Stink Bid Baker Hughes Bond, CUSIP 05723KAE0 For Safe Yield And Capital Gains
- The bond is Money Good.
- Recent turmoil in oil futures has resulted in mispricing.
- Purchased at the right price, this bond yields alpha versus comparable investment grade bonds.
Buying bonds at distressed prices is a powerful strategy. The bargain price both boosts yield and allows for a terminal capital gain when the bond pays out at par. Today, I'm recommending the 15DEC2027 maturity 3.337 coupon Baker Hughes (NYSE: NASDAQ:BKR) bond trading as CUSIP 05723KAE0. As of this writing, it has a yield to maturity of 3.8%. I'll demonstrate how that can likely be boosted to 17.9% by waiting for the right entry price.
This bond recently (before COVID-19 rocked the markets) traded as high as 108.6. It has likewise recently traded as low as 71.3. Current price is around 96 but I expect multiple pullbacks to a price of 95 or below. That is going to be the target price to enter this trade. CUSIP 05723KAE0 and Baker Hughes have an "investment grade" rating from Standard and Poors (A-). That is the bond is very safe. I'll detail cash flows to demonstrate that in a moment. Even with a steep drop in revenues, the company is going to be cash flow positive and have interest coverage to ride out the economic shock.(source: FINRA)
Baker Hughes is a company transformed (DISCLOSURE: author was previously employed by Baker Hughes as a Financial Analyst supporting the SEC reporting effort). The company previously traded under the ticker BHI and was a takeover target by rival Halliburton. To persuade the government the deal would not be anti-competitive, BHI had to sell some assets, especially in the Gulf of Mexico. The assets that were sold were expensive to maintain and raised substantial cash, improving the company's balance sheet. The deal fell through and Halliburton had to pay BHI $3 billion cash for the break up fee.
Shortly thereafter, General Electric took an interest acquiring BHI. That deal went through and combined the company with GE's Oil and Gas division. The combined company had a broader scope and, importantly in the current low oil price environment had revenue that was less correlated to the rig count thanks to the "turbo-machinery" product line and "midstream services" product line. The old company had two product lines (Petrolite and Centrilift) that had low correlations to rig count and a third nascent effort in "specialty chemicals", mostly industrial paraffins that made the company less reliant on rig count.General Electric later lost interest in Oil and Gas as a core revenue driver and sold its holdings to below the majority holder level to raise cash. This left Baker Hughes with freedom from some adminstrative headaches associated with doing things the "GE way". Senior management is now composed of the best of the best from both companies and G&A expense has been pared down in a now more efficient company.
Revenue will decline with the oil prices at multi-decade lows. Baker Hughes has been here before and knows how to manage cash in a downturn. While revenue will be down, cost of sales will similarly decline as suppliers also feel the crunch. The company will certainly suspend all growth capex to conserve cash. I will show that the company has plenty of cash and borrowing capacity to pay off CUSIP 05723KAE0 at maturity without suspending the dividend.
First, I want to show that even if the company didn't have the cash flow to pay off its obligations it is well positioned to refinance debt. Most companies can easily refinance a bond at interest coverage of two time.
As you can see, even with substantially reduced revenue for 2020, interest coverage never falls below 6.3 times, the level at which it becomes expected that a company can refinance.
On the other hand, I project 5.9 billion in Free Cash Flow between now and the bond's maturity. After considering: 1) dividend obligations 2) interest obligations 3) other debt due before bond maturity 4) the outstanding bond amount and 5) line of credit available, the company has a comfortable margin to afford paying off our bond.
ACTION TO TAKE: Bid up to 95.0000 for CUSIP 05723KAE0. Exit the position when you can get 104 pricing. We will target year end to receive that price (the bond recently traded as high as 108). If you do not get 104 pricing, it is acceptable to hold this bond to maturity for safe yield in a low yield environment.
It is likely the bond will trade for this price or better in the near future. Getting 95 pricing is essential to earning a good return for your effort. Your discount is directly correlated to the level of capital gains you earn.
Holding the bond to maturity will result in a yield to maturity of 4.11%, which is fair for a very safe bond in the current rate environment. If you sell at par by year end, your yield to maturity will be no less than 11.52%. If you get 104 pricing by year end as per the plan, your yield to maturity is a fat 17.87%. I feel that return or better is very achievable. That is fantastic alpha considering you are taking on substantially less risk than owning the underlying equity (you are supra in the capital structure and the company has a legal obligation to pay you at least par).
Many investors go their entire lives without buying a bond. The process can be a little intimidating as it is less user friendly than the single click equity buyer process at most online brokers. At many brokers, you cannot simply enter an order into the screen and have it executed. You will have to find the customer service number and speak to a live person at the "bond desk". They tend to not be very helpful and expect you to already know the process. Key to this process is the CUSIP number. They will not likely look it up for you and you will need to have it ready.
Prices are quoted in tens of dollars. To put in an order for this bond at 95 cents on the dollar, you will put in an order for a price of "95.0000", thus offering to pay 950 dollars. Interest (the coupon) is paid twice a year. You will have to compensate your seller for the accrued interest on the current coupon.
There is also a minimum order size. This will vary by broker. I prefer to buy bonds through Interactive Brokers. They have a minimum lot size of two. They also let you enter a CUSIP into the online interface and do everything yourself without contacting a bond desk. I receive no compensation for recommending Interactive Brokers. They are just what I use and recommend.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CUSIP 05723KAE0 over 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.
Author has a good till canceled bid in the market for CUSIP 05723KAE0
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