Merrill analyst's search reveals slim pickings of just 18 high gamma convertibles

By Ronda Fears

Nashville, Jan. 16 - The field of vision is very narrow when convertible investors are looking for issues with high equity sensitivity and strong bond floors that provide some downside protection. It is so narrow that Marc Malloy, convertible analyst at Merrill Lynch & Co., found only 18 in the entire universe of U.S. convertibles.

The 18 identified will provide an upside return more than 9% and a risk reward ratio of about 3:2 for a 25% move in the stock, up or down, over a one-year period, holding credit spreads constant. Malloy's search, it should be noted, was only among those convertibles that have a Merrill Lynch buy rating on the underlying stock.

He noted in a report Thursday that the average conversion premium of U.S. convertibles, as of Wednesday, was 90.4%.

"Due to the decline in the equity markets, conversion premiums have expanded and investment values premiums contracted considerably, thereby making it more difficult to find issues with strong stock participation," Malloy said.

Excluded for consideration were convertibles issued by REITs, because their aggressive dividend growth profile generally prohibits much premium expansion.

Issues identified in the report are not necessarily recommended by Merrill, however.

Cash-pay bonds listed in the report are the Province Healthcare's 4.25% due 2008 (B-/B3) and Quebecor (World Color)'s 6% due 2007 (BBB-/Baa3).

Discount or 0% bonds listed are the General Mills' 0% due 2022 (BBB+/Baa2), Hewlett-Packard Co.'s 0% due 2017 (BBB+/Baa1) and Lear Corp.'s 0% due 2022 (BB+/Ba1).

Mandatories listed are the Ace Ltd.'s 8.25% (BBB/Baa1), Cinergy's 9.5% (BBB+/Baa2), DTE Energy's 8.75% (BBB/Baa2), Dominion Resources' 9.5% (BBB+/Baa1), FPL Group's 8% (A-/A2), FPL Group's 8.5% (A-/A2), Hartford Financial's 6% (A-/A2), PSEG's 10.25% (BBB-/Baa3), St. Paul Cos.' 9% ( BBB+/A2) and Valero Energy's 7.75% (BBB-/Baa2).

Convertible preferreds listed are Commerce Bancorp's 5.95% (BBB-/Baa1), Dean Foods (Suiza)'s 5.5% (B+/B2) and Union Pacific's 6.25% (BB+/Ba1).

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