By Sam Watry RIA of Durig Capital
7.336 % yield to worst/call in 4 years.
Frontier Oil Corporation’s (NYSE:FTO) core business, originally Wainoco Oil, was established in 1949. Current business segments include gasoline and diesel refining while using the by-product in asphalt production. Their maximum capacity is at 187,000 barrels per day. They are headquartered in Houston, TX with operating facilities in Wyoming, Colorado, and Kansas. Their products are marketed regionally from the eastern slopes of the Rocky Mountains to the western plain states.
At Durig Capital, we have developed a process to review, select, purchase and monitor corporate bonds on an ongoing basis. Enclosed is our review, along with supporting documents, showing why we believe this corporate bond makes sense in clients' portfolios. We reviewed thousands of separate corporate bond listings to find what, we believe, is currently the best corporate bond for investors. The following illustrates our selection criteria.
Step 1 - Yield curve at 4-7 years out.
We have chosen this time frame as means of obtaining yield while understanding that long term inflation/deflation is a real threat to fixed incomes principal values. Investors are disgruntled with the yields that short term money market and saving accounts are yielding. US Government bonds are at historic lows leaving investors accepting break even inflation yields. Buying long term fixed income (10-30 years) puts real risk of principal reduction as short term uncertainty adds volatility to long term forecasting. The issue of Frontier Oil bonds, that we are currently buying for our clients, is callable starting September 2012. If not called, this issue matures in 2016.
Step 2 - We like companies that are profitable.
It is hard for us to comprehend, that it has been almost three years since the Dow Jones Industrial average was at it all time high of over 14,000. Since then, the economy in general has been hard on almost all companies profitability including Frontier Oil. They recorded their most profitable quarter as the DOW was peaking in the third quarter of 2007, posting annual earnings of $3.36 per share. Since then, negative earning have been reported for each quarter up until the last. The earnings per share, albeit starting negative, have been trending upward as they adjust to what some are calling the new “normal” economic environment. The last quarter saw a return to profitability when they announced $.63 of earning per share.
Frontier Oil generated operating income (EBITA) for the three months ended June 30th, 2010 of $115.99 million. While optimistic as it may be, operating income could payoff debt in a year, if margins remain the same.
The oil refining business has numerous barriers to entry thus almost eliminating any “going concern” for Frontier Oil. Due to environmental regulation, initial capital needs, N.I.M.B.Y. social issues and technical knowledge, there has not been a new refinery built in the US since 1976. Current production utilization capacity is above 98%.
The book value, original purchase price minus depreciation, of Froniter Oil is about 1 billion dollars. This gives them a debt to book value of .347. Since the book value is depreciated for tax purposes annually and the value market value of refineries, for reasons mentioned above, most likely has gone up, this gives them greater assets to cover the debt. Simply put, if needed, they could sell a refinery to pay off debt.
Industries such as the petrol, food and utilities are attractive because they are staple goods and not luxury items that have been priced out of consumers budgets. While the overall economy has rattled industries across the board, the petrol addiction of our society will not disappear in the near term, supporting a stable demand outlook for Frontier Oil's products.
Step 3 - We like companies with lower debt to cash ratio.
Frontier Oil has a long term debt load of $347.62 million. As of the end of last quarter, they had $444.24 million of cash. Having a debt to cash ratio of less than one, like the Fidelity bond, is impressive because it gives them the opportunity to pay off all their debt at there own will. The one two punch of cash and small amounts of outstanding debt allows Frontier Oil identifiable and established exit avenues should the need or want for capital present itself.
Step 4 - We like companies that have flexible balance sheets.
As mentioned above, they have the ability to pay off their debt but what investors should find attractive is the ability they have to increase or alter the current amounts of long term assets, liabilities and equity. Companies that are bloated with debt do not have options when business outlooks become cloudy but companies such as Frontier Oil, similar to our Expedia (NASDAQ:EXPE) review, can adapt to changing environments. Frontier Oil has a debt to equity ratio of 36% which is at the higher end of levels we view as attractive. With favorable liquidity, debt to asset, and debt to equity ratios, Frontier Oil has the ability to raise capital should it see a attractive opportunity. Their current balance sheet can be viewed here.
Step 5 - We like high yields.
Frontier Oil currently has a yield to worst of 7.336% and this is outstanding considering the current interest rate environment. This yield does compensate investors for higher risk, but in our opinion it over compensates. Being a callable bond allows the issuer the right, not the obligation, to call away the debt instrument. Investors are compensated for this risk with a higher yield when compared to non callable bonds. Enclosed is a link to current high yield bond offerings to use as a benchmark against Frontier Oil.
Important Yield Forecasts
**Current yield is 8.173%**
Step 6-We currently like shorter maturities.
This issue is first callable in September 2012. In our opinion, Frontier Oil will call this issue because they have the cash to repay and/or could refinance it at a lower rate. The yield to worst, lowest current yield metric, is 7.336% and this factors in the bond being called at par in September 2014. The bond is callable, at diminishing price levels, until final maturity on September 15, 2016. If called, there is reinvestment risk, however we are willing to accept that risk for the current yield. If and when this issue were to be called or not and held to maturity, the time frame is concurrent with our economic outlook.
This is a good 7.336% yield till worst case scenario. Even though it doesn't have an investment grade rating, a large cash position, investment coverage and profitability illustrates the relative health of the company. These metrics are similar to our previous bond reports such as Seagate Technology (SPX), Expedia (NYSE:EXP), Interpublic (NYSE:IPG) and Unitrin (UTR), which have done quite well for are clients.
For further review of Frontier Oil Corporate website is here.
- Coupon 8.5 %
- Ratings Ba3/BB
- Maturity 09/15/2016
- Price 103.269
- Yield to Worst 7.336% 09/15/2014 called at par
- Yield to Maturity 7.659% 09/15/2016
- Yield to Call 8.28% 09/15/2012 called at 104.25
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Disclosure: Durig Capital’s clients currently do have positions in Frontier Oil Corporation’s bonds.