The market is continuing its march upward and many are wondering when the music will stop. The economy looks very good right now. In fact, many of the economic and employment metrics are better than ever, so I am not concerned about the immediate future. For the most part, I am a long-term investor as long as I own financially safe securities that pay reliable and sustainable distributions. In other words, I prefer to hold the majority of my investments in good and bad times.
That is easier said than done, but there are two things that allow me to become a long-term investor. One of the big factors is knowledge. The more I know about a company I own, the better off I am. It is comforting to see historical records and metrics. The second factor is that I am an income investor. I get paid regardless of the price of the security I own. There is nothing better than being able to get paid and to then re-invest back into the market to increase my income.
I try to build my portfolio on a strong foundation. That may mean investing in lower risk securities with lower yields. One such asset class that is available are exchange traded debt securities (ETD). Many investors simply call them baby bonds as they are similar to preferred stocks in that they have a par value of $25 and can be easily purchased through your online broker program. However, unlike preferred stocks, they are debts and pay out interest instead of dividends. The interest is ordinary income. Since they are a debt, they are in theory safer than preferred stocks and common stocks. They are great for individuals looking for safety and income. Appreciation is not normally a factor unless you buy during periods when the price has dropped below par. One negative is that prices may drop during market drops or when interest rates rise high enough to cause yields to increase.
I track all baby bonds in the market through my website and database at: I Prefer Income. There are currently 172 ETD in the market with an average yield of 6.42%. Of the 172 ETD, 83 are rated investment grade by Moody’s or S&P. In this article, I will be highlighting 13 baby bonds from 7 parent companies. These 13 are currently among the highest yielding baby bonds in the market with prices below 25.25. I will be providing an overall review of these companies by using the Where’s the Metrics analysis system that uses 5 main metrics to help determine the overall financial health of the parent company and their ability to pay a reliable and sustainable distribution.
The purpose of this general review is not to give recommendations; but rather, to detail how I analyze a company and to show areas of strength and weaknesses from each company. From this review, each person will have a better understanding of the company and able to make their own investment decisions.
The 5 metrics that are used to analyze these securities are listed below:
- Payout ratios
- Debt Ratios
- Credit Ratings
- Dividend Metrics
General review of all 7 companies in the table
The table below contains the seven parent companies located in the gray rows. Directly under the parent company are their baby bonds. There are 28 columns of information, to include general info and financial metrics that I will use to obtain a better idea of each of the company’s overall financial health and ability to pay a reliable and sustainable distribution. Each of the five areas of metrics are displayed below within the red rectangles.
(Click on image to enlarge)
The table contains 13 ETD securities with an average yield of 6.93%. The seven parent companies are from diverse industries, including a mortgage REIT, two telecoms, a business develop company, a business equipment company, a financial company and a specialty retail company. Coupon rates range from 5.875% to 8% and yields from 6.2% to 7.9%. Most are priced near the top of the 52-week high price and substantially up from the 52-week low price. This indicates that most have risen from much lower prices. Eight are below par, with prices as low as $22.89.
When doing a general review, I am comparing the metrics of the parent company in all areas except rankings. My goal is to get a better idea of the overall health of the parent because they are responsible for maintaining and paying the distributions on the baby bonds. However, since the baby bond is a debt, it is more secure than the preferred dividend and the common stock dividend – if there is one.
Earnings: I have placed a blue rectangle around each of five areas for review. The first area for review is earnings. The two columns display five years and also five quarters of GAAP earnings from the parent company. There is only one company (PBI) that has a perfect record of five years and five quarters of profits. There are other companies that come close. (TDS) has four years of profits and four quarters of profits. (CTL) has four years and four quarters of profits. The worst record is from (AI). It has a record of two years of profits and only one quarter of profits.
