Corporate bonds

How to profit from downgraded corporate bonds

It is fascinating to study mergers and acquisitions which have turned out to be huge blunders. So often the timing was horrible and the overpayers had no limits. When a bond’s rating changes from investment grade to undesirable, we call those fallen angel bonds.

Occidental Petroleum

OXY
the acquisition of Anadarko Oil

APC
in 2019 ticks all the boxes of such an inconvenient and overpaid purchase. This management team should have known better. This formerly rated investment company saw its bonds downgraded to junk following the acquisition of Anadarko. New bonds were sold to help pay off Anadarko, adding tons of additional debt to Oxy’s balance sheet.

Fast forward to today’s high oil prices. Now, between asset sales and debt repayments, Occidental is emerging from the junkyard. Will the company return to investment grade over time? Our bet is yes. The closer it gets to investment ratings, the yield spread between each Western bond and its comparable-maturity Treasury bond will narrow, boosting the price of Oxy’s bond. And maybe make him a fallen angel worthy of investment.

Of course, it’s a bet that management will continue to reduce debt. But so far, they have stuck to their plan. Take into account Occidental Petroleum 8.50% deposit due on July 15, 2027 (CUSIP: 674599DZ5). Ba2, BB, BB and price of 125.25 for a yield of 3.22% at the worst call of January 15, 2027 and of 3.60% at maturity seven months later.

Worried that the bonds will be deposited? They have a full catering provision that will make you whole. See my Forbes column from April 20, 2021 on Make Whole Provisions for more information.

It’s hard to find a yield above 3% on a bond that will move down the yield curve quickly. Does this idea of ​​obligation entail a risk? Yes of course. Oil prices could drop significantly. The debt reduction promised by Oxy could suddenly stop. Interest rates could rise 2-3% with a flick of the Fed’s wrist. To me, these possibilities seem unlikely. Yet nothing is ever 100% certain.

Other companies whose corporate bonds are fallen angels trying to get back to investment grade are: Dell (DELL), Ovintiv

OVV
, an energy producer of petroleum liquids and natural gas, Ford (F) and Brand Newells

NWL
, to name a few with the possibility of upgrades.

I’m not suggesting an entire portfolio of fallen angels. But a few strong names will definitely improve your overall performance.