Lehmann's Look at Yields

05/19/2006 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

From high yield debt to convertibles, from preferreds to income trusts, Richard Lehmann is as knowledgeable about income-generating vehicles as any advisor I have ever followed. Here’s a sample of the wide breadth of his income-oriented advice.

"Canadian oil and gas trusts caught my attention in mid-2004 and have never disappointed. Their strong momentum reflects the energy industry in general, but also, they are finally being broadly recognized as an asset class for income-oriented investors. At current price levels, investors should probably take a pause since price run-ups are getting a little rich. For the long-haul, however, they should not be viewed as high risk, but rather as an important diversification to otherwise interest rate-dependant portfolios.

"Penn West Energy Trust (PWTFF Other OTC), which yields 9.20%, just recently agreed to buy Petrofund Energy Trust (PTF AMEX) and will issue 0.6 units for each Petrofund unit plus $1.00 (Canadian) per unit when the deal is completed. In addition, Penn West holders will receive 0.2 shares per unit of Exploreco, a spin-off company, and Petrofund unit holders will get 0.12 shares. This combination will create the largest conventional oil and gas trust in North America. Penn West expects to trade on the NYSE upon completion of the purchase that is expected in July.

"If the closing of the deal proceeds as expected, Petrofund unit holders will receive their first $0.34 distribution plus a special $0.10 distribution to align payment dates. Penn West is a strong well-managed trust, with significant opportunities for unconventional growth including the Peace River Oil Sands Project. This merger is good for both trusts; thus, I suggest unit holders of both trusts continue to hold their positions. Petrofund unit holders can round out their positions after the combined trust starts trading on the big board. Buy at or below $38.00.

"Since a rising rate environment is likely to be with us for some time, you may want to look at some instruments that can provide protection against these increases. Looking at our list of past recommendations, there are several which fill the bill. For example, previously, I recommended the adjustable IBM Synthetic Fixed Income Strats (GJI NYSE), which yields 4.8% and is tied to the three-month T-bill rate plus 50 basis points and resets monthly. This is a good vehicle to park money in until the Fed is finished raising short-term rates since it will follow short-term rate hikes.

"Another issue I like for those who like something a little more exotic is a Freddie Mac Variable Rate Perpetual Preferred (FRE L NYSE), which is adjustable every five years based on a five-year Treasury index. The next reset isn’t until December 31, 2009, so you might suspect that this issue hasn’t provided much protection and that’s true for anyone who bought it at par.

"At the current price of $38.40 it pays 3.58% and yields 4.7% of QDI income. The real attraction, however, is that as we move toward 2009, the price of the security should migrate back to its $50 par value in anticipation of the payout being reset to a market rate. That would be a 30% capital gain on top of a low tax yield. Not bad for an AA-rated security. The issue is thinly traded so be patient and buy under $40.

"General Motors and Ford preferreds are special situations for income investors. GM is not out of the woods, but it certainly hit bottom in December, price wise, due to tax related selling. Ford’s problems are not as severe and it’s still making money so its turnaround is highly probable. My prediction, and I don’t say this lightly: in 30 years of mostly successful investing in junk bond securities I have never felt more confident of a positive outcome than with the GM and Ford situation.

"While there are numerous GM and Ford issues, my favorite in the group is the Ford Motor Capital Trust II 6.5% $50 convertible preferred (F-S  NYSE). This issue presently sells for $28 for an 11.6% yield. It is convertible until 2032, or long after my children inherit this stock. The 2.82 shares of stock it converts into may take a few years to recover, but the good news is this preferred, at the $28 buy price, goes at least dollar for dollar with the stock once Ford recovers to $9.91 a share. If that takes five years, fine. I can live with an 11.6% yield in the meantime."

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