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A Great Bond for Your Portfolio

09/29/2011 8:30 am EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Picking the bottom is just as rewarding…and just as challenging…for bond investors as it is for stock investors, and we think we’ve found one, writes Marilyn Cohen of Bond Smart Investor.

Bond investors, like every other investor, look for companies that have reached bottom and launched into an uninterrupted upward trajectory. Catching such companies on the upswing is difficult. Mostly, it takes a lot of luck.

However, we think we can augment that luck with some intelligent analysis. There are some lessons learned from previous successes that you can generalize and apply to other companies.

A good example of a successful turnaround is Wynn Las Vegas (WYNN) bonds. Since 2010, we’ve recommended Wynn Las Vegas first mortgage bonds on each of the platforms Marilyn is seen: Forbes, MoneyShows across the country and at AAII meetings. We see few better turnaround examples than Wynn Las Vegas.

Here are the things we analyzed when investigating Wynn and adding it to our recommendations.

Lesson No. 1: Take What You Want and Leave the Rest
Wynn is a large, complex company. It has lots of interests scattered around the world’s top gaming and resort areas, each funded by separate bond issues.

We had no interest in most of it. We wanted just the Las Vegas property (specifically, their first mortgage bonds), because that was the one poised for a major turnaround. Though its Macau property is also enjoying robust success.

Lesson No. 2: Don’t Wait for the Rating Agencies
We first recommended Wynn Las Vegas bonds this time last year. Yet, Fitch Ratings finally got around to raising Wynn’s rating from BB- to BB on July 8, 2011.

As much as possible, stay ahead of the rating agencies. When you see the performance indicators you’re looking for, make your decision and execute.

Lesson No. 3: Position Yourself for a Rating Upgrade
If you follow Lesson No. 2 and the rating agencies eventually upgrade, the value of your holdings will likely increase.

In the case of our Wynn example, we did benefit from the recent upgrade to BB. But we hope the upgrades are not over for this name.

We don’t mind Wynn’s 6x leverage, since the company’s first mortgages secure our bonds. However, with a 6x leverage, it would be tough for all three agencies to raise Wynn again to investment grade. That’s why the company is split-rated with Moody’s giving it a Ba3 rating and S&P giving it an investment grade BBB- rating.

Nevertheless, another rating upgrade could happen if management recapitalized the company, replacing the secured debt with unsecured. Wells Fargo analyst Dennis Farrell agrees with us, saying, “…there’s a high probability Wynn will get to investment grade. They would be the first Las Vegas-headquartered gaming company to get back to investment grade."

With our current Wynn recommendations, we’re well positioned to benefit should another rating increase occur.

NEXT: Lesson No. 4: Go with the Leaders


Lesson No. 4: Go with the Leaders
We view the industry leader or market leaders as less risky. Granted, if you select a lesser company that turns in stellar performance, your ride to the top may be higher and faster. However, the probabilities of that happening are less than they are when going with the market leader.

We recognized that Wynn Las Vegas had EBITDA that outperformed all of its peers in seven of the last nine quarters. Further, to ensure their place at the top, Wynn has two night clubs coming on line shortly, and a new room-remodeling project at the hotel.

Another point for the leaders is that dominant market players often have a significant market share. There is a margin of error that those further in the back of the pack do not enjoy.

Wynn Las Vegas is one of just five high-end choices (Bellagio is second, then Las Vegas Sands, Caesars, and MGM) for the best properties.

Lesson No. 5: Watch for Signs of Industry or Market Turnaround
These are what drive major upticks in performance. Companies with the previous four attributes will leverage off of industry and market turnaround because they have positioned themselves so well beforehand.

The resort and gaming industry in Las Vegas happens to be fairly easy to analyze because the numbers are so accessible. There has been a noticeable increase (11%) in the international, convention, and group revenues on the Las Vegas strip.

For high-end properties like Wynn, this is part of the engine driving its turnaround. Some other indicators peculiar to the gaming industry that foretell the turnaround include:

• Revenue by particular game, such as baccarat, slot machines, and table games
• Enplanements—the number of airplanes carrying resort goers into Las Vegas

However, each industry has its own foretelling statistics. Identify them and follow them. If you can’t figure out what to look for, then get one of the securities analyst or rating agency’s reports. They have it all laid out for you.

Lesson No. 6: Watch Financial Indicators
We want to see a stable or improving debt coverage and stable liquidity. Like most bondholders, we do not appreciate leveraged stock repurchases or debt-financed M&A activity.

We oppose the special dividends declared by Wynn’s board. This reduced available cash reserves. Cash fuels any company’s turnaround. We bondholders must know there is sufficient cash to fund the company’s performance improvement.

Wynn is a name we follow. It should come as no surprise that we’re now recommending another bond issued by Wynn.

If you missed our recommendation on the Wynn first mortgage bonds maturing 2017 that we first recommended in September 2010 (and which we still have a HOLD on), don’t let this one get by you:

Wynn Las Vegas 1st Mortgage 7.75% bonds due August 15, 2020 (CUSIP: 98313OAR6) are callable August 15, 2015 at 103.88.

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