The Top 10 Reasons To Speculate On This 18.0% Yielder

by: Richard Lejeune


XKE holds Toys R Us bonds and passes through the bond interest as dividends.

XKE is now trading at an 18% yield to maturity.

Toys R Us' operational results are improving.

A near-term debt refinancing may be a catalyst for XKE to trade higher.

Includes a comparison to the JCP and SHLD bond trust issues.

It has not been all fun and games for Toys R Us since it was acquired for $6.6 billion by KKR, Bain Capital and Vornado Realty back in 2005. Tough competition from Wal-Mart Stores (NYSE:WMT) and (NASDAQ:AMZN) hurt earnings. However, things are improving lately. Toys R Us reported strong results for the fiscal year ended 1/30/2016 and has become a growing global brand. The Toys R Us 2017 notes have rallied to 93 cents on the dollar as top investment banks have been retained for a refinancing. Conditions are ripe for the long awaited Toys R Us IPO.

XKE is a par $10 trust preferred issue. The trust holds the Toys R Us 9/1/2021 notes (CUSIP 892335AC4) and passes the bond interest through to shareholders as semi-annual dividends. At a recent price of $6.64, XKE is trading at an 18.0% yield to maturity (calculated from my Excel model). See prospectus for additional information. Here are 10 reasons that XKE has speculative potential:

1.Top tier investment banks have been retained

Bloomberg has reported that Bank of America, Goldman Sachs Group and Lazard are working to refinance the 8/15/2017 notes (CUSIP 892335AN0). The 10/15/2018 notes (CUSIP 89235AL4) could also be included in a near-term financing. While having heavy hitters working on a debt refinancing doesn't guarantee success, it certainly improves the odds. XKE would be expected to trade higher once the refinancing risk of these near-term maturities has been resolved.

2. Improving operational results

For the fiscal year ended on 1/30/2016, the company reported Adjusted EBIDTA of $800 million as compared to $642 million for the prior year. Total debt was $4.7 billion with cash and cash equivalents of $680 million. (Net debt) / (Adjusted EBIDTA) was a manageable 5X.

3. Strong liquidity

Liquidity is always an important consideration for debt holders. As of 1/30/2016, Toys R Us had excellent liquidity of $1.8 billion. From the Q4 earnings report:

"The Company, including Toys"R"Us-Delaware, Inc., ended the year with total liquidity of $1.8 billion, which was relatively consistent with last year. This was comprised of cash and cash equivalents of $680 million and availability under committed lines of credit of $1.1 billion."

4. Market conditions are favorable to refinance high yield debt

Recession fears that caused the February market sell-off have faded. The recent rally in the high yield debt markets has created ideal conditions for Toys R Us to refinance. The strength in the high bond market is illustrated by the 3 month chart of SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK).

5. Low gasoline prices

Low gasoline prices leave consumers with more cash left to spend on discretionary items such as toys. An improving economy and low gasoline prices could make for a very Merry Christmas.

6. Private ownership is a good thing

It's very comforting for debt holders when 100% of the equity is owned by patient and deep pocketed investors such as by KKR, Bain Capital and Vornado Realty. With operating results now improving, these private owners may be a source of additional capital. Perhaps additional equity capital will be injected to facilitate refinancing at a more favorable interest rate.

7. Debt holders could benefit from an IPO

Favorable equity capital markets and improving operational results have created ideal conditions for a Toys R Us IPO. An IPO would be the next logical step once refinancing risk has been eliminated. The same investment banks working on the refinancing would be likely to earn lucrative fees from participating in a Toys R Us IPO. This provides a powerful incentive to get the refinancing done. A successful IPO would deleverage the balance sheet. XKE would be likely to trade near par $10 in this favorable scenario.

8. Refinancing risk is low for XKE

XKE holds the 2021 notes and this is a tiny issue with only $22 million outstanding. If Toys R Us is able to successfully refinance the larger 2017 notes and 2018 notes, refinancing risk will be negligible for the 2021 notes.

9. Growing international sales

Toys R Us has become a global brand. The 995 international stores (including licensed locations) now outnumber the 866 US stores. For the fiscal year ended 1/30/2016, international same store sales growth was 3.2% as compared to a domestic same store sales decrease of 0.6%. The international sales growth was especially impressive given the negative impact from the strong U.S. dollar.

10. XKE is easier to trade than the bonds

Readers have reacted very positively to my recent articles on other exchange traded debt issues including PBB, COWNL and JMPC. Bond market bonds including the Toys R Us 2021 notes often have a large bid / ask spread. Bond trusts such as XKE are much easier for retail investors to trade. Unlike traditional bond market bonds, XKE is marginable with most brokerage firms.

Due to the relative ease of trading, it's not uncommon to see a bond trust trading at a premium. For example PFH is a par $25 bond trust that holds the J.C. Penney Company Inc. (NYSE:JCP) 2097 bonds (CUSIP 708160BL9). PFH now yield 10.0%, which is slightly less than the 10.2% yield for the 2097 bonds.

In some cases a bond trust can trade at a large discount to the underlying bond issues. SSRAP is a par $25 bond trust that holds the Sears Holdings Corporation (NASDAQ:SHLD) 2032 bonds (CUSIP 81240BK6). At a recent price of $10.95, SSRAP is trading at a yield to maturity of 19.2% (calculated from my Excel model). At a recent price of $66.15, the 2032 bonds are trading at a yield to maturity of just 11.7%. The SSRAP discount to the underlying Sears bonds is truly astounding and may be the subject of a future article.


My Panick Value Research Report is focused on high-yield preferred stocks and exchange-traded debt issues. XKE provides a great way to speculate on improving conditions at Toys R Us. The expected near-term refinancing of the 2017 notes could be a catalyst for XKE to trade higher. The successful refinancing of near-term debt maturities would facilitate a Toys R Us IPO. An IPO would deleverage the company, enabling XKE to trade near par $10. SSRAP may also be of speculative interest given the huge discount to the underlying SHLD bonds.

Disclosure: I am/we are long XKE,SSRAP,PFH.

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.