Income Security Recommendations

BondsOnline Advisor – April 2006
By Stephen Taub

The BondsOnline Advisor strives to present you with income investment insights from analysts throughout the United States. Bonds, preferred stocks, real estate investment trusts, or master limited partnerships can be a part of a successful income portfolio – and BondsOnline www.bondsonline.com and PreferredsOnline www.epreferreds.com provide the “Income Investor Tools” to keep you informed.

Bear Stearns/High Yield Bonds

The investment bank’s high yield analysts recently recommended to trade into the following issues: MedQuest 11.875% senior subordinated notes, R.H. Donnelley and Viacom.

They say MedQuest offers “the best operational outlook for managing through a trying period in the space; a flexible capital structure … and the best relative value within imaging, with a current yield of nearly 15% and six-month annualized total return potential exceeding 20%.”

They recommend R.H. Donnelley with an outperform recommendation on the holding company bonds and a market perform recommendation on the rest of the structure. The analyst views RHD as a “relatively stable high yield play due to the defensive nature of the industry, the company’s high degree of operational visibility and the potential for a meaningful reduction in leverage. In terms of credit risks, RHD may encounter integration-related challenges and remains susceptible to the ongoing shift from print to online media, the analyst adds.

It also recently initiated coverage of Viacom with an outperform recommendation in cash and a market-perform recommendation in CDS. “The cable/media space should continue to experience high event risk associated with share repurchases and acquisitions opportunities,” it notes. “However, we believe management is committed to a balance sheet that is consistent with an investment grade rating.”

Merrill Lynch

Merrill Lynch's Dan Roling upgraded the Freeport McMoran Copper & Gold Inc. (FCX) convertibles to Buy and set a price target of $85 based on higher copper prices. The brokerage says Freeport-McMoRan has two convertible securities currently outstanding--The 7% senior unsecured convertible bond due in 2011 and the 5.5% preferred convertible until 2049. “Merrill Lynch’s Convertibles Research is recommending both convertible issues for investor looking for exposure to the common stock,” it elaborates. It adds that the convertibles provide attractive risk-adjusted returns and plus a yield pick-up.

The 7% Convertible Bond is trading at $205 with a conversion premium of 3.75%, versus $61 for the underlying common stock. “We estimate that the convertible is trading at approximately a 5.5% discount to our estimated theoretical value,” it notes. The convertible currently yields 3.4%, which compares favorably to the dividend yield of 2.1% on the common, the brokerage adds.

The 5.5% Convertible Preferred trades at $1314 with a conversion premium of 8.1%, versus $61 for the underlying common stock. “We estimate that the convertible is trading at approximately a 6.5% discount to our estimated theoretical value,” it noted. The convertible currently yields 4.2%, which compares favorably to the dividend yield of 2.1% on the common, the brokerage adds.

The equity department also raised its rating on the company stock to Buy (from neutral) due to an increase in its earnings outlook as a result of the higher prices for copper and gold. The brokerage called the company “cash rich” and expects it to continue to pursue shareholder friendly initiatives, such as the payout of special dividends and further share repurchases. It added it looks for 50 cents per share in special dividends on top of the existing $1.25 per share annual dividend in 2006. It also has about 14 million shares remaining under its current 20 million share repurchase authorization.
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Distressed Debt Investor/Worldspan Notes

Martin Fridson recently recommended a long position in the Second Secured Floating-Rate Notes due 2011 of Worldspan, L.P. The company provides transaction processing and information technology services to the global travel industry. It was founded in 1990 by Delta, Northwest, and Trans World Airlines.

“Worldspan’s operating profitability, cash flow generation and liquidity reserves are very strong given current pricing for this instrument,” the analyst notes. He acknowledges that the company may lose some volume after renegotiations with airline partners and on-line travel agencies. But, he asserts the company has already reduced its cost structure and developed various market broadening strategies to preserve its business franchise and mitigate potential adverse effects on profitability. “The Company is also committed to using its substantial excess cash flow to deliver its balance sheet,” he adds. The Second Secured Floating-Rate Notes are currently priced at 92, representing a 12.0% current yield based upon the present contract rate of interest and 13.6% fixed equivalent yield.

Real Estate Investment Trusts (REITs)

BondsOnline introduced coverage of Kimco Realty (KIM) with a “Buy” recommendation. BondsOnline Yield & Income Research report is available to subscribers of PreferredsOnline – Yield & Income Securities, however this report is available to current and past subscribers by emailing us at bonds@bondsonline.com.

Merrill Lynch published a list of six companies it believes have the greatest chance of reporting upside earnings surprises versus the consensus estimates. They include Vornado (VNO), AvalonBay (AVB), Kilroy Realty (KRC), Apartment Investment & Management Co. (AIV), Public Storage Inc. (PSA), and ProLogis (PLD).

In a separate, didactic report detailing the history of REIT investing, Merrill warns that under most metrics it analyzes, REITs are currently trading at record valuation levels except versus private market values where the stocks are trading at only a modest premium. “However, with the yield on the 10-year Treasury fast approaching 5% we believe the sector could experience multiple contraction,” especially given the group's strong performance during the first quarter of 2006.

It also points out that over the past 5 years, REITs generated annual dividend growth of between 6% and 9%. However, the brokerage expects dividend growth to slow toward a range of4% to 5% in 2006 and 2007 “as companies seek to reduce their payout ratios.”
Standard & Poor’s warns investors of the potential for a decline in the S&P 1500 Real Estate Investment Trusts Sub-Industry Index in the near future. It cites a combination of technical indicators, as well as high valuations compared to historical multiples and the current underlying fundamentals as the key drivers of a potential 5% to 15% correction within the next six months. "There are a number of potential catalysts for a short-term correction in the sector, including rising long-term interest rates, an earnings shortfall from a market leader, or widespread profit taking," said Robert Hansen, Financial Services Group Head, Standard & Poor’s Equity Research Services, in a report.
It says a good comparison to the current situation was at the end of July 2005 when the S&P 1500 REITs Sub-Industry Index showed similar technicals. Subsequently, it went into an 11-week correction, declining almost 14%.
Standard & Poors
Standard & Poor’s Equity Research Services has a “Strong Sell” recommendation on Equity Office Properties (EOP). It asserts the REIT could have to contend with a number of operating challenges over the next 12 months, including higher operating expenses and lower rental rates on expiring leases.
The research firm also has a “Sell” recommendation on AvalonBay Communities (AVB) due to concerns about the company’s valuation.
Bear Stearns’ high yield department said it is maintaining its market weight recommendation on the REIT sector and believes Equity Office could provide the best total return opportunity of the names that it covers. “We believe a catalyst for spread tightening is likely to occur after the company reports second quarter earnings,” it added.