Income Security Recommendations

BondsOnline Advisor – July 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

Fund/Stock	Ticker	Type	Current Price	Current Yield	Firm
SL Green	SLG		$109.22	2.20%	Merrill
ProLogis	PLD	REIT	53.40	3.10	Merrill
U-Store-It Trust	YSI	REIT	18.94	6.20	Merrill
CentraCore Properties	CPV	REIT	24.95	7.40	BancAmerica
Third Avenue Real Estate Value	TAREX	REIT	32.12	1.40	Morningstar
AT&T	T	E	27.90	4.80	Merrill
Pinnacle West	PNW	E	40.46	5.00	Merrill
UST Inc.	UST	E	45.84	5.00	Merrill
Progress Energy	PGN	E	43.40	5.60	Merrill
Dominion Resources	D	E	75.05	3.90	BancAmerica
Constellation Energy	CEG	E	54.50	2.80	BancAmerica
DR Horton	7.875% of 2011	CB	105.34	7.47	Citicorp
KB Home	6.250% of 2015	CB	88.79	7.04	Citicorp
Hovnanian	7.5% 2016	CB	93.00	8.06	Citicorp

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

Banc of America Securities/Strategy

Strategist Thomas McManus deems the market’s recent “disruption” the first correction in more than three years, and not a bear market. He says if his firm is correct, the downside risk is that the S&P 500 might fall another 5% to 10%, to 1150 or so before the correction is over. “We believe a drop below 1100 is unlikely,” McManus recently told clients in the firm’s second-half forecast. In fact, he is looking for a 10% to 15% rally in the fourth quarter, bringing the index back to 1300 by year-end. He calls his earnings outlook “mixed,” and expects growth will slow in the second half. He is looking for 8% growth this year, up 7.4% for 2007 (including options expense), and possibly 7% growth in 2008. But he does warn: “We expect the market indexes will remain volatile for several months in the face of redemptions, a data-dependent Federal Reserve, rising interest rates around the world, strong hurricanes in the Gulf, and election season.”

CreditSights/ Investment Grade Outlook

Half way through 2006, it remains as difficult to get excited about the corporate bond markets' prospects now as it did back in January even though high grade spreads are a little wider and high yield spreads are a little tighter, notes the newsletter.

“Our circumspect outlook is driven by the fact that spreads remain close to their historical lows, thus offering little chance of further appreciation whatever fundamental developments we experience in the economy,” it explains. “In fact, spreads have become largely impervious to the unfolding economic picture as a range of technical factors have kept them well bid throughout the cycle.”

The upshot: It says that as we head into the historically troublesome third quarter, it remains underweight both high grade and high yield corporate bonds.

Merrill Lynch/ REITs

Merrill notes in a recent report fired off after the Fed’s latest rate hike that the biggest issue facing the sector is that it is expensive on several valuation metrics “and we do not anticipate significant upward estimate revisions over the next several quarters which could help lift the stocks higher.” In an otherwise cautious report, it singles out office REIT SL Green (SLG) as its top pick in the sector due to “the rapidly improving rent trends in NYC.”

It also points out that ProLogis (PLD) remains its top pick in the industrial space.

Among storage REITs, its top pick is U-Store-It Trust (YSI), which it recently initiated coverage on. “In our opinion, the tailwinds afforded by a vastly improving fundamental environment combined with enhanced operating and finance expertise provided through a new, but tenured management team, can help capture over 500bp of occupancy and drive rental rates,” it writes in a recent report.

Banc of America/ REITs

BofA recently reiterated buy recommendations on REIT CentraCore Properties (CPV).

The bank asserts that CentraCore Properties, formerly known as Correctional Properties, will emerge unscathed from The Geo Group’s announced plans not to renew its seven leases that expire in 2008. “We find it unlikely that CPV will ultimately take a haircut on these lease revenues,” it adds.

Morningstar/ REIT funds

The fund rater says one good way to play REITs is with the Third Avenue Real Estate Value (TAREX) fund, which reopened to investors on July 1. “Although we've been wary of real estate funds lately, this is one of our favorites in the category,” it recently told subscribers.

