The high-yield corporate bond market has performed quite strongly since late November. In fact, as I noted in "High-Yield Holding Up Amid Stock Market Sell-Off," in recent days, it's even been able to show an unusual amount of strength in the face of a weak stock market with advancers outpacing decliners during the May 3 and May 4 two-day sell-off. Not surprisingly, the strength of the market's internals is showing up in the three popular high-yield corporate bond ETFs. Since the recent equity market sell-off began on May 3, PowerShares' Fundamental High Yield Corporate Bond Portfolio, symbol PHB, is actually trading higher. Two other well known high-yield bond ETFs, HYG and JNK, are down only fractionally since their May 2 closing prices.
With that said, until investors are able to sort out whether the equity indices or the high-yield corporate bond market is correct in its recent assessment of financial conditions, I prefer to focus my efforts on finding individual bonds that have sold off for company or industry specific reasons and to assess whether I view the credit risk to those bonds as acceptable at current prices.
In general, my preference is to stay away from bonds rated below B3/B- by Moody's and S&P respectively. And, in recent weeks, I've been finding it increasingly more difficult to find bonds rated B3/B- or higher trading at prices that really excite me. However, there are three that I find noteworthy about which I would like to share some of the details.
Chesapeake Energy's (NYSE:CHK) senior unsecured note (CUSIP: 165167BU0) maturing 11/15/2020 has a 6.875% coupon and is asking 98.375 cents on the dollar (7.133% yield-to-maturity before commissions). It has a make whole call and pays interest semi-annually. Moody's currently rates the note Ba3; S&P rates it BB.
Alpha Natural Resources' (ANR) senior unsecured note (CUSIP: 02076XAC6) maturing 6/1/2021 has a 6.25% coupon and is asking 94.85 cents on the dollar (7.028% yield-to-maturity before commissions). It pays interest semi-annually and has the following call schedule: make whole and an equity call at 106.25 until 6/1/2016, callable at 103.125 beginning 6/1/2016, callable at 102.083 beginning 6/1/2017, callable at 101.042 beginning 6/1/2018, and callable at 100 beginning 6/1/2019. Moody's currently rates the note Ba3; S&P rates it BB.
Nokia's (NYSE:NOK) senior unsecured note (CUSIP: 654902AC9) maturing 5/15/2039 has a 6.625% coupon and is asking 81.00 cents on the dollar (8.418% yield-to-maturity before commissions). It has a make whole call and pays interest semi-annually. Moody's currently rates the note Baa3; S&P rates it BB+.
Regarding the Nokia corporate bond, I recently wrote an article discussing a long bond, long stock, short call option strategy investors interested in Nokia might consider rather than simply buying the stock outright. Should you use the same type of strategy on Chesapeake Energy and Alpha Natural Resources? I wouldn't.
With regard to Chesapeake Energy, I'd like to see the company work through some of the nonsense involving the CEO before taking a position in the equity. I'm a big fan of selling puts on equities in lieu of outright buying the stocks. But in the case of Chesapeake, I'm still not at the point where I'm comfortable even thinking about selling puts.
Alpha Natural Resources is a bit of a different story. If the company paid a reasonable dividend, I'd consider presenting a strategy similar to that which I presented about Nokia in the aforementioned article. However, since the company doesn't pay a dividend, a long bond, short put position would be an alternative for the income oriented investor who also wants a bit of exposure to the equity.
Here is an example of what I am referring to: Purchase the 7.028% yield-to-maturity Alpha Natural bond mentioned above with 50% of your investment. Sell the January 19, 2013 $12 puts at the current bid of $1.78 using the other 50% of your investment. By doing this, you will have created a position that will bring in 10.71% over the next twelve months assuming you don't sell any more puts after January expiration, or if you are assigned the stock, assuming that you don't sell any covered calls.
To calculate the 10.71% in income you would do the following:
Long bond position: One bond equals $1,000. Interest per bond equals $62.50 (6.25% coupon). The bond is currently asking 94.85 cents on the dollar. Therefore, you get $62.50 of interest per $948.50 invested (ex-commission). The current yield equals 6.59% ($62.50 divided $948.50). Since the bond position equals 50% of the total investment, divide 6.59% by two. Answer: 3.295%.
Short put position: $1.78 put premium divided by the $12 strike price equals 14.83%. Since the put position equals 50% of the total investment, divide 14.83% by two. Answer: 7.415%.
Add 3.295% and 7.415% to get the total income payable on the entire position, 10.71%.
Regarding each of these bonds, I would like to note that despite selling off for company/industry specific reasons, if the high-yield market in general were to sell-off, it is possible and perhaps even likely that each of these notes would sell-off further as well.
Please be aware that prices in the over-the-counter U.S. bond market may vary depending on the broker you use. I discuss this in my article, "Are You Paying Too Much For Your Bonds?" The current prices may also differ greatly from those listed at the time this article was written. For more information on any of these notes, including additional call or put features, please contact your broker or read the indenture.
Also, please do your own due diligence on the financial profiles of the companies mentioned in this article. Only you can determine if taking the counterparty risk of purchasing individual bonds is suitable for you.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long CUSIPS 165167BU0 and 02076XAC6.