R.R. Donnelley: High-Yield Junk Bonds

| About: R.R. Donnelley (RRD)

R.R. Donnelley & Sons (NASDAQ:RRD) is a publisher ranked 249th in the Fortune 500, though it had $122M in losses. To put R.R. Donnelley's rank into perspective, H.J. Heinz (HNZ) is 244th, and has $989M profit; Stanley Black & Decker (NYSE:SWK) is ranked 252nd, and has $674M profit.

On September 19th Moody's (NYSE:MCO) downgraded R.R. Donnelley's bonds to Ba3:

The outlook is negative given Moody's concerns about the secular decline of the commercial printing industry combined with management's historic bias towards shareholder returns vs. reducing financial risks.

A negative outlook and junk rating, for any company, Fortune 500 or not, is worrisome. Therefore it is important to consider allocation size, in the event the company fails.

Seeking Alpha's December 6th Wall Street Breakfast: Must-Know News reported:

Garmin (GRMN) will join the S&P 500... and will replace R.R. Donnelley, which is joining the S&P MidCap 400. RRD has had a tough year, punctuated by declining demand for printing services and an embarrassing mishap related to Google's (GOOG) Q3 report.

R.R. Donnelley's Attention-Getting Yields

R.R. Donnelley & Sons currently has several bonds on the market that investors might consider for their high yields. For instance R.R. Donnelley's 2021 bonds have an 8.57% yield; that is more than 5 times greater than the current 10-year U.S. treasury rate:

rating price yield
Donnelley R R & Sons Co Deb 8.875% 2021 (cusip: 257867AC5) call protected, sinking fund protection Ba3/BB $101.75 8.57%
Donnelley R R & Sons Co Deb 6.625% 2029, (cusip: 257867AG6) Make Whole Call, not call protected, sinking fund protection Ba3/BB $86.70 8.10%
Donnelley R R & Sons Co Sr Nt 7.625% 2020, (cusip: 257867AW1) Cond Put Change Of Control, Make Whole Call, not call protected, sinking fund protection Ba3/BB $97.50 8.07%
Donnelley R R & Sons Co Sr Nt 8.25% 2019, (cusip: 257867AY7) Make Whole Call, not call protected, sinking fund protection Ba3/BB $102.20 7.79%
Donnelley R R & Sons Co Nt 7.25% 2018, (cusip: 257867AX9) Cond Put Change Of Control, Make Whole Call, not call protected, sinking fund protection Ba3/BB $98.00 7.70%
Donnelley R R & Sons Co Nt 6.125% 2017, (cusip: 257867AT8) Cond Put Change Of Control, Make Whole Call, not call protected, sinking fund protection Ba3/BB $97.99 6.69%
Donnelley R R & Sons Co Nt 8.6% 2016, (cusip: 257867AV3) Cond Put Change Of Control, Make Whole Call, not call protected, sinking fund protection. Ba3/BB 108.45 5.99%

The 2029 bonds are trading at $88.62, some might consider this a good discount. The 2017 and 2018 bonds are trading slightly under par and offer very high yields, 6.69% and 7.70%, respectively. Of course, the bonds are rated below investment grade for a reason, so investors must realize there is more risk.

R.R. Donnelley Z-Score

The Altman Z-Score is one formula for gauging a company's risk of bankruptcy. The Z-Score relies on total assets and fractions of the company's:

  • working capital
  • retained earnings
  • sales
  • earnings before interest & taxes [EBITDA]
  • market value of equity over book value of liabilities

A score above 2.99 is thought to be a safe zone, a score between 1.82 and 2.98 is a grey zone; 1.81 and under signifies a distress zone. R.R. Donnelley's Altman Z-Score is currently 1.631:

RRD Altman Z-Score Chart

RRD Altman Z-Score data by YCharts

R.R. Donnelley is in the distress zone. The company has about $392M in cash equivalents and $3.7B in debt. The company's debt to equity ratio has gone up significantly since 2011:

RRD Debt to Equity Ratio Chart

RRD Debt to Equity Ratio data by YCharts

R.R. Donnelley's net income went from negative to positive, in the past few quarters. For the quarter that ended December 30th, 2011 R.R. Donnelley listed negative $326M net income, however, there was a $507M non recurring expense:

Sept. 29, 2012 June 29, 2012 March 30, 2012 Dec. 30, 2011
Net Income Avl to Common Shares $71.4M $88.8M $37.4M ($326M)
Non Recurring Expenses $13M $34M $50M $507M

The 2011 Annual Report shows:

An example of organic grown was reflected in the opening of a new RR Donnelley facility in Chengdu, China in the heart of the emerging high tech operations center for our global customers...

During 2011 we added companies such as Press+, Helium, Sequence Personal, and LibreDigital. Together these new operation expanded RR Donnelley's ability to help customers create, manage, distribute, and monetize digital content.

