I have entered a good till canceled order for CUSIP: 075896AB6 at 72 cents on the dollar.
music selection: “Long Train Runnin'” — The Doobie Brothers
I love investing in high yield bonds when they are selling for significant discounts to their par value. This is especially true for the “Fallen Angels” that get downgraded from the lowest investment grade rating to the highest “junk” rating. Most institutional investors can no longer legally hold these bonds as investments and are *forced* to sell. This depresses prices beyond what their realistic market clearing price should be. That is, great bargains are available in the Fallen Angel space.
Today, I’m opening a good till canceled limit order in just such a Fallen Angel: Bed, Bath, and Beyond (BBBY). The company still has a strong balance sheet but is beleaguered by recent declines in same store sales. A turnaround plan is in place. SSS will probably continue to decline for another couple of quarters while management executes. And I have a lot of faith in their plan.
You see, BBBY has a lot of stores in strip centers and very few in “tier 3” malls. They are in well priced long term leases usually with a renewal option. They are closing unprofitable stores (and opening more under the fast growing Buy Buy Baby operating unit.) They are focusing their stores around “life event” shopping. Their research has shown that major life events like going to college, getting married, and buying a first home lead people to want to shop in person and touch the things they are going to buy. They are also dropping unprofitable products to stream line stores while focusing on exclusive in store brands that Amazon and other online competitors can’t under cut them on. Lastly, they have an online shopping experience upgrade in motion that will transform the company to a hybrid ‘bricks and clicks’ model.
I am bidding 72 cents on the dollar for CUSIP: 075896AB6, the 1AUG2034 maturity 4.915 coupon bonds. Today’s close was 74.78 and I expect to get filled in time. (Ravenous lizards playing the home game are cautioned against chasing this higher. Hold out for 72. Patience while stalking prey is the Raptor Way.) That would result in a play that yields about 9.4% annualized yield to maturity. But I expect the bond to be trading close to par again within 24 to 36 months if the turnaround is a success. That could as much as triple the return. Else, I am content to wait for what I feel is a very safe 9+% return.
No analysis of a high yield bond investment is complete without a discussion of whether the borrower can pay. The company only has 1.5 billion in outstanding debt against 7.5 billion in assets. The company pays 72 million a year in interest on its three bonds outstanding. I have assumed a 2% decline in sales for the next two years and get roughly 500 million in cash profits. Add back in the 72 million paid out to get 572 in cash flows and the company can meet its coupon obligations even with a 70% decline in profit! This to me, is a very safe bond.
We also want our principal back. The company has far more assets than debt and can pull a lot of levers (including a fat credit revolver) to cover maturities. In a worst case scenario, the company would be unlikely to declare bankruptcy before the earliest maturity in five years. The credit rating agency (S & P) that put them in Fallen Angel status estimates a recovery of 65% in bankruptcy reorganization (a highly unlikely liquidation would see closer to 48% by my back of the envelope estimate). So I will collect 5 y ears of coupon payments plus 65 cents on the dollar that I only paid 72 cents for. That is a roughly 24% return EVEN IF I AM WRONG about the safety of this bond. Hungry lizards playing the home game are reminded safety in this case starts with not over paying. Do not chase this bond higher than 75. You are almost certain to get 72 (or better) if you just sit on your hands.
I’ll be divesting of JPS preferred shares yielding 7.40% in favor of the 9.4% bond to prevent adding leverage. I think this adjustment makes my portfolio more diversified and less aggressive while increasing yield.
Devour your prey raptors!