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Generally speaking, companies with solid financial positions make safer investments than those with weak balance sheets. Although this may seem obvious, it follows that investors in higher-quality companies are more assured of dividends and interest payments. This makes sense, as financially strapped companies would likely have more difficulty making payments to bond holders and shareholders than a company with an iron-clad balance sheet.

That said, convertible notes and convertible preferreds issued by high investment-grade companies are generally viewed as less likely to default on their obligations and, thus, are often expected to offer lower coupons and small yields when compared to weaker companies. Again, on the surface, this makes a great deal of sense, since the higher coupon would compensate for the added risk that comes with the potential for not being paid.

This quality/yield dynamic, however, isn’t always the case. Indeed, there are some high-quality issues, such as Alaska Communications (ALSK), Universal Corporation (UVV), and Apollo Investment (AINV), that all have high-yielding convertible bonds and/or preferred stocks (a brief overview of each is below the table). So, investors need not give up quality to get a higher yield in all cases. Still, investors need to be picky. Below is a short list of high investment grade convertible securities in our universe that defy the common logic by offering a high yield as a starting point for further research.

 

Conv

Recent

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

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

Convertible Securities

Symbol

Price

 Yld

YTM(%)

Prem (%)

Price

YLD(%)

Ticker

Alaska Commun 6.25s2018 (144A) 

      

63.19

9.9

16.4

108

$3.12

27.6

ALSK

Callaway Golf $7.50 B          

ELYZP 

$120.75

6.2

 PFD

21

$7.01

0.6

ELY

Health Care REIT $3.25 Series I

HCN I 

$52.67

6.2

 PFD

15

$53.93

5.1

HCN

Universal Corp $67.50          

UVVZP 

$1,120.07

6.0

 PFD

12

$46.32

4.1

UVV

Fifth Third Bancorp $8.50 G    

FITBP

$142.49

6.0

 PFD

22

$13.48

0.3

FITB

Fifth St. Fin 5.375s2016 (144A)

      

91.4

5.9

8.0

35

$9.96

12.8

FSC

Apollo Investment 5.75s2016    

      

98.32

5.8

6.4

92

$7.05

15.9

AINV

Ares Capital 5.75s2016 (144A)  

      

105.72

5.4

4.2

23

$16.46

8.5

ARCC

National Healthcare $0.08 A    

NHC A 

$14.89

5.4

 PFD

35

$45.46

2.5

NHC

Affil'd Managers $2.55         

AMGZO 

$49.75

5.1

 PFD

40

$107.06

 NIL

AMG

*Prices as of 3/8/2012

 

Highlighted Convertibles:

Alaska Communications Systems Group 

Alaska Communications Systems Group provides leading integrated communications services in Alaska. Its wireline and wireless networks extend throughout the state and into the Continental United States via two undersea fiber optic cable systems. The wireline business is one of the most comprehensive in Alaska. The wireless segment includes a state-wide, third-generation (3G) network.

Alaska Communications managed to eke out a profit in 2011. The company reported a gain of $0.05 a share versus a $0.01 loss incurred the year before, as revenues inched up 3%. The company is likely to see further improvement in its bottom-line, especially if the build out of its 4G LTE network progresses as scheduled.

ALSK 6.25% convertible note due 2018 offers a 9.9% current yield and about 16% to maturity. The yield from the deeply discounted note is no match to the dividend yield from the common stock, but if the company falls into financial distress, the common dividends are usually the first expense to get cut. The convertible is also much more price-stable than the common.

Universal Corporation

Universal Corporation, formerly Universal Leaf Tobacco, is the largest leaf tobacco exporter/importer in the world. It conducts business in more than 35 countries and employs more than 25,000 permanent and seasonal workers. The company engages in the purchasing, processing, and selling of tobacco to cigarette, pipe tobacco, and cigar manufacturers.

UVV showed weakness in its latest quarterly report (December 31, 2011; Fiscal year ends March 31, 2012).  In addition to an oversupply of tobacco, the company faced many challenges that resulted in a 2.3% drop in sales during the period, but net earnings rose over 10%, to $1.81 a share. However, Value Line expects more softness in the final fiscal period which could result in earnings being about 25% below fiscal 2010 figures. Still, the common dividends were increased as the company lives up to its promise of boosting the payment annually, and has done so for 41 straight years.

The convertible preferred offers a 2.0% current yield advantage over the stock. It is favorably leveraged and should share in as much as 70% of any gains in the common, while providing solid downside protection. If the common should fall, the preferred should decline only 28% as far as the common does.

While common shareholders are rewarded annually through dividend increases, preferred dividends are secured since they are paid before common dividends. So, should the company come up for dissolution, preferred holders will benefit before common shareholders are considered.

Apollo Investment Corporation

Apollo Investment Corporation is a specialty finance company. It invests primarily in middle-market companies with annual revenues of $50 million to $2 billion. Investments are in the form of mezzanine and senior secured loans. The company makes direct equity investments, as well.

Apollo has experienced sluggish quarterly performances over the past few quarters, especially in the second quarter (ended September 30, 2011) of the current fiscal year when it reported a $1.36-a-share loss. A turnaround occurred in the following period when the company recorded a $0.20-a-share profit, but Value Line still estimates that the company will finish the fiscal year (ends March 31, 2012) on a negative note.

The more price-stable convertible bond matures on January 1, 2016. Currently, it trades near both its par value and investment value, and offers a 6.0% current yield and a 6.9% yield to maturity. Common dividends were lowered from $0.28 a share to $0.20 in the fourth fiscal quarter for a yield of about 10%. But more cuts could materialize in the future as the company struggles through a slowly rebounding U.S. economy.



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