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Convertible bonds offer an interesting middle ground between a stock and a bond, and thus, an interesting mix of between risk and reward. In others words, convertible bonds can provide more upside potential than “non-convertible,” straight bonds (because of the ability to convert the security into equity) and more downside protection than stocks (because of the fixed-income nature of the security).

For investors seeking a high level of income, high-yielding convertibles might be a good option. Of course, a high yield often means increased risk. High-coupon convertibles are often issued by companies with questionable financial strength. These securities often trade below par, at which point they are deemed “busted.” As such, they provide only minimal exposure to the upside of the underlying stock.
 
Still, because of the bond component, so called “busted” convertible securities are higher up on a corporation’s ownership chain than stocks, providing more safety than an equity investment in the event of a bankruptcy. Moreover, assuming the financial condition of the issuing company improves, there is likely to be more upside potential in a convertible than in a straight bond issued by the same company. And, if performance improves enough, the convertible’s value could rise above par, allowing it to reflect more of the stock’s price performance.

Below is an abbreviated list of convertible bonds with coupon rates of 10% and higher in our survey. The list contains both “busted” convertibles and those trading above par value. Convertibles trading above par will offer more meaningful exposure to the fluctuations in the common stock of the issuing company, while providing decent income for above-average total returns.

 

 

<-------------Convertible--------------->

<--------Common--------->

Convertible Securities

Recent Price*

Curr Yld(%)

Y-to-M(%)

Ticker

Price*

Yield(%)

NorthStar Realty 11.5s2013(144A) 

92.48

12.4

17.6

NRF 

$3.48

11.5

Hutchinson Technology 8.5s2026 

69.41

12.2

13.8

HTCH

$1.72

 NIL

Geomet $0.80 A                 

$6.63

12.1

 PFD

GMET

$1.14

 NIL

China Med Tech 6.25s2016 (144A)

52.35

11.9

23.4

CMED

$5.00

 NIL

AMR Corp. 6.25s2014            

55.95

11.2

31.6

AMR 

$2.69

 NIL

ATP Oil & Gas $8.00            

$71.81

11.1

 PFD

ATPG

$10.08

 NIL

PMI Group (The) 4.5s2020       

41.25

10.9

19.3

PMI 

$0.31

 NIL

ATP Oil & Gas $8.00 B           

$75.35

10.6

 PFD

ATPG

$10.08

 NIL

Network Equipment 7.25s2014    

68.16

10.6

26.3

NWK 

$2.00

 NIL

Unisys Corp $6.25 A            

$61.87

10.1

 PFD

UIS 

$19.11

 NIL

 * Prices as of October 21, 2011

 

Highlighted Convertibles:

GeoMet, Inc. (GMET) primarily engages in the exploration for and development and production of natural gas from coal seams (coalbed methane, or "CBM") and non-conventional shallow gas. The company's principal operations and producing properties are in the Cahaba Basin in Alabama and the central Appalachian Basin in West Virginia and Virginia. GeoMet also owns additional coalbed methane and oil and gas development rights, principally in Alabama, Virginia, West Virginia, and British Columbia. As of December 31, 2010, the company owned approximately 160,000 net acres of coalbed methane and oil and gas development rights. For the first half of 2011, the company suffered a loss of $0.05 a share compared to earnings of $0.13 in the like period a year earlier.

The stock’s volatility exceeds market averages, and it pays no dividends. On the other hand, the company’s Series A convertible preferred is more price-stable and pays a quarterly distribution, albeit a relatively low $0.80 a year. And as long as the company remains viable, preferred dividends will be paid. Meanwhile, if the common price advances, the preferred stands to benefit.

Hutchinson Technology, Inc. (HTCH) is the leading manufacturer of suspension assemblies for (magnetic) hard-disk drives. Sales of these products contributed 98% to the company’s top line in 2010. Hutchinson has also developed a medical device that uses an optical technology to measure local oxygen saturation of hemoglobin in tissue.

The company recorded its seventh consecutive quarterly loss in the September period, bringing total losses for fiscal 2011 to $2.38 a share. Still, the highly volatile common demonstrates a wide price recovery potential if there is a sustained demand for its key products.

The convertible note trades with a high premium over conversion value, which limits its participation in the stock’s upside activities. On the other hand, downside protection is solid, as the convertible trades below investment value. With a 12% current yield and about a 14% yield to maturity, the convertible could be a worthwhile addition to income-oriented portfolios.

Network Equipment Technologies, Inc. (NWK) provides telecommunications equipment for multi-service networks and associated services. It offers voice solutions that include the VX Series and the Quintum Series of switching media gateways that provide enterprise customers with voice interoperability solutions; IP-based devices to government agencies; and traditional VoIP switching gateways. It offers multi-service solutions, including the Promina product line that enhances network reliability and security; NX1000 platform that provides a WAN switching solution to enable multi-service and serial data applications; and NX5010 line, which enables secure interconnection and extension of geographically distributed grid computing clusters and storage area networks for data transfer. NWK also has installation, maintenance programs, and Web-based services.

At this juncture, the stock is not an attractive lure, but should it return to its 2007 price levels, investors could realize a windfall. Still, returning to 2007 price levels calls for a doubling of the stock price. That could take some time, and the stock is very volatile with an above average Beta.

Investors willing to stay with the company may find its 7.5% convertible notes due 2014 to be a more attractive security. The convertible note currently yields 10.6%, and about a 19% yield to maturity. Also, should there be a turnaround in the stock, convertible holders are most likely to be rewarded.


At the time of this article's writing, the author did not have positions in any of the companies mentioned.