The past six months has been a challenging market to manage a solid bond portfolio considering that the 10 year US Treasury yield has gone as low as 2.5% in October 2010 to pushing up to the much higher 3.75% levels this February, rising 1.25% or about a whopping 50%. The 30 year has moved from historic yield levels of 3.55% in September 2010 to 4.7% range in recent weeks. This typically means significant erosion in bond holders' principal. We believe these rates could go even higher due to a number of economic factors and have been limiting maturities to off set the long term interest rate risk.
One interesting note is that our bond rating criteria have not experienced the yield rise or price drop similar to the 10 and 30 year treasury. Corporate debt has gotten more expensive relative to the US Treasury. The bond bull market of the past nearly 30 years may have finally come to an end as every cycle should. During this time of rising interest rates our selection strategy is focused on finding bonds with strong balance sheets and income statements while attempting to maximize income for our clients. This has worked extremely well providing both high income while also seeing limited if any principal decline. We still believe that investors should be very cautious about what issues they are using to ladder their portfolios. Below is an update on some of our recommended bonds.
We originally wrote our review of a Netflix issue back in September 2010. This company has performed well and we still wonder why rating agencies have a junk rating (Ba2/BB+) on their issues. In the trailing twelve months, they have generated revenues of over $2.1 billion with net income of $160 million. The long term debt that they have outstanding is still at $200 million and the market cap has exploded to well over $11 billion. This is a very solid bond from a financial standpoint as they currently have enough cash to pay off the issue, make enough over a year on a pretax basis to pay off the debt, and have a staggeringly low (almost zero) long term debt to equity ratio. We still like this bond although it is trading at higher prices even as US Treasuries are trading at lower prices. It was trading as of this week with a yield to worst of 4.499% and yield to maturity of 5.949%. This is still quite good however down since we first reviewed them.
Frontier Oil (FTO)
Frontier Oil may be one of the best performing bonds that we have purchased for clients over the last year. We started placing this bond for clients in August of 2010. Earnings for Frontier were not very strong for the quarter ending 9/30/10 as earnings per share dropped to $0.08 per share from $0.63 the prior quarter but other ratios we analyze remain strong. Cash and investments on hand are still larger than long term debt and the market cap of the firm has almost doubled. They announce 4th quarter earning on February 24th, 2010 and we will be keen see their execution. The price of the issue has risen significantly as its current yield to worst is 4.66%.
Blyth Inc (BTH)
We started placing Blyth Inc bonds for clients in mid-December for clients. The Christmas season is their largest quarter by far and we anticipate hearing how they performed. Yields on this shorter term, less than three years, bonds have gone down as prices have risen. This may be due in part to investors taking a bit more risk than they typically do in order to obtain income. We have seen yields drop from 5.9% to 5.5% since we reviewed it.
DaVita Inc (DVA)
We reviewed DaVita Inc at the end of October 2010 when they refinanced their debt. This issue just fit into our maturity horizon due to its maturity in 2018. Earnings were quite strong and revenue rose. The dialysis industry may be the definition of a defensive industry and we like buying into these sectors. Limiting holdings to less than eight years may be important in these uncertain interest rate times. Although this does stretch the outer bounds of our maturity horizon, we like the defensive nature of the industry.
We have placed multiple foreign/global issues including sovereign and corporate debt issued in Australian Dollars, New Zealand Dollars, Brazilian Real, Hungarian Forint and Turkish Lira starting a year ago and they have performed quite well. We continue to forecast a weakening US Dollar as the fiscal mess seems to be growing. In January 2011 alone, it is estimated that the US deficit grew by over $100 billion dollars.
President Obama’s recent budget announcement could add an additional $80 million per HOUR to the deficit over the next ten years. Including foreign fixed income in to one's US denominated portfolio may be prudent to insulate against the possible continued fall of the US Dollar.
GE in Australian Dollars (GE)
We placed General Electric bonds denominated in Australian Dollars for clients in December. Since placing them, GE announced solid 4th quarter results, raised future forecast and announced a higher yield on their common stock. They announced an astonishing $4.5 billion dollars in sales for the quarter which is up significantly on what management said was demand from emerging markets. When looking overseas, we like finding companies that people are familiar with such as General Electric.
Brazilian Real debt
These bonds have performed quite well from a total return aspect you could see one of our recommendations here. We have seen principal rise by as much as 10% while obtaining current coupons of almost 12.5%. Brazil is a large developing economy that may be leading South America. The war of words going on between Brazil and the United States governments is interesting although we along with other pundits remain skeptical that either government could greatly affect exchange rates in the intermediate term. We are still syndicating Brazilian denominated debt offerings maturing in less than 5 years.
Total in New Zealand Dollars (TOT)
Total is a global vertically integrated energy firm. We found notes denominated in New Zealand Dollars that were yielding 5% for four years. Although the yield is better than what one may find for debt denominated in US Dollars that is Aa1/AA rated, we like the potential currency appreciation from a country that is commodity rich. This Total bond is an example of an option for investors seeking to diversify away from the US Dollar.
One of the easiest ways to further diversification is to add some foreign holdings, while often achieve a much higher income. They also protect clients from the possible continued risk of the long term decline of the US Dollar.
Even though we may be starting to see a bear market for bonds, we believe that there are still good opportunities out there for investors seeking income. We find it possibly more important than ever to find offerings with shorter maturities, strong cash flow, and solid fundamentals that possibly are improperly rated, allowing clients to obtain a current yield often much higher than most fixed income alternatives.
We continue to seek out foreign debt that could help investors diversify their fixed income holdings.
Disclosure: I am long NFLX, FTO, DVA, BTH, GE, TOT.
Additional disclosure: Durig Capital's clients are long the bonds mentioned in the article.