Reasons

Better than expected Third Quarter: BTU reported EBITDA (Earnings Before Interest, Depreciation, and Amortization) of $460 million versus consensus forecasts of $399 million. The surprise was due to robust volumes in Australia better pricing from the Western U.S Mining segment. BTU generated $153 million in free cash flow after $463 million in capital expenditures during the quarter.

Room to Reduce Capital Expenditures: Management commented that it would reduce expected capex in 2013. Meaningful declines in capex would in turn create free cash flow flexibility for the company next year.

Hunkering Down: BTU is doing well to control costs as the company highlighted $100 million of savings from administrative costs and from operations. Furthermore, the company is in the process of cutting 925 jobs as it approaches year-end.

Deleveraging is “number one priority”: While total debt has increased from $2,459mm from a year ago to a current $6238mm (Total Debt to EBITDA ratio is at 3.1x from 1.3x) management believes that reducing debt is its “number one priority” going forward. For 2012, the company is headed in the right direction as total debt declined by $300 million. As the company deals with deleveraging, BTU’s Interest Coverage is still healthy at 4.8x, down from 8.6 at the same time in 2011.

If you have any questions or feedback on anything regarding the economy, markets, and bonds, feel free to Contact Us. We would be delighted to respond.

Disclaimer
The above content is provided for educational and informational purposes only, does not constitute a recommendation to enter in any securities transactions or to engage in any of the investment strategies presented in such content, and does not represent the opinions of Bondsquawk or its employees.