Merrill Lynch/ Dividend Paying Stocks

Noting the recent uncertainty about inflation, the investment bank recently ran a screen of dividend-paying stock for income-oriented investors who may want a hedge. These are higher yielding stocks with positive real dividend growth rates,” it explains. These stocks tend to be concentrated in REITs and in the Oil & Gas industry. They offer on average 17 percent "simple expected return", more than two times that of the S&P 500.

Merrill points out that just 32 companies pass the screen, including just 4 stocks currently in the S&P 500. When the bank ran the same screen two years ago, 59 stocks passed, including 18 in the S&P 500.

The four companies on this year’s list from the S&P 500 are:

AT&T (T), 4.8%

Pinnacle West (PWW), 5.0%

UST Inc. (UST), 5.0%

Progress Energy (PGN), 5.6%

Banc of America/ Electric Utilities

The investment bank asserts that while it continues to believe that an abrupt movement in the Treasury will hurt utilities over very short periods, it expects investors will focus on utilities’ strong fundamentals, driven by improving realized commodity prices and substantial rate-base growth. Assuming the 10-year Treasury settles in below 5.3% to 5.4%, it expects utilities to perform “relatively well” in the second half of the year. So, it recommends focusing more on the stocks which could unlock better value or gain a higher relative multiple.

It elaborates that with Duke Energy’s (DUK) recent announcement to spin off its natural gas business, Dominion Resources (D) would be “the logical next candidate to unlock further shareholder value.” Its yield is currently 3.7%. It also expects Constellation Energy (CEG) to outperform over the second half, figuring that Maryland will become more “constructive” on the regulatory front. Its current yield is 2.8%.

Citicorp/ Homebuilder Bonds

While equity analysts are cooling to homebuilder stocks due to softening home sales and rising interest rates, fixed-income analyst Julie Hung Fischer initiated buys on the bonds of three homebuilders--DR Horton, KB Home, and Hovnanian.

Her reasoning: spreads have widened in recent months due to increasing volatility. “At this time, we continue to have a stable, high-risk fundamental view for the overall sector, given the improved credit quality across our homebuilding coverage and a relatively healthy underlying economy,” she adds.

The analyst says DR Horton is the largest homebuilder in the investment banker’s universe, “which should provide scale benefits,” and is one of the most geographically diverse homebuilders. “DHI has substantially improved its credit metrics and financial profile, and we think its spreads are attractive relative to other investment grade homebuilding credits,” Fischer adds. Her recommendation: the 7.875% 2011.

She says KB Home has improved its credit profile and targets investment grade ratings. “While the company is on positive outlooks at Moody’s and Fitch, its aggressive share repurchase program and higher debt levels constrain its ratings given the softer homebuilding market,” she adds. The analyst asserts that if the company can keep debt levels at the lower end of its targets, a ratings upgrade is possible, which should tighten spreads by 30–40 basis points. Her recommendation: the 6.250% 2015.

The analyst says Hovnanian has substantially improved its balance sheet, and its goal is to become investment grade. “The company is willing to use excess cash for debt reduction before share repurchases,” she adds. Her recommendation: the 7.5% 2016.

Baring Asset Management /Global Bond Outlook

John Birdwood, Director of Fixed Income and Currency for Baring Asset Management, recently declared that the "cheap money" era is over in the U.S. and U.K. and will soon end in Japan.

However, if U.S. cash remains in the 5% to 51/2% range, and does not become "expensive" toward 6 %, Birdwood does not see a rush from equities to fixed income. “Toward 6 % is a signal that inflation worries have become serious, he says, and bond markets may rally,” he explains.

As for fixed income asset allocation, Birdwood and his team look to countries where the cycle of interest rate hikes is nearly done--U.S., U.K., and Australia. They add that Canada will be more appealing as it gets closer to the peak of its rate hike cycle.

In emerging markets the Baring fixed income team likes Mexico, with bond yields at 9 ˝%, “with a measure of fear built into the prices,” they recently told clients.