Income Security Recommendations
BondsOnline Advisor – June 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 and PreferredsOnline provide the “Income Investor Tools” to keep you informed.
Lehman/Bond Strategy
Market psychology has become accustomed to expect potential problems during August through October, says Jack Malvey, Lehman Brothers' Global Chief Fixed Income Strategist. “Most capital market participants tend to adapt a defensive attitude around this time of year," he adds.
He notes that the best month for treasury bond returns in the US, UK, and Japan is October, while in the eurozone, it is September. “.Most credit sectors deliver peak excess returns in November,” Malvey adds.
Citibank/Municipal bonds
The bank asserts that these are challenging times for investors in municipal bonds. It points out that munis aren't "cheap" in comparison with taxable investments based upon historical standards. However, municipal yields have increased a bit relative to taxables in recent weeks. “We continue to consider it possible that the Fed will tighten one more time, but note that this outcome remains dependent on whether recent slowing in the economy continues and ultimately translates into lower inflation/inflation expectations,” it adds.
It also notes that demand for municipal bonds from individual investors should continue to expand as Baby Boomers approach retirement, as more substantial investors cash out a portion, or all of their holdings of privately held corporations, and as holdings of cash/near cash continue to build. “In our view, the net flow of new municipal bonds is modest in comparison with these potentially massive sources of demand,” Citibank adds.
The upshot: It recommends investors utilize a basic laddered structure, “but without slavish adherence to a smooth ladder from one maturity to the next.” It suggests targeting an average maturity range “that is appropriate for a given investor,” but purchase blocks of bonds that are attractively priced at a given point to fill in the ladder.
Specifically, Citi suggests utilizing in-state insured bonds as a way to diversify credit exposure, particularly in high-tax states where the after-tax yield disadvantage from purchasing out-of-state bonds may be large. “The key target should be an average maturity that makes sense for that investor,” it adds.
It also suggests focusing on premium bonds as a key component of a total portfolio. “In particular, we often find that so-called ‘cushion bonds,’ high-coupon callable bonds that have not been advance refunded, can provide an attractive combination of yield, market risk, and call risk,” it adds. Trouble is, this type of bond has become harder to find, Citi laments.
Also, focus on the five- to 14-year maturity range, “with some potential additions in longer maturities when such maturities appear particularly ‘cheap’ on a relative basis. “In our opinion the best relative value is in the eight- to 14-year range, especially given the sharp drop in relative yields on longer maturities,” it adds.
On shorter maturities, Citibank suggests looking at taxable bonds, when and if they make sense on an after-tax basis, in the investor's combined federal/state tax bracket. “Toward that end, some of the best values on taxable bonds are on callable agency debt,” it adds. It also thinks CDs make sense for many investors.
Citi also points out that investors can increase their average after-tax portfolio yield without taking on too much market risk simply by extending maturity within the municipal bond market, taking advantage of the fact that the municipal bond yield curve has some slope, unlike the Treasury sector.
And finally, incorporate a small "yield" component into an investment portfolio, such as high-yield munis, triple-B credits, AMT paper, to name a few. Citi figures investors should set aside 5-10% of their portfolios for this type of paper, where appropriate. “We find that a broad range of portfolios can incorporate a modest amount of yield product as an income enhancement technique without reducing the overall risk parameters of the portfolio to an unacceptable degree,” it explains.
Bear Stearns/ High Yield Bonds
Cable/Media/Telecom analyst Doug Colandrea has an “outperform” rating on the cash bonds of Embarq, which is in the phone and wireless business that was formerly a subsidiary of Sprint Nextel Corp. “We believe management is committed to reducing debt over the next two years, which should provide some stability to the credit story,” the analyst asserts. “Over the next 18-24 months, Embarq should be a relatively stable credit story with the focus on debt reduction and deleveraging the balance sheet.”
Its yield to worst (YTW) on the paper that mature in 2013 is 7.06%, its YTW for the 2016 maturity is 7.50% while the YTW for the ’36 bonds is 8.22%.
Telecommunications and Cable analyst Sandy Liang issued a report noting the firm continues to favor Dobson Communications bonds “after a slight earnings shortfall” in the second quarter. It singled out the Libor+425 senior floating rate notes, which are rated as a top pick. It also favors Dobson Cellular 9.875% notes over American Cellular 10% notes.
Bear Stearns analyst Karen Miller likes Playtex as a core holding in the consumer products space. She singles out its 9.375% senior subordinated notes due 2011, at a price of 104.25. Its yield to worst is about 7.64%.
Merrill Lynch/ Dividend Yield Screen
Merrill’s high quality and dividend yield screen generated 14 names this month. These
rankings are based primarily on the growth and stability of earnings and dividends over a 10-year period; Return on Equity (ROE) greater than the average S&P 500 ROE; Debt/Equity lower than the S&P 500; Dividend Yield greater than the S&P 500, and Merrill Lynch indicates the likelihood that the dividend will remain the same or be increased. Finally, the ratio of the last 12-months’ free cash flow to dividends must be greater than 1.0.
The 14 companies are:
|
Stock |
Ticker |
Current Price |
Current Yield |
|
Altria |
MO |
$31.09 |
4.00% |
|
Merck |
MRK |
26.20 |
3.77 |
|
Polaris |
PII |
38.06 |
3.24 |
|
VF |
VFC |
19.21 |
3.24 |
|
Kimberly-Clark |
KMB |
22.19 |
3.21 |
|
General Mills |
GIS |
19.04 |
2.70 |
|
3M |
MMM |
31.73 |
2.61 |
|
Abbott Labs |
ABT |
23.75 |
2.47 |
|
Avon Products |
AVP |
50.80 |
2.41 |
|
Johnson & Johnson |
JNJ |
28.62 |
2.40 |
|
KB Home |
KBH |
34.29 |
2.35 |
|
Emerson Electric |
EMR |
22.55 |
2.26 |
|
Procter & Gamble |
PG |
19.78 |
2.21 |
|
McCormick |
MKC |
24.72 |
2.05 |
UBS/Preferreds
Analyst Barry McAlinden asserts that the total return outlook for preferred securities appears more favorable than it has “in quite some time.”
He cites “a supportive interest rate forecast,” balanced with expectations for stable to modestly wider credit spreads. “However, with credit weakness expected to be concentrated among lower-rated securities, high-quality preferreds should continue to perform well,” he adds.
So, McAlinden has upgraded six fully-taxable preferreds to Buy from Neutral, which he says represent a good mix of credit stability, coupon income, and the ability for further price appreciation. The securities include Bank of America, Lehman, two separate Morgan Stanley Capital Trusts, US Bancorp, and Wachovia.
Merrill Lynch/REITs
Merrill Lynch provides these current average dividend yields for a wide range of REIT groups:
Apartment: 3.8%
Strip Center: 4.1%
Regional Mall: 3.8%
Triple Net: 7.1%
Office: 4.0%
Industrial: 3.1%
Self-Storage: 3.0%
Diversified: 3.6%
|
