Income Security Recommendations

BondsOnline Advisor – March 2007
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.

Citigroup/Strategy

The investment bank has cut its earnings estimate for the S&P 500 for the first time since early 2003. Citi reduced the 2007 growth rate from 7.2% to 6.6%.

It says the major sector sources of the 2007 earnings slowdown will be commodities and financials. It adds that compared with its January forecast, it expects slightly smaller declines in materials and energy, and slightly weaker earnings per share for financials.

“U.S. growth at the end of 2006 was less robust than earlier estimates, and the starting point for this year’s activity is lower,” it explains in a recent report to clients.

It also cut the full-year average U.S. GDP forecast for 2007 from 3.1% to 2.7%.

Citigroup/Fixed-Income Strategy

The investment bank points out that despite upbeat remark from the Fed about the state of the economy, futures contracts are currently pricing in a 25-basis point cut to the 5.25% overnight rate at the June 28 FOMC meeting.

Why the concerns? Growing problems in the subprime mortgage market, the downturn in China and suggestions from former Fed chairman Alan Greenspan that a recession could arrive by the end of the year.

This said Citi assures it continues to be comfortable that the high-yield bond market will provide an important source of support of the stock market. “We remain cautious, however, on purchasing high-yield bonds directly,” it warns.

It adds it continues to be comfortable that the high-yield bond market will provide an important source of support of the stock market.

However, it remains cautious for what it call a new incursion into the high-yield bond market itself. “We think it is unlikely that the widening of spreads from all-time record levels will be retraced any time soon,” it adds. “Moreover, additional signs of weakening in the U.S. or global economy could push spreads a bit wider from here. If that were to occur, we would probably become more sanguine about adding to high-yield allocations in individual investor portfolios.”

Merrill Lynch/REITs

Merrill Lynch points out that the recent decline in REITs was caused in part by high valuations, a concern over widening credit spreads, and a general view that real estate values would decline due to the possibility of higher interest rates. “The pullback in the REIT sector has created an attractive entry point for several high quality blue-chip stocks,” it adds.

The investment bank says that based on current fundamentals, the recent decline in stock prices, and slowing GDP growth, its favorite asset class remains regional malls followed by the office sector. However, it recently upgraded seven REITs to buy from neutral in the apartment, industrial, and storage sectors due to the pullback.

”While many non-dedicated REIT investors continue to focus on relative dividend yields and price to cash flow multiples as meaningful valuation metrics, we believe that the most important metric is net asset value (NAV), especially when attempting to determine where a ‘floor’ is for the sector or individual stocks,” it adds.

It points out that in general, REITs are currently trading at a 5% premium to NAV which is in-line with the sector's long-term average and below the 8% premium at the start of the year. “To put these figures in perspective, the REIT sector has traded between 80% and 130% of NAV over the past 11 years with extended periods at both extremes representing good buying and selling opportunities,” it adds.

Archstone Smith is one that Merrill likes. For the list of the seven REITs Merrill recently upgraded to “buy” ratings, see this month’s Yield and Income Newsletter.

UBS also recently upgraded three apartment REITs. The investment bank asserts that it expects to see M&A/privatization should the group’s stocks continue to trade at discounts to NAV. “While lower yielding deals are tougher to make pencil, those trading at higher yields could work in the current financing environment,” it adds. BRE Properties Inc. is one that UBS likes. For a full list, see this month’s Yield and Income Newsletter.

Citigroup/ Exploration & Production MLPs

The investment bank is recommending a number of master limited partnerships that it deems to be key mid-continent shale plays. It points out that in the past few years, U.S. exploration and production companies have ramped up capital spending toward onshore unconventional natural gas plays, while reducing exposure to offshore projects. “The primary reason for this new focus is improved risk-adjusted returns,” it adds. It says no region better exemplifies this new focus than the Barnett Shale in North Texas.

“Following the success producers are having in the Barnett Shale, other unconventional natural gas plays, such as the Fayetteville Shale in Arkansas and the Woodford Shale in Oklahoma, are beginning to gain momentum,” Citi elaborates. “Combined, these new mid-continent onshore natural gas plays should make up an increasing percentage of U.S. production as they grow and mature.”

Citi singles out three master limited partnerships that are poised to take advantage of these trends; all, including Energy Transfer Partners LP, are covered in Yield and Income Newsletter.

Merrill Lynch/Dividend Yield Screen

Each month, the investment bank screens for higher quality companies that offer relatively secure dividend yield. The stocks are selected from the Merrill Lynch Universe that currently consists of approximately 1650 companies. The criteria:

1) S&P Common Stock Rank of A+, A, or A-. The brokerage stresses that the S&P Common Stock rankings are the main measure of quality. These rankings are based primarily on the growth and stability of earnings and dividends over a 10-year period.

2) Return on Equity (ROE) greater than the average S&P 500 ROE.

3) Debt/Equity lower than the S&P 500.

4) Dividend Yield greater than the S&P 500.

5) Merrill Lynch Investment Opinion indicates the likelihood that the dividend

will remain the same or be increased

6) The ratio of the last 12-months’ free cash flow to dividends must be greater than 1.0.

This month, 17 stocks were kicked out from the screen. We highlight the four whose current yields exceed 3% in this month’s Yield and Income Newsletter.

Stephen Taub is the editor of Yield and Income Newsletter, and a veteran finance/business journalist with more than 26 years of experience. He has been associated with BondsOnline and the BondsOnline Advisor for five years. Taub is also currently a contributing editor for Institutional Investor magazine, Alpha magazine and. CFO.com, and a contributor to complianceweek.com. Previously, Taub served as Editor-in-Chief of Financial World magazine and individualinvestor.com, and V.P. of Content for CFO.com.