Thus far, the return to positive quarterly net income is a sign that such expenditures could be paying off. However, investors are currently weary of printing companies, especially those not involved in business that can draw revenue from the internet. So let's take a look to see how R.R Donnelley is trying to keep up with the digital age. R.R. Donnelley's digital solutions segment includes:

  • Automated Print Management
  • e-Book Services
  • eDelievery
  • Publishing Automation Tools

To give an idea of some of these services, the e-Book service states:

The eBook market is booming, opening the door for publishers to connect with tech-savvy consumers. Bring us your content and we'll convert it seamlessly into a digital format that's compatible with every major marketplace -- expanding your online presence and keeping you on the cutting edge.

The eDelivery services states:

Our eDelivery capabilities include design, creation, content conversion, distribution, data analytics and business intelligence. This tool set ensures effective development and delivery of your content while providing you with meaningful data to better manage your campaigns.

R.R. Donnelley: Most Recent Quarterly Report

R.R. Donnelley's most recent quarterly report shows net sales for three months ended Sept. 30th:

2012 2011 % Change
Magazines, catalogs & retail inserts $452M $486M (7.0%)
Books & directors $309M 341M (9.1%)
Variable print $285M 311M (8.3%)
Financial print $191M $195M (2.2%)
Forms & labels $186M $195M (5.0%)
Logistics $192M $178M 8.0%
Commercial $135M $173M (21.7%)
Office products $59M $57M 4.5%
Premedia $39.M $39M 1.3%

*parenthesis indicate negative percentages

Only three of the listed operations had positive net sales increases from 2011 to 2012:

  • logistics
  • office products
  • premedia

The commercial business took the biggest hit, with a 21% percent drop in net sales. R.R. Donnelley's debt maturity schedule is as follows:

Total 2012 2013 2014 2015 2016 Thereafter
$3.74B $344M - $258M $300M $350M $2.49B

The quarterly report also shows that Asia was the only international market where R.R. Donnelley saw increased net sales:

2012 2011 % Change
Asia $176M $169M 4.3%
Latin America $112M $145M (22.6%)
Europe $97M $116M (16.9%)
Canada $59M $63M (5.8%)

This is even more of a reason for investors to be cautious. In fact, I would only consider R.R. Donnelley bonds if I had profit from other positions to fund the majority of the investment. As well, consider allocations, to individual junk bonds, at less than 5% of a total portfolio.

Balancing Quality and Yield

Here I will form an example that will combine R.R. Donnelley bonds, higher quality Goldman Sachs (NYSE:GS) bonds and an income fund. While the 10-year and 20-year treasury rates have fallen to 1.62% and 2.36% respectively; junk bonds like R.R. Donnelley's may tempt investors:

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

In this example I will use the 2017 R.R. Donnelley bonds, over the 2016 bonds, because the 2017 bonds are under par. I will also use the 2021 bonds, because they are listed as call protected, and they currently offer a greater yield than the 2029 bonds (though the 2029 bonds are less expensive.)

I will also use R.R. Donnelley common stock, because it currently has an 11.2% dividend. To counterpoint the non-investment grade R.R. Donnelley bonds, I will include Goldman Sachs bonds, because they are call protected, offer a monthly coupon and are investment grade. There is also an income fund, to provide exposure to multiple other companies and types of income:

portfolio size R.R. Donnelley 8.875% 2021 / R.R. Donnelley 6.125% 2017 / R.R. Donnelley Common Stock price: $9.30 Goldman Sachs 5.5% 06/15/2030 price: 107.10 yield 4.89% income fund total / %
$150,000 $2,100 / $2,000 / $250 $2,200 $500 $7,050 / 4.7%
$1M $3,150 / $3,000 / $350 $5,500 $750 $12,750 / 1.27%
$5M $5,250 / $5,000 / $500 $10,900 $1,250 $22,900 / 0.45%

*totals include estimated commissions and accrued interest

This example adds just one more R.R. Donnelley bond to each position in the $1M portfolio. This illustrates the conservatism I believe investors should consider, however, even a smaller portfolio could consider these individual high yield bonds.

While Moody's and S&P rate Goldman Sachs bonds investment grade, like any company they are not totally risk free. Given the fact treasury rates are so low, the R.R. Donnelley bonds may be worth the risk; so long as proper allocations, that balance risk, are employed. The company is in the Z-Score distress zone, and the business is hurting, so a bankruptcy is not impossible. Still at this rate R.R. Donnelley would generate ten years of treasury returns (1.62% x 10 = 16.2%) in two years, at an 8.57% yield.

If you have any thoughts regarding R.R. Donnelley and Sons junk bonds, or this example, please leave a comment below.

Disclosure: I am long RRD, MCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long Goldman Sachs bonds, and am considering a long position in R.R. Donnelley 2021 and 2017 bonds. This article is not a recommendation to buy or sell, please consult a financial adviser to determine proper allocations, if any, for your objectives.