High Yield Bonds: 'The Rally'

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Includes: AKS, AMD, AVP, BBEPQ, BTUUQ, CGG, CHK, CLF, CLMT, CRC, CRK, DNR, DPM, DVN, ESV, EXXIQ, GNW, HELIQ, HK, HYG, I, IHRT, JNK, LINEQ, LQD, MEMP, MPO, NAV, NGL, NM, OAS, PACD, PDS, RIG, SM, SN, SSE, TECK, TLN, UPLMQ, WLL, WPX, X, XCO
by: Eric Parnell, CFA

Summary

Are high yield bonds experiencing "the rally"?

Are companies seeming to be doing better when they actually are not?

A monthly return to the battlefield that is the high yield corporate bond space.

A phenomenon exists in the health field called "the rally." A terminally ill patient appears to be on the brink of passing. But suddenly, they become more lucid and responsive. They may even become eager to talk and have the renewed energy to get out of bed. A few have gone so far as to get back to regular living for a day or two. Unfortunately, for most, "the rally" ends up being a fleeting, confusing and often inexplicable event, as the patient often ends up passing almost immediately after. Recognizing this phenomenon may stretch beyond the physical realm, one has to wonder if "the rally" is currently taking place in segments of the high yield bond market.

With this in mind, we return once again to the high yield (NYSEARCA:HYG) hospital to check on our patients.

The Terminally Ill

In February, we had five companies that were effectively on the brink of expiration. Three remain in intensive care and are listed below, while one has been added to the list in BreitBurn (BBEP).

BreitBurn Energy Partners

Peabody Energy (BTU)

Seventy Seven Energy (NYSEMKT:SSE)

Ultra Petroleum (UPL)

What of the other two? Energy XXI (EXXI) delayed interest payments on the debt of one of its subsidiaries in March. In short, the defibrillator has now been drawn and the bonds have exited the index. As for the other, this terminal company and former Seeking Alpha favorite is apparently experiencing "the rally" and is back out roaming the halls. The name, of course, is Linn Energy (LINE).

Intensive Care

Last month, we had ten companies that were trading at a discount between 75% to 90% below par. In addition to BreitBurn being downgraded and Linn Energy showing signs of "the rally" and upgrading into the group as a result, SandRidge Energy (NYSE:SD) has left the building altogether after missing a debt payment in February and seeing their shares delisted along the way as it grasps for survival. This leaves us with the following five names below.

EXCO Resources (NYSE:XCO)

Halcon Resources (NYSE:HK)

Linn Energy

Memorial Production Partners (NASDAQ:MEMP)

A notable number of beds in intensive care are now empty, as a group of names have "rallied" their way out of the ward and back to the front lines.

The Front Line

In February, we had 16 publicly traded names on the front lines as defined by trading at a highly stressed 50% to 75% discount to their par value. Since that time, none of these names were shipped off to intensive care, and five have made their way back into the front line fight, at least for now.

California Resources (NYSEMKT:CRC)

CGG (NYSE:CGG)

CHC Group (HELIF)

Chesapeake Energy (NYSE:CHK)

Cliff Natural Resources (NYSE:CLF)

Comstock Resources (NYSE:CRK)

Denbury Resources (NYSE:DNR)

iHeart Media (OTCPK:IHRT)

Intelsat (NYSE:I)

Midstates Petroleum (NYSE:MPO)

Navios Maritime (NYSE:NM)

Pacific Drilling (NYSE:PACD)

Perhaps most notably, seven former front line fighters have made their way back to the second wave and have found some breathing room at least for the moment. An eighth name in Oasis Petroleum (NYSE:OAS) has improved its way off the lists altogether, although it stands on the brink of falling back into the second wave.

The Second Wave - High Yield Bonds

Last month, a sizeable list of 25 companies had debt that was trading at a 25% to 50% discount to par. But not only has this list shrunk substantially to just 17 names, eight of the names now in the group are those that have either returned from the front lines or made the jump from intensive care in the case of Genworth (NYSE:GNW).

Advanced Micro Devices (NYSE:AMD)

AK Steel (NYSE:AKS)

Avon Products (NYSE:AVP)

Calumet Specialty Products (NASDAQ:CLMT)

DCP Midstream Partners (NYSE:DPM)

Genworth Financial

Navistar International (NYSE:NAV)

NGL Energy Partners (NYSE:NGL)

Precision Drilling (NYSE:PDS)

Sanchez Energy (NYSE:SN)

SM Energy (NYSE:SM)

Talen Energy (NYSE:TLN)

Teck Resources (TCK)

Transocean (NYSE:RIG)

U.S. Steel (NYSE:X)

Whiting Petroleum (NYSE:WLL)

WPX Energy (NYSE:WPX)

What of the 17 names that were on the above lists last month but have since "rallied"? While these recent signs of improvement are promising and some companies were likely trading at unjustified discounts, we should not be so bold as to assume that all of these companies are completely out of the woods just yet. In fact, a good number continue to reside just outside of the second wave zone with debt that is trading just short of a 25% discount to par.

The Second Wave - Investment Grade Corporate Bonds

Lastly, we have also seen meaningful improvement among the more at risk investment grade bonds (NYSEARCA:LQD) in the mix as well. Last month, the list of companies in the investment grade corporate bond universe that were trading at a 25% to 50% discount to par had ballooned to 23. In the month since, all but a pair of companies have seen their bond prices rise out of this zone, although it should be noted once again that a good number continue to reside just above the 25% discount threshold.

Devon Energy (NYSE:DVN)

Ensco (NYSE:ESV)

Bottom Line

The past month has seen considerable improvement in the high yield corporate bond (NYSEARCA:JNK) space. While a number of names remain on the brink, many more have risen back out of the battle zone. This has been a promising development, but the question remains as to whether this is sustainable. For some, it almost certainly will be. But for others, we should not be surprised if they find themselves being shipped back out to the front lines when the next broader market pullback sets in.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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