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Subject:  Re: Sara Lee Medium Term Bonds Date:  7/9/2011  4:03 PM
Author:  charliebonds Number:  33047 of 37023


OK, I’ll play with you, given that I have to be at my desk anyway, rotating a newly-built fly rod in a drying rack 180 degrees every 10-15 minutes while a coat of epoxy on the guide-wraps cures enough so that it won’t sag.

You’re thinking about buying Sara Lee’s 6.125’s of ’32. If you go five, then commish would add $2/bond (if the trade were done through E*Trade). Let’s say you could get in next Monday at your target price of 93.500. Settlement would be the 14th. So let’s compute yields from then. The nominal YTM is going to be 6.68%. So the question to ask is this: “In today’s market and interest-rate environment, is 6.7% an appropriate yield for a long-dated, Baa1/BBB/BBB issue (assuming the ratings are creditable)?

The first step, always, is to pull a chart of the bond’s recent prices (at FINRA or similar). What you see is that price began falling around last September, traded sideways most of Spring, spiked in April, and then rolled over again to where it now is. So that’s one of the thing you need to explain to yourself. Why is this bond behaving the way it is? To my eye, the chart is worrisome. Now pull a chart for the stock. Compared to presumed competitors like Kellogs and General Mills (both of which have mostly traded sideways since the launch of September’s rally), SLE is tracking the broad market, suggesting that the stock guys, at least, aren’t worried. And a lowly 1.7% short ratio confirms that.

The stock guys aren’t worried. But the price action of the bond suggests that bond buyers don’t want these bonds. (Confirmed by the sizes of the current offers for Sara Lee’s four issues). That should worry you. This isn’t to say that the crowd is right, only that if you intend to make a contararian play, you had better know (or at least strongly suspect) why you might be right and why they might be wrong. “Who’s your counter-party?” That’s a question you always need to ask yourself.

Now do something as simple and unimaginative as taking a quick look at their balance sheet for the last four quarters and look at just two items: Net Receivables versus Accounts Payable. That’s ugly. They can’t meet current expenses from current revenues. Now look at another pair of numbers: Total Liabilities versus Total Assets (minus the fluff like ‘Goodwill’ and ‘Intangibles’). Again, the picture is ugly. They have a negative net-worth, meaning, should they file Chapter 11, the bond-holders are going to take a haircut. So that’s a number that needs to be estimated. “Just how bad might the downside be?” So the game a would-be buyer of these bonds is implicitly playing is this:

Risk = Likelihood of the most favorable event (aka, maturity) times the Magnitude of the event (a YTM of 6.7% over the holding-period)

divided by

the Likelihood of a downside event (aka, a Chapter 11 filing) (aka, around 13%) times the Magnitude of the event (aka, the workout-price, which might be $0.30-40 cents on the dollar, at best).

Frankly, I think the deal sucks majorly. Or as Jack would say (and could back up by better fundamental work than I can do):

“A favorable reward/risk ratio doesn’t exist at the current price.” (IMHO, ‘natch)

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