Something a little different emanating from bond research.

music selection:  “I Think We’re Along Now” — Tiffany (tee-hee-hee)

On Friday’s I like to cover the fixed income investing universe.  My favorite way to invest here is by buying corporate high  yield bonds that are selling at a steep discount to par that I think will either mature or liquidate at a fair price.  I have made great money that way.  Better than with equities and options.  My second favorite, which has been the subject of many FFI posts; is to buy closed end funds with high yields that are trading at a discount to Net Asset Value (NAV.)  Today, I’m going to show you a third way to profit from bond research.  You see, the bond market is often called the “smart money”.  It is mostly institutional investors that have huge teams of analysts, attorneys, and expertise in multiple industries to help them evaluate a security.  Sometimes, a stock (the equity) will fall 50% or more while the same company’s bonds barely budge from trading around par.  Nine times out of ten or better, in the disagreement regarding the company’s future, the bond market has it right.  You can expect the equity of these beaten down companies that still have the faith of the bond community to double or better over the next 18 to 24 months.  It is important however to wait for an uptrend to establish itself.  I’m going to share three recent purchases I made that fit this description.

Acuity Brands (AYI) is a lighting and lighting solutions provider in North America.  It’s shares have fallen from a high around 277 to a low of 112 around April of this year.  Since then, shares have rallied to over 136.  Throughout the period the shares were tanking and continuing through today, the bonds always traded ABOVE par.  I bought shares at 133 and expect a double in the next 24 months.  The smart money will rarely steer you wrong.

Stericycle Inc (SRCL) provides regulated and compliance solutions to the healthcare, retail, and commercial businesses in the United States and internationally.  They are a major provider for removing and safely disposing of medical waste.  At the peak in October 2015, shares traded around 149 a share.  They bottomed at 58 or so a share.  An uptrend is in place that has seen shares over 70 and currently at 61.50 a share.  The company’s only bond matures in 2020 and continues to sell well above par despite a rising interest rate environment.  I purchased a synthetic long position at the 70 strike, taking a small credit for my trouble.  This is a company that provides a service required by regulation that is hard to replicate successfully. I expect to do very well here.

AMC Entertainment Holdings (AMC) through its subsidiaries, operates in the theatrical exhibition business. The company owns, operates, or has interests in theatres. As of December 31, 2017, it owned, operated, or had interests in 649 theatres with a total of 8,224 screens in the United States; and 365 theatres and 2,945 screens internationally.  The movie theater business has taken a hit in recent years as more people have switched to streaming services.  The industry is still hugely cash flow positive however.  Shares in this company traded as high as 35 dollars a share in December 2016.  By November of 2017 they bottomed around 11 a share.  An uptrend is in place that has shares trading at  17.23 a piece as of today.  The bonds trade just a few cents below par as they did when the stock was at its peak.  Clearly, bond investors (the smart money) feel there is nothing to fear.  I opened another synthetic long at the 20 strike, taking a credit of a little over 3 dollars a share for my trouble.  A double is a realistic goal for this investment.

Devour your prey raptors!

Friday Fixed Income

Never miss another opportunity to devour prey!

7 thoughts on “Friday Fixed Income

  • August 4, 2018 at 4:56 am

    Bond holders are higher up in the capital structure, and have first claim on the assets of the business in the event of bankruptcy. Equity investors have more risk as they only receive the residual value after debt investors have been repaid.

    Is it possible that the “smart money” is pricing the debt based on their assessment of getting repaid even in the event of a restructuring or bankruptcy, and that concern over equity holders isn’t factored in at all?

    • August 4, 2018 at 10:07 pm

      Bond holders usually have first claim on assets. There are bonds that are structured to be lower in the capital structure and bondholders come after banks in a liquidation where the company lines up “debtor in possession” financing. You make a good point. Bond holders don’t give a rip if equity gets wiped out. But if there is a chance equity could be wiped out, there is a chance of bondholders been somewhat less that made whole in liquidation. In fact, the average recovery for a senior bondholder in a liquidation is about 40 cents on the dollar. If default is a reasonable likelihood, the bond will trade at a discount. For one thing, is the bond is close to default, many institutional holders are legally forbidden to hold certain credit ratings.

  • August 4, 2018 at 5:21 am

    Apologies, but I posted my comment too soon.

    A second concern I would have is if the company is highly leveraged, they might decide to issue new equity to balance out their capital structure. In this scenario the stockholders would get diluted, and the bond holders would go unscathed. Could this also explain why a bond would trade at or near par, when there remains substantial risk to equity holders?

    • August 4, 2018 at 10:09 pm

      Yes, the company can sometimes issue a secondary equity offering. If the company is in that much trouble though, it is almost always reflected in the bond price. Institutional bond investors are SUPER conservative with respect to risk. It is where the retail investor gains their advantage in this market. Regulations and covenants prevent the big institutional investors from acting in a purely rational manner with respect to distressed bonds. Believe me, especially when the credit cycle is near the bottom, you can make better and safer returns in discounted bonds than you can in equity.

  • August 4, 2018 at 9:08 am

    Thanks for these detailed thoughts.

    Over what estimated timeline do you hope AMC might double?

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