Income Security Recommendations

BondsOnline Advisor – December 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.

Income Security Recommendations

Company	Ticker	Type	Current Price	Current Yield	Firm
AvalonBay	AVB	REIT	$127.10	2.40%	PreferredsOnline
Boston Properties	BXP	REIT	114.25	3.10	Merrill
Cousins Properties	CUZ	REIT	35.23	4.20	Merrill
Douglas Emmett	DEI	REIT	26.57	0.50	Merrill
SL Green Realty	SLG	REIT	131.67	2.10	Merrill
Vornado Realty Trust	VNO	REIT	122.97	2.80	Merrill
Developers Diversified Realty	DDR	REIT	63.74	3.70	Merrill
Macerich	MAC	REIT	82.73	3.40	Merrill
Simon Property Group	SPG	REIT	99.97	3.00	Merrill
Sunstone Hotel Investors	SHO	REIT	27.23	4.60	Merrill
Buckeye GP Holdings, L.P.	BGH	MLP	15.85	5.50	Merrill
Buckeye Partners LP.	BPL	MLP	45.70	6.70	Merrill
Enterprise Products Partners LP.	EPD	MLP	29.46	6.20	Merrill/ PreferredsOnline
Energy Transfer Partners LP.	ETP	MLP	54.28	5.50	Merrill
Kinder Morgan Energy Partners LP	KMP	MLP	48.39	6.70	Merrill
Magellan Midstream Holdings L.P.	MGG	MLP	22.01	4.20	Merrill
Magellan Midstream Partners L.P.	MMP	MLP	38.95	6.10	Merrill
Plains All American Pipeline L.P.	PAA	MLP	51.64	5.70	Merrill
Sunoco Logistics Partners L.P.	SXL	MLP	49.97	6.20	Merrill
TC Pipelines L.P. (TCLP)	TCLP	MLP	32.76	7.30	Merrill
TEPPCO Partners, L.P.	TPP	MLP	41.29	6.50	Merrill
Williams Partners L.P.	WPZ	MLP	38.04	4.70	Merrill

* E – equity; REIT – real estate investment trust; CB – corporate bond; Pr – preferred; MLP – master limited partnership; ETF – Exchange Traded Fund.

Standard & Poor’s/Asset Allocation

The S&P Investment Policy Committee has moved to a more neutral bond-investing approach for 2007. It currently recommends a 40% fixed-income allocation, with 25% in bonds and 15% in cash. Its recommended equity allocation is currently 60%, with 40% in U.S. equities and 20% in foreign equities.

“The IPC recommends spreading the risk along the yield curve by maintaining a position in longer dated government bonds to allow for the possibility of a harder-than-expected landing for the economy,” it adds.

On the other hand, S&P now deems corporate bonds as expensive, “even though expectations of increased volatility leave the window open for opportunistically increasing exposure,” it explains.

“Conditions look too complacent in the corporate bond market,” S&P asserts. “Market volatility has tapered down considerably amid strong liquidity, low default rates, and high recovery rates on defaulting debt. Spreads remain tight, with the latest reading showing a fair amount of risk tolerance on part of investors.”

This said, S&P says risks remain skewed to the upside, given the slowing economy and deceleration in profits growth. “In short, the market may have priced in too much good news and remains susceptible to both idiosyncratic and systemic risks in the quarters ahead,” S&P adds.

Looking at high yield bonds, S&P says the strong returns in 2006 won’t be repeated, asserting that the risk/reward tradeoff is likely to deteriorate. “A more cautionary stance for high yield investors at this stage of the credit cycle is viewed as important, since the growth slowdown underway is likely to dent profits growth and trip credit quality in the process,” it adds.

Citigroup/Municipal Bonds

As the economy begins to slow down and interest rates ease, the investment bank recommends investors continue to ease into the muni market.

It suggests investors focus on sectors/maturities where supply is heavy or institutional support is relatively light. “In a number of states, that pattern has occurred recently on longer intermediate maturity par bonds,” it adds.

More specifically, it recommends investors stay in the 5-14 year maturity range. “However, when yields are attractive in maturities beyond that range, we would not be averse to purchasing some—but generally with the purchase of longer paper offset by a reduction in the average maturity of holdings elsewhere in the investors portfolio,” the investment bank adds.

