Bargains in B Ratings
Marilyn Cohen, Forbes Magazine, 09.02.09

Find bonds from companies with good managers operating in businesses with the economic winds at their backs.

Attention, bond investors. the rally in the bond market--including the one in munis--is making it harder to find bargains. Prices are up; yields are down; spreads have narrowed. Institutions and individuals have been on a buying binge. Fixed-income investors have reason to be encouraged by improving corporate balance sheets. They're looking stronger every quarter. Pointless share repurchases are out, as are ego-driven, debt-funded acquisitions. Cost-cutting, dividend slashing and raising equity to pay down debt are back in vogue. It's a blissful environment for most bondholders.

The last time corporations went on a Slim-Fast diet was after the tech wreck in 2000. I don't think this newfound sanity will last forever, so please join me in selectively buying into it while it lasts.

Here are two of my rules for corporate bond buyers: Buy the bonds of companies that will benefit from the economic rebound and find companies whose management have demonstrated that they were swift and agile in handling the recent recession. Chances are, smart managing during the downturn will continue as we head into the up cycle. In short, find bonds from companies with good managers operating in businesses with the economic winds at their backs.

With this in mind, I am buying Jefferies Group 8.5s due July 15, 2019. They trade at 103.06 to yield 8.04% to maturity. That's 4.5 points over the ten-year Treasury bond. This $400 million issue, rated BBB, will serve your portfolio well. Like most investors during the frenetic financial meltdown, I swore I'd never buy financials again. I am changing my mind.

Jefferies has not only survived, it has thrived. While the market focused on the likes of Goldman Sachs, Bank of America and Morgan Stanley, Jefferies revamped its management, raised capital, became a primary dealer and attracted talent that fled other firms. In terms of sales and trading, Jefferies has become an impressive David in the land of discredited Goliaths.

If the ten-year Jefferies bond is too long for you, then buy Leucadia National bonds, due in four years. The New York City holding company invests in insurance, real estate, telecom and manufacturing. For years Leucadia National has been known as a miniature Berkshire Hathaway. And, just like Berkshire's, Leucadia's second quarter was good; profit doubled to $411 million from $187 million even though revenue declined. Leucadia also owns a 14% stake in Jefferies. In 2008, when Jefferies was bleeding losses and raising capital, Leucadia shrewdly bought into its current position. Leucadia's bond credit quality is weaker than Jefferies'. The 7s of Aug. 15, 2013 are rated slightly below investment grade at BB+. The $344 million Leucadia issue matures before the company's largest debt issues mature in 2015 and 2017. Also, Leucadia's equity stake in Jefferies is locked up for two years and cannot be sold without board approval. The Leucadia bonds are priced at 97 for a yield of 7.89% to maturity.

Next, to benefit from pent-up shopping demand, take a position in department store chain Nordstrom, a strong player in a weak industry. Nordstrom's same-store sales were down 9.8% in the second quarter from 2008. In the year to date total sales are down 7.6%. But this company has a tremendously loyal customer base--just ask any woman who shops there. When the economy corrects, you will hear the high heels clattering through its stores.

Buy Nordstrom's 6.25s due Jan. 15, 2018. The BBB+ issue size is $650 million. Priced at 101, the noncallable bonds yield 6.02% to maturity. Maturities of debt, including the revolving line of credit, are widely spaced: 2010, 2014, then our 2018 date. A small uptick in retail sales, especially in the West, which represents 52% of their operations, will do wonders for Nordstrom's income statement.

Finally, here's an offbeat recommendation for both your taxable and tax-deferred cash. In September California will issue $10 billion of 8- to 9-month revenue anticipation notes. My guess is the yield will be from 2% to 2.25%. This nominal yield will beat the socks off both your tax-free and taxable money market funds, which currently yield from 0.01% to 0.20%. Buy these municipals as a money market or CD substitute. There will be a two-day retail order period that gives individuals first priority over the institutions, so take advantage of it.

Marilyn Cohen is president of Envision Capital Management, Inc., a Los Angeles fixed-income money manager. Visit her home page at www.forbes.com/cohen .