One thing to note is that these two columns only show GAAP earnings. All companies report GAAP earnings, but three also report Non-GAAP earnings. You can tell if the company reports Non-GAAP earnings from what is reported in column 3 (Type Payout). Companies that only report GAAP earnings show EPS in column 3. The other designations are Non-GAAP earnings. The bottom line for GAAP or Non-GAAP earnings is to determine if they are earning enough to cover the dividend. The next table below shows the comparison between GAAP and Non-GAAP earnings from the three companies. The top row shows EPS and the second row shows the Non-GAAP earnings for years and quarters.
When you compare the two, you can see that Non-GAAP earnings are substantially better than GAAP earnings.
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Parent Company Symbol
GAAP and NON-GAAP Earnings
(Table 2 courtesy of I Prefer Income)
Payout ratios: The second area for review is payout ratios, including stock dividend payout ratio, preferred stock dividend ratio, and preferred dividends or interest expense to operating cash flow payout ratio. Remember that preferred stock dividends cannot be stopped or delayed until the company is in serious financial condition and it has completely stopped paying their common stock dividend. That is a hurdle that we want to pay attention to. Also remember that a score under 1 means that the company is earning enough in earnings to cover the dividend. A score over 1 means that they are not covering the dividend.
All companies in the stock dividend payout column show scores under 1, except for CTL and TA. TA doesn’t pay a common stock dividend and CTL took a very large impairment charge in the 4th quarter that destroyed their TTM earnings and payout score. Please remember that it is important to have as low a payout ratio as possible.
The second payout ratio we use is the preferred stock dividend payout ratio. This will tell us if the company is able to cover their preferred stock dividend. Again, a score of under 1 shows they are covering the dividend; however, we really want the score to be much lower. You will note that five of the seven companies show ETD instead of a score. This means that they do not have a preferred stock so there are no scores.
The third payout ratio is the distribution to operating cash flow payout. This shows if the interest expense payments are covered by operating cash flow.
Debt: The third rectangle shows three debt ratios of interest coverage, debt-to-EBITDA and debt-to-equity. We want the interest coverage ratio to be over 1 and the other 2 debt ratios to be as small as possible. Each industry is different, but in general, it is best to see a score of under 4 or 5 with debt to equity. I should also point out that many financial companies do not have interest coverage scores because of the nature of their business. They report interest differently than other companies. In this table, there are two that do not have interest coverage scores.
Credit Ratings: The credit ratings located in the fourth rectangle are mixed. Five of the 13 baby bonds do not have a rating and six are rated investment grade. The other two are non-investment grade. Remember that these ratings are on the baby bonds, not on the parent.
Dividend metrics: The fifth area contains several dividend related fields of information that are important. The first thing to note is that all parent companies pay a common stock dividend except for TA. I looked back and do not see that they have ever paid a dividend. Remember that the company cannot stop or delay the preferred stock dividends unless the common dividend is stopped first. Since we are reviewing ETD, this logic is somewhat the same, except that ETDs are even safer than preferreds since baby bonds are a debt and preferreds are equity. Companies pay debts before dividends.
Other dividend metrics I use is to compare the 10-year median yield with the current yield to see if the spread is wide enough to provide insight into current market sentiment. Next is the three-year average yearly dividend growth rate. This shows that four of the seven parent companies have reduced their dividend over the last few years. There is only one that has raised the dividend and one with no change.
The last dividend metric we use are the companies that are designated as dividend diamonds. These are companies that have increased their dividend every year for five or more years. TDS is the only company to be designated as a dividend diamond. They have increased their dividend 45 years in a row!
In summary, the review of the seven companies and 13 ETD shows a diverse set of companies in several diverse industries. The results from using the Where’s the Metrics analysis system are mixed, but I do see reasons to be encouraged. I will now dig a little deeper by reviewing each company.
Review of each parent company
Arlington Asset Investment Corp (AI) is a mortgage REIT company that invests mainly in mortgage-related assets that are generally issued or backed by the U.S. government. They have 2 baby bonds with prices below par and yields at 6.7 and 7%. Both call dates are in the past. Non-GAAP earnings look good compared to GAAP and are enough give good payout ratios. Debt ratios are mixed, but debt-to-equity is good. Credit ratings are NF/NF, but our analysis gives us the ability to do our own rating.
