Adding a new distressed bond to my holdings.

music selection:  “Rattlesnake Shake” (live) — Aerosmith

Each Friday, I try to post something from the fixed income world.  This is a major sector and important part of asset allocation that is largely being ignored by the financial media.  I have had great success over the years in distressed bonds, earning greater returns than in equity with lower risk.  I have just such an opportunity today.

US Steel (X) is the least indebted of the major American producers of steel.  It is also the only relevant player in high quality steel produced from ore and coke.  Companies like Nucor produce steel from recycling using an electric arc furnace.  That is fine for low quality steel but the steel needed by aircraft and auto manufactures, and for the upcoming infrastructure frenzy in the US need primary steel.  I expect US Steel’s revenues to soar in the coming years as its investments in modernizing facilities begin to pay off.

I bought on Thursday the 6.250 coupon 15MAR2026 expiry bond (CUSIP: 912909AN8) for 87.485 cents on the dollar.  My reasoning?  Any company with two times or more interest coverage strikes me as “safe”.  US Steel has an impressive seven times interest coverage.  Just in case, I’ve done a liquidation analysis and find that in the event of a bankruptcy liquidation, bond holders would recover about 46 cents on the dollar.   Assuming this bankruptcy comes at expiry, thirteen coupons of 31.25 would be collected.  That makes total recovery 866.25.  My loss would be a mere 8.60 per bond.  Most bankruptcies are not liquidations however but reorganizations where shareholders are wiped out and bond holders acquire equity in the new debt free business.  Substantial gains are projected in that scenario.

The gains here assuming my entry point of 87.485 on 16MAY2019 are an annualized yield to maturity of 9.38%.  That is if the bond is held to maturity.  If the bond trades for par before that time, significant improvement in the yield occurs.  I see three catalysts that could cause that to happen 1) the market wakes up to the fact this bond is undervalued due to its superior safety to its peers and it reprices 2) revenue increases due to booming infrastructure demand driven by the $2 trillion infrastructure bill making its way through congress 3) historically poor steel pricing turns around lifting margins.  Cashing out at par one year from now would boost the yield to maturity to 21.41%.  I am expecting at least 15% annualized return.  This comes with much greater safety than owning the underlying equity, a bet I will take every day and twice on Sunday.

ACTION TO TAKE: BUY 912909AN8 up to 88.0000.  Do not chase the price higher, patience while stalking prey is the raptor way!

In other news, my limit order on AFSI’s 15AUG2023 6.125 coupon bond finally sold at 99.15.  I have opened a fresh limit order to buy again at 95.0000 if prices fall that far again.

Devour your prey raptors!

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5 thoughts on “Buy 912909AN8

  • May 17, 2019 at 2:10 pm
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    I think I’m going to join you on this one. US Steel is famously volatile as their furnaces are expensive to operate and they’re probably going to be hit when the tariff situation sorts itself out. But they’ve survived some pretty bad recessions before and I doubt that they will go bust anytime soon.

    Side question: do companies ever buy back debt? I know that in the case of this bond, US Steel can call it early at a premium or at face value depending on the year, but were they to buy it back on the open market, it would be a better value. Or is it the case that any company whose debt is trading below face value has bigger issues to worry about that cause them to never buy that debt on the open market?

    Reply
    • May 17, 2019 at 3:18 pm
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      Steve, companies are allowed to buy back their own debt and sometimes do. It makes sense if you have a credit revolver at a lower interest rate than coupon.

      Reply
  • May 19, 2019 at 6:23 pm
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    How is the liquidation calculation done? Thanks.

    Reply
    • May 20, 2019 at 4:46 pm
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      There are multiple components here. I assumed a 10% reduction in revenues. That would lead to a drawdown on bank credit facilities, estimated at another billion dollars before the bank cuts them off. That would force the company into bankruptcy in late 2024. Next I assume that the PPE would be worth about 2.5 billion in liquidation (it will be worth more than that on the books but couldn’t fetch that price in a fire sale auction). That leaves receivables, estimated to be collected at 75% or 900 million. Finally, inventory would be smaller due to shrinking sales and worth only 55% in liquidation or about 770 million. There would be about a 1/4 billion in hard cash left on the balance sheet. I assume all other assets to be worthless in liquidation (a conservative approach).

      The rest of liquidation involves disbursing the proceeds to the most senior creditors first. After our bond comes up in the queue, the liquidation analysis shows an estimate of what is left.

      But I don’t expect a bankruptcy from a company that has weathered many recessions. And in the unlikely event of a bankruptcy, I expect the bankruptcy judge would consider the company worth more to creditors as a “going concern” than in liquidation. It would be granted the right to obtain senior “debtor in possession” financing and continuing to operate. Debt holders would have their notes exchanged for equity. After that you take your chances.

      Reply
  • May 26, 2019 at 12:48 am
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    I see. Thanks for the thorough explanation!

    Reply

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