Merrill Lynch identifies converts with attractive risk/reward profile

By Ronda Fears

Nashville, Tenn., Aug. 30 - It is tougher to find convertibles with attractive risk/reward profiles and strong stock stories but a new Merrill Lynch & Co. report identifies 33 candidates.

"Due to current market conditions, it is becoming increasingly difficult to find attractive converts with Strong Buy or Buy equity ratings, which offer solid equity participation and a favorable risk/reward ratio," said Yaw Debrah, head of U.S. convertible research at Merrill Lynch, in a report Friday.

"In the past, we favored issues that offered a risk/reward ratio of 2:1. Today this ratio has declined significantly."

The starting point for the search was stocks rated buy or attractive by Merrill Lynch that have outstanding convertibles. The search unveiled 33 convertibles with the most attractive risk/reward profiles in the current market environment.

The analysis is a weekly exercise.

Convertibles with the most attractive risk/reward profiles include J.C. Penney Co.'s 5% convertible due 2008, Province Healthcare Co.'s 4.25% convertible due 2008, Sempra Energy's 8.5% mandatory, TXU's 8.125% mandatory, Ford Motor Co.'s Capital Trust II 6.5% preferred, Suiza/Dean Foods Co.'s 5.5% convertible preferred stock and Health Management Associates 0% convertible due 2022.

Newcomers to this week's list include Gap Inc., Ohio Casualty's 5% convertible due 2022, Northrop Grumman's 7% mandatory, Raytheon's 8.25% mandatory, Newell Rubbermaid's 5.25% convertible preferred, Health Management Associates and Idec Pharmaceuticals' 0% convertible due 2032.

Issues dropped from last week's analysis include Echostar's 5.75% convertible due 2008, Extreme Networks' 3.5% convertible due 2006, Quest Diagnostic's 1.75% convertible due 2021, General Motors Corp.'s 4.5% convertible due 2032, Markel Corp.'s 0% convertible due 2031 and Valassis Communications' 0% convertible due 2021.

Merrill Lynch estimates that over a one-year horizon the issues will provide a total return of at least 10% if the stock rises by 25% The total return cutoff was expanded to 9% for discount and 0% convertibles.

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