The dividend metrics does bring up reasons for concern as the 10-year median yield is 15.3% and the current yield is now over 19%. In addition, the 3-year average yearly dividend growth is -13.5%. And finally, there is the 52-week high and low prices. In spite of the economy and the market doing very well, the parent company’s stock price is down 34.7% from its 52-week high. It would appear that the company does have some issues and the price is reflecting that concern. I note that the company did cut its quarterly dividend from .55 to .38 in the second quarter of 2018 and the Non-GAAP earnings appear to cover their common stock dividends and the two preferred stocks they have issued.
CenturyLink Inc. (CTL) is one of the large U.S. telecom companies with interests in legacy and wireless phone service and in internet and cloud connectivity for residential and business. There have been numerous discussions about their recent merger and how they are faring in the huge change to digital telecom and cloud services. CTL has 4 baby bonds in this group with yields up to 7.1% and prices as low as $22.89. All call dates are in the past. Earnings show four years and 4 quarters of profits. The loss came in the fourth quarter of 2018 when they had a large impairment charge that not only destroyed the fourth quarter earnings but also the whole year. If you take out the impairment charge, they would have had a quarterly profit of .38.
And because of that impairment charge, it caused CTL to have a negative stock dividend payout ratio. However, the dividend-to-operating cash flow payout looks good.
Debt ratios are mixed with debt-to-EBITDA being a little high. Jeff Storey, the CEO, addressed this subject in the 2018 4th quarter earnings report by stating: “strong business fundamentals allow us to make the important decision to lower our leverage target to 2.75x to 3.25x Net Debt to Adjusted EBITDA and accelerate our timeframe to reach that target”. CTL also has an S&P investment grade credit rating of BBB- on all 4 baby bonds.
CTL made the decision to cut their common stock dividend from .54 to .25 in the 4th quarter of 2019. This gave them a negative dividend growth score. However, the lower dividend will help them achieve a positive payout ratio if they can regain their footing and return to their traditional earnings record.
Pitney Bowes Inc (PBI) is the company that many people remember them as the company that sold postal meters and other similar type machines. As the world of postal mail has changed, they have evolved into company that now provides a multitude of products and services, including shipping, mailing, location, etc. The change to new products and services has been a challenge with many important financial metrics dropping over the years. PBI has 1 baby bond that is priced at $23.26 and a yield of 7.2%. PBI has the best record for GAAP earnings with 5 years and 5 quarters of profits. They also have an excellent record for all 3 payout scores, coming in with the lowest and best records of all 9 companies in this group.
The debt ratios are a different story. The interest coverage ratio is fine, but debt-to-EBITDA and debt-to-equity being a little high. In addition, the credit ratings are below investment grade
The final metric is dividends. The company maintained a quarterly common stock dividend of .188 for several years, but in February of 2019, they reduced it to .05. In their 2018 4th quarter report, the president and CEO advising that “today, roughly half of Pitney Bowes revenue is coming from growth markets. Importantly, PBI is winning in those markets and growing revenue . . . Consequently, there are opportunities available for Pitney Bowes to create value for our shareholders and continue to grow. Therefore, it is appropriate for the Company’s capital allocation to evolve.” The result of that dividend cut is a negative dividend growth rate and also the market price to drop to where it is now 42% below the 52-week high.
Prospect Capital Corp (PSEC) is another business development company focusing on loans to the middle market companies. Over 85% of their loans are secured by either first or second lien rights. PSEC has 3 baby bonds in this table with prices just above $25 and yields from 6.2% to 6.8%. They have a good GAAP and Non-GAAP earnings record and a good stock dividend payout ratio. The debt-to-equity ratio is also good. In addition, all three credit ratings are investment grade.
The one negative metric is in dividends. They report a negative dividend growth rate. They went from paying $1.00 annually in 2016 to .72 per annum in September of 2017. They have maintained paying .06 per month since then.
