There are many challenges for a do-it-yourself investor who wants to buy a bond like Sherritt, which offers an enticing 8% coupon, writes Rob Carrick, reporter and columnist for The Globe and Mail.

In a world where a virtually risk-free five-year Government of Canada bond yields 1.3%, it's hard to take your eyes off Sherritt International's (Toronto: S) 8% 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.

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 favor of these bonds is the 8% coupon. That's 8% based on the price of the bonds when first issued. In today's interest environment, demand for the 8% 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% coupon, you get a yield around 6.5%. 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 (Toronto: GWO) and NBC Asset Trust bonds at 3.3%, and some TD Capital Trust bonds at 2.8%. NBC is connected to National Bank of Canada (Toronto: NA), TD Capital Trust to Toronto-Dominion Bank (TD).

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% range. Sherritt will double that, but what's the risk?

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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% this year and a cumulative 14% over the past three years. Still, the consensus rating from stock analysts is "buy."

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 ten 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%.

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%. There are also Sherritt bonds maturing in September 2019, and September 2020-they both had yields in the area of 6.9%.

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 (Toronto: BBD.B) and Atlantic Power (AT), all rated BB.

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

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