Leucadia: The "Little Berkshire"

03/26/2004 12:00 am EST


Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

How can you play rising rates? Marilyn Cohen, president of Envision Capital and columnist with the prestigious Forbes magazine says, "When the Fed tightens–and it will–don’t bail out of bonds. Think junk on the mend, such as Leucadia, the 'little Berkshire'."

"With interest rates not far above the rock bottom, bond portfolios did fairly well last year. Junk bonds did particularly well. It won't last. Rates can't stay this low for much longer. A 1% Federal funds rate is too low for an economy growing at a 4% annual clip. And even before the Fed tightens, a new generation of bond vigilantes will begin work. Result: weak bond prices.

"This gathering storm, however, doesn't mean you should abandon bonds. There are still some wise moves to make. In junk the sweet spot is at the high end of the credit quality spectrum. Go for corporates that stand a good chance of getting an upgrade to investment quality (meaning BBB or better). Near this borderline between junk and investment grade you can pick up almost a three-point yield spread over Treasuries, meaning a ten-year corporate will yield close to 7%. Look for issuers with improving business performance and with balance sheets that have already benefited from lower rates.

"A good example is Leucadia National (LUK NYSE), known as ‘the little Berkshire Hathaway' ’for its potpourri of businessesbanking, winemaking, insurance, mining. Run by the same consistent management team for years, profitable Leucadia has a long history of integrating new acquisitions. With an improving economy, earnings will continue to advance. This borrower is right on the borderline, with a split rating: Moody's rates its bonds Ba1, or high-grade junk, while Standard & Poor's rates them BBB-, the lowest investment-grade rating. Two issues interest me, the Leucadia National 7.75% and 7.0% coupons both maturing Aug. 15, 2013. The 7s, issued last year, are priced at 103 to yield 6.6% to maturity. The 7.75s, issued in 1993, are priced at 106 to yield 6.9%. And get this: Both are noncallable. Despite Moody's rating, I think your principal is safe."

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