This is potentially a great strategy to lock in better than average rates of returns without having to deal with the wild swings of the market. We will use the Edison mission energy bonds that expire on 06/15/2016 as an example, but first let’s look at the whole company in a bit more detail.
Edison Mission Energy is a subsidiary of Edison International (NYSE:EIX). Edison International, which is based in California, was founded in 1886, so they have been around for awhile and should be here for many years and decades to come.
It has interests in 45 power plants, one of which is located in Turkey. Its 45 power plants have an aggregate generating capacity of 11,247 megawatts of which EME (Edison Mission Energy) share is roughly 10.170 megawatts. It trades energy on the open market and sells power via contracts with large utilities and distributors. As of December 31, 2009, the company served approximately 400 cities and a population of approximately 13 million people.
Approximately 73% of the company's power was generated by coal plants, 15% by natural gas, and 12% by wind energy. As of Nov 2010, it had 29 projects in various stages of completion in its wind portfolio, with a projected capacity of roughly 3,700MW.
EIX as of the 1st of Sept has a market cap of 12.02 billion. It has a trailing P/E of 11.53 and a forward P/E of 13.98. It ha 945 million in cash which works out to $2.90 a share; revenue is growing at a quarterly rate of 8.08% (Y-O-Y). Revenue for the year came in at $12.62 billion, or $38.72 per share. Institutions own a healthy 77.8% of the float which serves as a strong vote of support for the company. It also suggests that they have to be bullish on EIX's long term prospects; otherwise they would not be so heavily invested in it. The company also pays out a yearly dividend of roughly 3.4%; the average yield for the past 5 years was 3.01%.
Here is some pertinent information in regards to this bond.
Payment Schedule SEMI-ANNUALLY
Maturity Date 06/15/2016
Moody's Rating CAA1
The bond is selling below par. It is currently selling for $750, the coupon is 7.75%. So you are paying $750 for a bond that will have a face value of 1000 in June of 2016. The holding period is just 2 months shy of 5 years. Every year you will receive a payment of $77.50 (paid semi annually). As you paid only $750 for this bond your rate will actually be 10.33% instead of 7.75%, which is not too shabby considering that most banks are paying next to nothing for your money.
So for roughly the next 5 years you will collect $77.50 a year, which works out to $387.50. But that is not all; at maturity you will receive 1000 so you will collect another $250 in profit. Thus, in total you will have earned 637.50 for a total gain of 85%. Or put in another way, it works out to annual gain of 17% a year. If you sell earlier your annual gain could be much higher. Investment grade bonds historically have roughly above a 90% guaranteed rate of paying you on time.
There are many such bonds out in the market; one simply has to do some due diligence and one can potentially find other such lucrative deals. One thing to remember though is that no matter how good the investment looks, one should never ever put all of one’s eggs in one basket.
The company generates a healthy $12.62 billion a year in revenues with a gross profit of $3.7 billion. It pays a yearly divided of roughly 3.4% and has never missed a payment since 1910 except for 3 years in the early 2000’s due to the energy crisis in California; the ability not to miss a payment for roughly 100 years is a strong vote of confidence.
Given the above facts, it seems unlikely that it would default on its bond payment. In the unlikely event the health of EIX deteriorates, its subsidiaries could be sold off, leaving this debt to be serviced by the power plants such as Edison Mission Energy.
Please note that this is just a suggestion and we recommend that you do your due diligence. In fact, regardless of the investment, individuals should always do their due diligence before taking a position.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.