It recommends a laddered structure, but assures investors that it does not need to be perfectly smooth. It suggests using taxable investments on the very short end, when the after-tax yield is sufficient.

In general, investors should keep average credit quality high, Citi adds.

Banc of America Securities/Fresh Money Focus List.

The investment bank recently added Johnson & Johnson (JNJ) to its Fresh Money List, which contains just 10 stocks. Among the reasons: The current dividend yield of nearly 2.3% is attractive, BofA asserts, especially when compared to the company’s long-term track record of rising dividends. J&J replaced Alcon, because the bank analyst left.

It also added Accenture (ACN) and Genworth (GNW), whose yields are 1% and 1.1%, respectively.

Merrill Lynch/10 Stocks For 2007

The investment bank has announced its annual list, and it points out that its themes continue to be quality and dividend yield. In fact, seven of the 10 stocks on this year’s list have a higher dividend yield than the S&P 500.

In general, this list is meant as a simple buy-and-hold portfolio for the entire year. Two stocks from 2006 returned to the list for 2007--Emerson Electric and Merck.

The 10 stocks for 2007

Merrill Lynch/Energy MLPs

Although master limited partnerships (MLPs) have been around for 25 years, they have recently gained attention due to the proliferation of Energy MLPs, the strong demand for energy infrastructure in the US and the sector’s very strong track record, points out Merrill. (For a primer on this sector, please see PreferredsOnline).

It describes the group as a compelling blend of growth and income due to their high yield as well as total return potential. Merrill expects the asset class to offer investors annual 10-15% total return potential, comprised of a 6.7% current yield and 5-8% annual cash distribution growth. Merrill calls the sector a “hidden gem” that “should continue to offer investors annual double-digit total return potential.”

In fact, Merrill points out MLPs have outperformed REITs and utilities over the last 10 years.

Merrill says traditionally, the level of interest rates has driven MLP performance and valuation. Increasing interest rates put pressure on MLP yields as lower-risk alternatives, such as Treasury bonds, become relatively more attractive. So, investors must be compensated for the incremental risk. A higher yield also translates into a higher cost of capital for an MLP.

The investment bank says the MLPs are typically valued by examining the spread between the yield on the 10-year Treasury note and the yield of an MLP. It points out that the current spread is 211 basis points, compared to an average of 279 basis points historically. “This seems to suggest that MLPs are overvalued relative to historical levels,” the report asserts. “However, we view the spread over the 10-year valuation methodology as too quick and easy (as well as backward looking), and prefer a distribution discount model approach.”

Merrill goes on to explain that although MLP performance has been negatively correlated to interest rates historically, this correlation has weakened over time.

The investment bank currently has its highest rating on 12 individual MLPs, excluding one I-Share and two closed-end funds. These are the 12, including their current yields.

Lehman/REITs

Lehman recently raised its price target or rating on 25 REITs. ”In a modest return environment in 2007, we believe REITs will provide returns that are competitive with general equities,” it asserts in a recent report. “Investor enthusiasm for property should remain positive and company earnings growth could exceed the overall market.”

Its favorite names among office companies are Boston Properties (BXP), Cousins Properties (CUZ), Douglas Emmett (DEI), SL Green Realty (SLG) and Vornado Realty Trust (VNO) and among retail companies Developers Diversified Realty (DDR), Macerich (MAC) and Simon Property Group (SPG).

Lehman asserts it remains cautious about the valuation/risks of apartment companies and overseas industrial developers.

Merrill Lynch/Lodging REITs

The investment bank says that compared to other REIT property types, lodging REITs continue to trade at a deep discount. It points out that lodging REITs trade at roughly 11.3 times their estimated 2007 funds from operations (FFO), compared to apartment, self storage, and office REITs, which are at 21.7 times, 19.3 times and 18.9 times FFO, respectively.

It also expects lodging REIT FFO growth to be in the high teens in both 2007 and

2008. “Over the next couple of years, lodging REITs should continue to benefit from favorable lodging fundamentals, as well as recently completed portfolio enhancements,” Merrill added.

Merrill recently singled out Sunstone Hotel Investors (SHO), currently trading at $27.23 with a 4.6% current yield. The investment bank’s 12-month price objective is $31.50. “We believe that the company’s stable balance sheet, attractive dividend yield , long-term growth strategy and the potential to improve the recently acquired properties warrant a higher multiple,” it asserts.