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Sherritt International chairman Ian Delaney (J.P. MOCZULSKI/REUTERS)
Sherritt International chairman Ian Delaney (J.P. MOCZULSKI/REUTERS)

Portfolio Strategy

The rarefied world of high yield bonds Add to ...

In a world where a virtually risk-free five-year Government of Canada bond yields 1.3 per cent, it’s hard to take your eyes off Sherritt International Corp.’s 8-per-cent bonds maturing in November, 2018.

Sherritt is not one of the heavyweights in Canada’s mining community, but it’s a steady dividend payer, a member of the S&P/TSX composite index and a global player that has the unique distinction of being a big operator in Cuba. Greedy for yield? Then consider these bonds as a definitive example of the risk-reward balance in high yield.

More Related to this Story

High-yield bonds are issued by companies with credit ratings outside the top tiers – below BBB, in technical terms. To attract investors, these companies must offer yields that are double or even triple those of governments and blue-chip companies. The smart way for investors to buy high-yield bonds is through a diversified mutual fund or exchange-traded fund, and there are plenty of options. But adventurous investors may finding it rewarding to buy individual high-yield bonds.

Full disclosure: Several years ago, I bought some Sherritt bonds for an account I look after and, sadly, they’ve matured. We were all very happy together. Might I buy some more? It’s possible.

The argument in favour of these bonds is the 8-per-cent coupon. That’s 8 per cent based on the price of the bonds when first issued. In today’s interest rate environment, demand for the 8-per-cent coupon has pushed up the price of the November 2018 bonds to roughly $106 per $100 of par value (the amount you get at redemption). In other words, it would cost approximately $5,300 to buy Sherritt bonds that will pay $5,000 on maturity in November, 2018.

If you factor in both the premium price and the 8-per-cent coupon, you get a yield around 6.5 per cent. That’s a midweek quote from Scotia iTrade, one of a minority of online brokerage firms that offer high-yield bonds to clients.

For context on that Sherritt yield, let’s look at what some blue-chip corporate bonds maturing in 2018 are yielding. There are some Great-West Lifeco and NBC Asset Trust bonds at 3.3 per cent, and some TD Capital Trust bonds at 2.8 per cent. NBC is connected to National Bank of Canada, TD Capital Trust to Toronto-Dominion Bank.

If you want bonds backed by companies as solid as a big bank or insurance company, you’ll get yields no better than the low 3-per-cent range. Sherritt will double that, but what’s the risk?

Let’s take a closer look at Sherritt, which is an interesting company. It’s a nickel miner with operations in Canada, Cuba, Indonesia and Madagascar, it’s Canada’s largest coal producer and it’s the largest independent energy producer in Cuba. The company’s shares have been kicked around by investors – they’re down about 7.5 per cent this year and a cumulative 14 per cent over the past three years. Still, the consensus rating from stock analysts is “buy.”

The bond rating agency DBRS rates Sherritt bonds at BB (high). Here’s how DBRS describes a rating in the BB zone: “Speculative, non-investment-grade credit quality. The capacity for the payment of financial obligations is uncertain. Vulnerable to future events.”

DBRS says in its most recent report on Sherritt, dated April 2, that the company’s strengths include diversified, low-cost resource holdings that have produced positive earnings before interest, taxes, depreciation and amortization over the past 10 years, including the 2008-09 downturn. Challenges include political uncertainties related to its businesses in Cuba, volatile commodity prices and costs associated with ramping up the Ambatovy nickel project in Madagascar.

The question all bond investors want answered is how confident they can be that they will receive their semi-annual interest payments and get their money back on maturity. DBRS says Sherritt’s long-term credit profile is expected to improve. But the company “is expected to be challenged in maintaining relatively stable credit metrics over the next two years as Ambatovy spending continues, albeit at a reducing pace, and lower expected average commodity prices strain operating cash flow.”

The ultimate comment on Sherritt’s creditworthiness is the high interest rate required to find buyers for its bonds. On the positive side, the company was able to issue more bonds recently with a coupon of 7.5 per cent.

Now for a few more words of caution about these and any other high-yield bonds. For one thing, they are quite vulnerable to economic or financial market turmoil. In dire conditions, you might not be able to sell them at anything close to a reasonable price, if at all.

Two, they’re like most bonds today in that they’re trading at premiums to their par value. The high coupon compensates you for the fact that these bonds mature at less than you paid for them, but this kind of a loss is still a turn-off to some investors.

Another consideration is the fact that these bonds mature almost six years from now. The sooner a high-yield bond matures, the lower the risk investors take on. Sherritt has another bond issue in the marketplace that matures in November, 2017, and its yield this week was about 6.5 per cent. There are also Sherritt bonds maturing in September, 2019, and September, 2020 – they both had yields in the area of 6.9 per cent.

A logistical challenge for do-it-yourself investors interested in high-yield bonds like those issued by Sherritt is that many online brokers don’t sell them. Reasons for excluding these issues include the illiquidity of the relatively small Canadian high-yield market, a claim that is backed up by the slim pickings when you search broker inventories. Aside from Sherritt, the only high-yield bonds I could find were from Bombardier Inc. and Atlantic Power LP, all rated BB.

The upside of this shortage of high-yield bonds is that investors can’t over-indulge. One or two issues mixed with government and investment-grade corporate bonds is sensible.

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What’s Available in High Yield

The online bond inventories of the 12 firms covered in The Globe and Mail’s annual ranking of online brokers were checked this week for high yield bonds. High yield bonds are in strong demand right now, so there wasn’t much available. Here’s what did turn up:

Qtrade Investor

 

Issuer

Coupon

Maturity

Ask Price

Ask Yield

DBRS Rating

 

Atlantic Power L.P.

5.95%

2036-June-23

74.500

8.47%

BB

 

Bombardier Inc.

7.35%

2026-Dec-22

106.000

6.68%

BB

 

Sherritt International

7.50%

2019-Sept-24

103.250

6.89%

BB (high)

 

Sherritt International

8.00%

2017-Nov-15

106.250

6.49%

BB (high)

 

       

Scotia iTrade

 

Issuer

Coupon

Maturity

Ask Price

Ask Yield

DBRS Rating

 

Bombardier Inc.

7.35%

2026-Dec-22

106.000

6.68%

BB

 

Sherritt International

8.00%

2018-Nov-15

106.375

6.46%

BB (high)

 

Sherritt International

7.50%

2020-Sept-24

103.375

6.87%

BB (high)

 

       

Virtual Brokers

 

Issuer

Coupon

Maturity

Ask Price

Ask Yield

DBRS Rating

 

Atlantic Power L.P.

5.95%

2036-June-23

74.500

8.47%

BB

 

Bombardier Inc.

7.35%

2026-Dec-22

106.000

6.68%

BB

 

Sherritt International

8.00%

2017-Nov-15

106.375

6.46%

BB (high)

 

       

Terms explained:

Coupon: The interest payout based on the issue price

Maturity: The date the issuer will redeem the bonds

Ask Price: The price a seller is asking, with 100 representing the par value, or redemption price

Ask Yield: The investor's yield based on the coupon and the ask price

Source: The Globe and Mail

 


For more personal finance coverage, follow me on Twitter (@rcarrick) and Facebook (Rob Carrick).

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