Buying large or well-known company bonds is no guarantee of success, according to M&G's head of reta...
Buying large or well-known company bonds is no guarantee of success, according to M&G's head of retail and institutional fixed interest Jim Leaviss.
After a period of record defaults, Leaviss said there is plenty for investors to go for on a stock-specific level within higher yield and he made it clear that large stocks were not necessarily secure, as evidenced by the fate of Marconi.
In addition, he pointed out that bonds, including high yield, are paid out before equity holders and as such form a safer asset class than buying shares.
Within Moody's Ba3, equivalent to an S&P rating of BB-, there is currently a broad range in yields from Remy Cointreau on 5.73%, to Weightwatchers on 7.08% and Gap on 8.52% through to Rank Hovis McDougall (RHM) on 11.06%.
Leaviss said: 'The first three are well-known names and that is why they are expensive. It is to do with name recognition. But these massive yield gaps mean you should not just rely on the credit ratings. You need to analyse the quality of the companies. There is a difference between them.'
As a basic rule of thumb, he suggested high-yield managers should avoid stocks in industries they wish to avoid long term, such as European steel makers or UK shipbuilders. They should rather focus on stocks such as RHM, owner of Mr Kipling among other brands, which are producing non-cyclical earnings. 'It is a dull company with no volatility of returns and so is perfect for a high-yield investor,' said Leaviss. 'It is a food manufacturer, a brand owner and brands add value. It provides the UK with one third of its bread. The biggest risk is that many of its customers are supermarkets and these are very good at cutting down costs from suppliers.'
According to M&G calculations, using data going back to 1930, a Ba3 bond needs to provide a 1% yield over gilts to provide compensation for their greater risk. RHM currently provides a premium of 3.73%.
As a second stage of analysis, Leaviss showed that its current debt burden is 4.5 times the company's annual income. This puts it in a similar position to Weightwatchers but with a far higher spread over gilts.
At the third stage of valuation, Leaviss considered what the assets of RHM would be worth. If sold as a going concern its debt of £650m taken from its past purchase price of £1.15bn would mean that there would be plenty of money left over for investors.
In the case of it being broken up in a distressed situation M&G has calculated that it has property worth £436m while an independent audit of its brands valued them at £678m, again giving it greater worth than its liabilities.
In addition, the RHM bonds have covenants, giving bondholders protection against equity holders in predetermined scenarios.
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