Income Security Recommendations
BondsOnline Advisor – May 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
Issue Ticker Type* Current Price Current Yield Firm
Energy Transfer Equity, L.P. ETE MLP $26.98 1.10% Smith Barney
Energy Transfer Partners LP ETP MLP 42.12 5.60 Smith Barney
Trizec Properties TRZ REIT 23.89 3.30 Merrill
Pan Pacific PNP REIT 66.84 3.80 Merrill
HRPT Properties HRP MLP 10.70 7.90 Bear
Equity Residential EQR REIT 43.63 4.10 Merrill
Kimco Realty KIM REIT 36.70 3.70 BondsOnline
* E – equity; REIT – real estate investment trust; CB – corporate bond; Pr – preferred; MLP – master limited partnership.
Merrill Lynch/Asset Allocation
Merrill Lynch has altered its asset allocation recommendation mainly because it believes global monetary policy will further hurt the dollar.
Its new asset allocation is 50% stocks/30% bonds/20% cash. Previously, it was
40%/45%/15%. It stressed it is increasing its equity weight and lowering its bond weight, but that cash is the only asset class overweighted versus its 60%/30%/10% benchmark.
“Strategically, it appears as though the Fed is at the end of their tightening cycle just when the ECB and BOJ are beginning theirs,” Merrill Lynch wrote, before the Fed’s recent rate hike. “However, the risk of whipsaw seems quite high. Watch the slope of the yield curve as a potential warning indicator.”
Among equities, Merrill downgraded the high-yielding utilities group to underweight from overweight. “The combination of rising inflation expectations that accompany the dollar’s fall and the potential for non-US investors to increasingly prefer non-US assets makes it likely that bonds could be the asset class hurt the most by a continued fall in the US dollar,” Merrill wrote.
It believes cash is good competition for stocks. “The change in the spread between short-term interest rates and the S&P 500 dividend yield continues to widen,” Merrill stated. “The shift from bonds to cash reflects our view that shorter-duration assets (both in terms of maturity and quality) should be emphasized as the dollar falls and inflation expectations potentially rise.”
Smith Barney/MLPs
Smith Barney initiated coverage of Energy Transfer Equity, L.P. (ETE) with its highest buy rating and a 12-month target price of $36. (It is currently trading around $27.) The bank called Energy Transfer “the fastest-growing general partner” in its coverage, with expected distribution growth of 25% annually over the next four years. It noted that its target price and distribution estimates imply a 47.5% 12-month return. It called the stock a derivative investment on Energy Transfer Partners LP (ETP), which operates an integrated set of natural gas midstream assets in Texas. The analyst also said his $36 target price is 20% above the highest target price among the analysts who follow the company.
Merrill Lynch/REITs
Merrill Lynch recommended several paired trades that investors should consider, whereby they buy one stock and sell or short a similar one simultaneously. They include:
Trizec (TRZ) vs. Duke (DRE). Merrill points out that Trizec is trading at a Price-to-net asset value ratio of 95% vs. 114% for Duke. However, Trizec’s yield is 3.3% vs. 5.3% for Duke.
Pan Pacific (PNP) vs. New Plan Excel (NXL): Merrill points out that Pan Pacific’s P/NAV ratio is 93% vs. 102% for New Plan. “While acquisitions remain challenging in PNP’s core west coast markets, the company’s higher internal growth, underleveraged balance sheet and quality portfolio makes PNP a more likely acquisition candidate than NXL,” it adds. The yields are 3.8% for PNP and 5% for NXL.
Merrill also reiterated its recommendation of Equity Residential (EQR), which specializes in multifamily properties. “The company’s continued portfolio repositioning effort is not being fully reflected in its same-store results,” the analyst writes. It is emphasizing high-growth area like the New York metro area, Washington DC metro area and Seattle and selling assets in markets such as Tulsa, Minnesota, Southeast Michigan, and San Antonio. Its current yield is 4%.
Merrill also noted these current REIT yield averages:
Apartment Avg: 4.0%
Strip Center Avg: 4.5%
Regional Mall Avg: 3.8%
Factory Outlet Avg: 4.3%
Office Avg: 4.0%
Industrial Avg: 3.3%
Self-Storage Avg: 3.0%
Diversified Avg: 3.8%
Total Sector Average 3.9%
Bear Stearns/REIT bonds
The brokerage recently upgraded its rating on office REIT HRPT Properties (HRP) from market-perform to outperform, citing improving operating performance, solid financial fundamentals, stronger than average bond covenants, good relative value as well as the recent sale of the remainder of its equity investments in its former subsidiaries. “While we still view external management as a negative, we note that the name trades cheap compared to its office peers,” it added.
The company also has four bond issues:
6.95s that mature in 2012
5.75s that mature in 2014
6.40s that mature in 2015
6.25s that mature in 2016
The dividend yield on its stock is 7.9%
Smith Barney/Munis
The investment bank recently pointed out there is a shortage of paper, as year-to-date issuance runs roughly 20% behind 2005 levels. It noted that the shortage is especially bad in relatively high tax states, while the shortage in the shortest maturities—inside five years—is even more acute in many states. What’s more, Puerto Rico munis—which some investors had recently flocked to--have run into budgetary problems that resulted in Creditwatch status by Standard and Poor’s, and a recent downgrade by Moody’s.
Even so, Smith Barney said municipal bonds still provide the best after-tax return, relative to risk, for a wide range of individuals. It recommended looking out-of-state more aggressively, especially when the supply in-state is so tight as to depress the yield versus after-tax yield on out-of-state paper.
It also recommended that investors look beyond the first three–four maturities, where the supply shortage is the most acute. On shorter maturities in particular, look to the primary market whenever possible, the firm’s muni analysts added. “In the shortest maturities, callable agencies may provide a relatively attractive after-tax return for a portion of holdings, particularly in moderate tax brackets,” Smith Barney noted.
Distressed Debt Investor
The newsletter recommends buying Brookstone’s 12% Senior Second Secured Notes due October 2012. Last October, the specialty retailer was acquired by OSIM International Ltd. and affiliates of J.W. Childs Equity Partners III, L.P. and Temasek (Private) Capital Limited. The newsletter noted that declining same-store sales and reduced gross margins have continued to reduce operating profitability in 2006, but asserted that it expects performance to improve during the remainder of 2006, due to new sales incentives, product introductions, new store openings, and weak comparisons in upcoming quarters.
It also claimed the company appears to have more than adequate liquidity, even given seasonal needs and increased leverage. As a result, it recommended the notes, “given prospective unlevered returns from a one-year position of approximately 15%, the company’s credit profile, potential for performance enhancements, and the second lien position of this instrument.”
PIMCO/Emerging Markets
The bond gurus at PIMCO recently told clients that investments in Emerging Markets debt continue to be compelling, citing a number of factors: a yield of 6.7%, almost half the credits are now investment grade, large and growing levels of self-insurance, minimal financing needs for the rest of the year, a growing investor base, and a strategic complement to China.
© 2006 BondsOnline Group, Inc.
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