Shift Happens: 'New' Paradigms, And Three Yield Ideas for the Week

Includes: KCAP, KVR, PL
by: Yieldpig
The other day I saw a chart published by permabear value-guy Jeremy Grantham titled “The Great Paradigm Shift”. The chart tracks the rise and fall of commodity prices since World War One. Apparently, commodity prices have been in a multi-decade decline and have now turned painfully upward for the next who knows how many decades. I don’t buy it.

In my experience, and being a student of history, whenever a large group of smart people loudly proclaim a new, permanent paradigm has emerged, it typically hasn’t. The rise of computing and the Internet was hailed as a paradigm shift and it was to some extent. However, while that technology changed how we do stuff it didn’t change the stuff we do. We still communicate with each other. We still buy and sell things. We just go about it a lot differently.

Now, it appears that commodity prices: food, precious metals, energy, are all going to be much higher permanently. “We’re running out of food!” the headlines scream. “We’re not farming like we used to!”. Um…I live in the South. I can drive thirty minutes in just about any direction and see cows and rows of crops. Newsflash folks: there’s plenty of farmland. We can make more.

Humans, even going back to when we drew on cave walls since we didn’t have TiVo, have always, always adapted to food scarcity. Sure, sometimes we jack up the price or conserve or ration or form angry mobs in order to overthrow a corrupt monarchy. But most of the time, we just make more. And usually, it ends up being more than we need at the time.

Are food commodity prices rising? Duh. Will they go up forever? Again, duh. For argument sake, let’s say wheat goes away. It’s too expensive or is blighted out somehow. What would happen? Potato flour. Rice flour. Rye. Barley.
What if those weren’t available? Yeah…I know and if my aunt had… get the picture. Click to enlarge:

Yes. Commodity prices are high. They may go higher. But they’re gonna come down sooner than later. A “New Paradigm” has been declared by the smart people complete with charts. Look at the spike where they wrote “Great Paradigm Shift”. Prepare for bargains at the Food King.

Well…let’s shift over here and meet this week’s three lil’ piggies…

“Hit rewind…again…”

Kohlberg Capital Corp (NASDAQ:KCAP)
Recent Price: 7.40
Current Yield: 9.31%

The Skinny
We talked about business development company KCAP quite a while back. We decided to revisit and take another looksee. At the time of our first discussion, KCAP was having a couple of problems. Mainly with their lenders and auditors. That mess seems to be straightened out and everything seems fairly hunky dory. Numbers look OK. Q4 earnings were a little better than expected thanks to some higher earning assets and some asset sales. They paid down some debt in one area which improved credit quality and did a convertible bond offering that raised some cash which will be used for new investment. Shares trade a bit below a book value of $8.21. Interesting looking value and yield for an improved story.

The Danger
The convertible bond offering raised some investment capital for KCAP. However, the interest is a bit high at 8.75%. BDC’s make money sort of like banks: on the spread. Even at the higher rates they typically charge borrowers, KCAP’s high rate will put some pressure on their moneymaking ability. Also, the company lost some ground during the workout. Wrangling with your creditors and firing your auditor can take your eye off of the ball. Lastly, KCAP’s portfolio has shrunk some which can also put pressure on the BDC business as well.

“The power of imagination…AND yield!”

CORTS TR General Electric Capital 6% Pfd (NYSE:KVR)
Recent Price: 24.98
Current Yield: 6.01%

The Skinny
If you were coordinated enough to buy GE bonds at a deep discount during the
Panic of 2008, you’ve got a tidy profit on your hands. If your bond is trading at
108 or 109, keep in mind that at the end of the day it’s only worth 100. A swap
Into KVR might make some sense. Same GE credit quality (AA+/AA2) and you’ll
probably pick up 50 to 100 bps in yield. Keep your limit order tight and you may
pick it up at a slight discount.

The Danger
KVR is a hybrid preferred composed of a trust holding a particular GE bond and
then busted up into smaller parts. The stated maturity date is 3/15/32. Long time
from now. It’s also callable at anytime at its par price of $25 per share. So, the
risk of buying KVR right at about par and then having it called away quickly is
fairly healthy. Don’t get too attached. Also remember that GE Capital is GE’s
financial arm. Not immune from turmoil during any future (most likely) financial

“Do you have protection?”

Protective Life Corp. (NYSE:PL)
Recent Price: 26.52
P/E: 8.99
Current Yield: 2.09%

The Skinny
When I started working on this week’s post, I had originally intended to profile Protective’s preferred shares PL-PB. Naturally, we do work on the issuer itself and, as I looked closer at the numbers, I kind of liked the common stock better. Granted, the yield at barely 2% is somewhat paltry. But the valuations are what
grabbed me. Shares trade with a single digit P/E and just 0.86 times book value. I like that kind of value. Earnings have improved a bit thanks to increased annuity sales (Have you tried to open a checking account at a bank lately? If you drive by a branch with your window open, they’ll throw an annuity in your car). Mortgages in the PL’s investment portfolio are improving as well with delinquencies falling 66% quarter over quarter. The company still has some work to do, but for the deep value buyer who can wait, a pleasant surprise may be had whether through turnaround or acquisition.

The Danger
Although earnings improved, Q4 was still a disappointment. Higher mortality expenses have also put the pressure on margins. And, being an insurance company with a lot of cash to put to work in 2005-2007, PL has it’s fair share of crappy commercial real estate on the books. Gonna take a while for that stuff to shake loose. If you’re sort of interested but don’t have the time, patience or you don’t like 2.09% dividend, then check out the preferred which trades a small discount to par. The yield’s better, but keep in mind the upside is very limited.
Disclosures: None