Yield Under the Hood

07/07/2010 11:49 am EST


Carla Pasternak

Editor, The Income Investor

Dollar-denominated interest payments on Daimler’s debt are a wunderbar deal for investors, writes Carla Pasternak in High-Yield International.

Investment grade rated fixed income is at historically cheap prices and high yields right now. The average credit spread (the difference in yield from ten-year treasuries) is at 213 basis points, well above the historical average of 151 basis points.

This particular income security currently pays a stellar 7% yield. Moreover, it's backed by a company that sells one of the world's most iconic brands, and business is booming. So if you're looking for a high relative return on safe money, this unusual issue might be just the thing.

Daimler 7.25% Trust Certificate (NYSE: PYO) is a trust preferred stock of German auto-maker Daimler AG (OTC: DDAIF). Merrill Lynch created these third-party trust preferred securities from Daimler's 8.50% bond that matures in 2031. Merrill purchased the bonds and repackaged them as preferred stock with a $25.00 par value and a 7.25% coupon.

Daimler is the maker of the world-renowned Mercedes-Benz brand and one of the world's largest auto manufacturers. Revenues of EUR 79 billion in 2009 were derived from Western Europe (46%), United States (21%), and Asia (15%), including China (5.5%). Primary revenue contributors were Mercedes-Benz cars (51%), Daimler trucks (21%) and Daimler Financial Services (15%), which provides financing and leasing services.

These securities mature in 2031 and are callable any time at $25. Annual interest payments of $1.8125 per share are made in two semi-annual distributions of $0.90625 on January 18th and July 18th.

The securities make interest payments, which are taxed as ordinary income, and payments are made in US dollars, so there is no currency risk. Based on the latest treaty arrangements, the income may also be exempt from withholding tax if held in an IRA type of account.

Daimler has a reasonable amount of debt for a large auto maker. PYO is rated A3 (Moody's)/BBB+ (Standard & Poor's), indicating high security.

Daimler helped itself in 2007 by spinning off 80% of Chrysler before the financial crisis and freeing itself of tens of billions of euros in pension and health care liabilities. In addition, the company's restructuring and cost reduction initiatives have made it leaner and meaner. [After losing money in 2009], Daimler swung to a solid profit in the first quarter of 2010.

On the surface it may appear that Daimler's sales would be hurt by the current debt crisis in Europe. On the contrary, the falling euro has been an absolute boon for sales overseas. The euro, which traded at $1.50 in December, has fallen to $1.22 against the dollar today.

The main risk for the preferred securities is interest rates. As rates rise, the price of bonds and preferred stocks typically fall so that the yield rises to meet current rates of competing products. However, rising rates might be a ways off. This is a weak recovery after a steep recession. The Fed has reiterated that rates should remain low for "an extended period."

PYO offers a rock solid and secure 7% yield that is protected from currency volatility. The shares also offer some price appreciation reflecting the company's improved performance.

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