2 Comeback Corporate Bonds

02/06/2012 7:45 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

In this kind of environment, there are some great bond bargains out there…if you know where to look for them, writes Marilyn Cohen of Bond Smart Investor.

Goodyear Tire (GT), a past recommendation, is evolving even though the company forecasts soft global volume. Sales are up, margins have improved, and pricing power has improved because rubber prices are down 36%. And all of this is on the back of low volume.

Remember that Goodyear sells a lot of high-margin, high-performance tires. Many people who can’t or won’t commit to buying or leasing new cars must maintain their existing vehicles. Upgrading to cool-looking, high-performance tires is one way they are coping with their economic reality.

Anecdotally, the average age of cars and light trucks on the road is 10.6 years, according to Ford (F) economists.
So it’s not just the high-performance sector that’s keeping Goodyear running. The company operates commercial truck service and tire-retreading centers as well as produces rubber-related chemicals.

Unfortunately, the 800-pound gorilla is Goodyear’s underfunded pension plan. It is a work in process. The company is slowly making progress and is expected to double its 2012 contributions to catch up.

If you haven’t purchased the Goodyear Tire 10.5% due May 15, 2016 callable May 15, 2012 that we previously recommended—don’t. You’ve waited too long. At 1.92%, the yield to worst call isn’t worth it. That’s why we moved our recommendation from buy to hold.

However, there is hope. The 8.25% due August 15, 2020 callable August 15, 2015 @ 104.135 (CUSIP:382550BB6) is worth it. Its price has also moved up since our original recommendation. I reiterate, Goodyear remains a strong buy.

On the other hand, the Boston Scientific (BSX) 4.5% due January 15, 2015 Non-Callable (CUSIP: 101137AJ6) is one only for those investors with cast-iron stomachs.

BSX develops and manufactures medical devices—stents, catheter systems, infusion devices, endoscopy equipment—all the stuff we all need as we age. The company will benefit greatly when Johnson & Johnson (JNJ) exits the stent business.

Nevertheless, the company isn’t relying on just stents for its growth. BSX plans to launch new defibrillators in 2012 and 2013 if the FDA approves. Moreover, BSX is going heavily into emerging markets like China, Brazil, and India—all of which have growing middle classes.

BSX paid down $1.2 billion of debt in 2011 via asset sales. Analysts are projecting roughly $1 billion of free cash flow in 2012. The good news is that BSX’s new President and CEO is Michael Mahoney from Johnson & Johnson. Hopefully, he’s the right person to stop BSX profit margins from eroding and clean up the tax and legal problems the company has.

This is a slowly evolving turnaround if it happens. Moody’s thinks these bonds are junk. Standard & Poor’s and
Fitch both say BSX is on the last rung of investment grade (BBB-). We agree with Moody’s that they are junk bonds.

The new CEO will have to maintain leverage ratios around 2.0x to 2.5x, generate free cash flow, and stop the margin erosion. These are all possible if Mahoney is up to the challenge. We think it’s worth the risk.

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