6.2% Century Aluminum Bonds Worth A Closer Look

Nov.22.11 | About: Century Aluminum (CENX)

We have developed a process to screen, review, select, purchase and monitor high yielding corporate bonds. Each week we screen thousands of corporate bond listings to find what we believe to currently be the best corporate bond for investors needing or seeking higher yields with the least amount of risk as possible relative to its projected return. The following is our review process, along with supporting documents, showing why we believe this high yield short 6.218% bond with only 20 months to call for Century Aluminum (CENX) passes the criteria for our clients.

Step 1 - Assessing the Yield Curve

While the M1 money supply is currently growing at over 20% year over year, and the Consumer Price Index moving up to 3.9%, our screening has revealed to us the highest 3 yr CD rates for 3 years is about 1.6 % percent. This is woefully below what is needed to keep pace with the officially stated inflation rate. The math tells us that CD savers are actually losing about 2.3% per year in buying power, before taxes. Factoring in compounding, CD savers would lose about $215.62 of buying power per year on a $10,000 dollar CD in one year at these current rates. Taxes are dues on the mystical gains, so in reality the after tax loss of buying power would be even greater. When this is multiplied over several years, it’s no wonder that so many savers are now angry at the banks. Perhaps this anger would be better directed towards the FED, whose flamboyant money printing while simultaneously pressing short term interest rates to record lows has resulted in a toxic combination for accruing wealth.

Step 2 - A look at the issuer

Century Aluminum Company produces primary aluminum in the United States, Iceland, and internationally. The company offers molten aluminum, as well as standard-grade ingot, extrusion billet, and other value-added primary aluminum products. It also holds a 40% joint venture interest in a carbon anode and cathode facility located in China. The company was founded in 1981 and is based in Monterrey, California.

Step 3 - We like companies that are profitable

Century Aluminum Company reported Third quarter 2011 net loss of $6.6 million ($0.07 loss per basic and diluted share), which was positively affected by mark to market contract gains. Net income for the first 9 months of 2011 was reported at $42.4 million. During the last 3 quarters they made several large strides towards improving their balance sheet by paying down debt, reducing pension costs, and had plant curtailment costs of around 91 million dollars, which significantly realigned their balance sheet. Industry giant Alcoa (NYSE:AA) continues to project that aluminum demand will grow 12% in 2011 versus 13% growth in 2010, well ahead of the 6.5% compound annual growth rate needed to double aluminum demand by 2020.

Step 4 - Interest Coverage Ratios

Century Aluminum Company provided $42 million in operations income for the last nine months. They owed about $25.2 million during the same time period in interest expense on the debt, and when annualized, show Century’s income coverage for it was just under 1.66 times. Knowing that the last few quarter were influence by many factors, we reviewed the previous calendar years numbers and found 4 times coverage. After this quarter’s loss, and considering the economy last year, this is a number than we would like to see improved.

Step 5 - We like companies with lower debt to cash ratio

Century reported long term debt at $ 256 million. Cash and short term is about $216 million. Long term debt is more than cash on hand, meaning that while they would be able pay off most to the debt, they would still be short about $40 million were an unforeseen event to occur. Considering that they had net income in calendar 2010 of $102 million and $42 million in the last nine months, the debt level appears quite manageable. One should take special notice here about the $144 in accrued retirement and post retirement benefits not funded. This should be looked at from both a balance sheet perspective, and from the union protesting and liability issues from past operations.

Step 6 - We like companies that have flexible balance sheets

Century Aluminum currently has a market capitalization of $992 million, while long term debt is around $256 million. A debt to equity ratio of around .25 is a very low number. For example, if they were a home valued at $ 100,000, they would only owe about $ 25,000 to the banks. There is a second issue of 15% owed to retirement related issues, which leaves them with about 40% of the total value. Banks often loan up to 75% of the value, and if the company needed additional funding they could issue new stock (although this would be quite dilute to current shareholders.) Based on previous quarter’s results, they have made strong inroads into these issues.

Century owns the Hawesville and Ravenswood properties, and a 49.7% undivided interest in the property on which the Mt. Holly facility is located. We could not get a value on these 2 ½ properties, but we are seeing Rio Tinto (NYSE:RIO) put 13 aluminum facilities for sale at the asking price of $7.5 billion. While the above sales prices may not be close due to capacity, size, electrical contracts, workers salaries, etc., it does show the closest comparable assets we could identify. While the current price/book value is shown at .85, we think that merely subtracting depreciation from the historical purchase price of their properties might greatly understate the current market value of these assets. Judged buy the above Rio Tinto valuations, it appears the value of Aluminum plants have been gaining in value well above historic book value.

Step 7 - We like high yields

This issue of Century Aluminum currently has a 6.218% yield to worst call in the 5th month 2013, while corresponding U.S. Treasuries yield only .24%. Although the credit ratings are widely different, we believe this large 5.88% spread between the yields is extremely high given the risks that we can identify. If this bond is held to normal maturity May 2014, the yield would be an even higher 6.89%. We currently are finding 5 year loan rates with banks well below these rates, and thus, we believe the probability is high that these bonds will be called in the earlier time period of May of 2013.

Step 8 - Risks Considerations

Century Aluminum's unfunded liabilities are our biggest concern, but their proactive approach, along with the rally in the investment market and slight glimpses of a better US economy, could significantly benefit them.

Even though Century Aluminum provides very specialize Aluminum products and services, they are still in a commodity based industry, which is known for large cyclical changes in prices. However, they have been well managed through this last downturn and were even able to significantly reduce their balance sheet. The price of the metal has been moving higher since 2008 but has been dropping in the last few months. “Of all industrial metals, aluminum will have the biggest annual increase in demand through 2015 as the surplus supply turns to a shortage”, according to researcher CRU.

Greece, Europe and China could all effect global aluminum prices, and have over the last several months. However, we believe the U.S. economy has shown some resilience and would have more of a direct effect on the majority of their operations. We also believe that these Century bonds have similar to slightly higher risks, a similar maturity, and similarly high yield that the bonds reviewed in Tutor Perini building with highway and infrastructure bonds and American Railcar 2014 Bond.

One should be mindful of the spread indicated between bids and ask on these bonds, as this appears to be one of the widest we have seen. We recommend contacting a professional to assist buying inside the offer, if possible.

Summary and Conclusion

This is a strong yield, especially when considering the short 20 month call possibility, the cash holdings at 84% of its debt, and its large real estate holdings, which in and of itself might be enough collateral to merit restructuring all their outstanding debt into a new, lower cost loan. Although Century Aluminum bonds are rated a single B, we believe they are a savvy risk offering a significantly higher yield from a company that has a good cash position, solid interest coverage, and possibly a more flexible balance sheet than what it first appears as.

  • CUSIP: 156431AJ7
  • Coupon: 8.00
  • Ratings: B
  • Maturity: 5/15/2014
  • Price: 102.5
  • Yield to Maturity: 6.89 %
  • Yield to Worst, 5/15/2013 Call: 6.218%

Disclosure: Durig Capital and certain clients may currently have a position in Century Aluminum bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.