B. Riley Financial, Inc (RILY) provides a lot of different services, including investment banking, wealth and asset management, commercial lending and owning and acquiring businesses that provide cash flow opportunities. They were recently in the news for acquiring MagicJack, a company that provides internet phone products and services. RILY has 5 ETD, but only two that meet the criteria for this article. Both are under par with yields of 7.3% and 7.5%. They have a fair GAAP earnings record but an even better Non-GAAP record (see table 2 for a comparison). The good earnings record results in having an excellent dividend payout ratio of .22, the second lowest in the group of seven companies.
The debt ratios look good, but the credit ratings on the two ETDs are NF/NF. The dividend metrics are stable. Since going public, they have kept the dividend at .08 per quarter, although they do issue special dividends every year. In fact, they recently announced another special dividend of .18 that is payable on May 29.
TravelCenters of America LLC (TA) operates gas stations with restaurants across the United States. These are set up to service the trucking industry and regular motorists. TA has three baby bonds, but only one that meets the criteria for this article. It is priced at $25.17 and a yield of 7.9%, the highest of all baby bonds in this article. Their earnings record is poor with the last five quarters showing all losses. I do not show that they have ever paid a dividend so there is not a stock dividend payout score. And since they have only issued ETDs, they do not have a preferred dividend payout score. However, their debt expense to operating cash flow is a respectable .26.
The debt ratios are mixed. Credit rating is NF / NF. The final metric is dividends and since they do not pay a common stock dividend, there are no scores.
Most of TA’s metrics are coming in on the negative side. This includes earnings, ratings and dividends. The positive includes a good expense to operating cash flow ratio and not bad debt ratios. The other thing to note is that price-to-book is very low and the price is close to the 52 week high. And finally, it should be noted that this is a baby bond, not their common stock. It is much more secure than either the common or preferred stock.
Telephone and Data Systems, Inc (TDS) is one of the large U.S. telecom companies providing telephone, wireless, internet, TV, cable and voice products and services. They have four baby bonds, but only one that meets the criteria of this article. It is priced at $23.36 and a yield of 6.3%. Their earnings record is good with four out of five years of profits and five quarters of profits. These earnings result in excellent common stock dividend payout ratio of .54 and a low expense to operating cash flow ratio. Their debt ratios are good, but the credit rating on the baby bond are non-investment grade.
The final metric for review is dividends. They pay a dividend and have a 3-year dividend growth rate of 2.2%. However, the one metric that really stands out is that they are designated as a dividend diamond. These are companies that have increased their dividend five or more years in a row. TDS stands out because they have increased their dividend 45 years in a row!
The purpose of this article is to introduce some of the highest yielding baby bonds that are currently available in the marketplace. This allows investors a chance to see what baby bonds are available and to provide a general review using the Where’s the Metrics analysis system that analyzes earnings, payout ratios, debt ratios, credit ratings and dividend metrics. This review included seven companies with 13 baby bonds. The seven companies are from several industries with a very diverse set of financial metrics. The average yield for the 13 baby bonds is 6.8%. The lowest yield is 6.3% and the highest yield is 7.9%.
Exchange traded debts (ETD) are also called baby bonds because they are a debt instrument and pay interest rather than dividends. They are generally safer than common stock dividends and preferred stock dividends because they are debts and are higher up the ladder if it ever comes to liquidation.
All of the seven companies have positive metrics and many have one or more negative metrics that could be of concern to a potential investor. The review does point out these specific areas and give a solid foundation for further review. TA was the hardest to review with several negative metrics. TDS appeared to have the most positive metrics, including the fact that they were designated a dividend diamond with 45 years of consecutive dividend increases. This explains why TA has the highest yield and TDS at the low end of yields.
For those that are somewhat disappointed with the overall metric results uncovered by this review, remember that the securities are baby bonds, not common stock. They might deserve a higher rating just by being safer. Also remember that the yields are higher for a reason. I hope that this review has uncovered 1 or more baby bonds that are worth considering for an investment.
Thanks for reading.
Disclosure: I am/we are long CTBB, CTDD, PBC, TDE, TANNZ. 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.