By Ronda Fears
Nashville, Tenn., Sept. 17 - For the opportunistic investor, Merrill Lynch & Co. convertible analyst Robert Dia suggests there are some attractive retail issues that offer defensive plays in the sector.
"While we expect the overall retail environment to be relatively difficult, we believe opportunistic investors should view the consumer staples and several consumer discretionary names as attractive investments," Dia said in a report Tuesday.
"We recommend focusing on higher quality names, early stage turnarounds and mispriced capital structure trades to increase total return."
His recommendations are Fleming Cos. Inc., Supervalu Inc., Sonic Automotive Inc., Duane Reade Inc. and Gap Inc.
"In late August, the Merrill Lynch retail equity research team recommended a shift to a more defensive posture for the broadline, hardline and softline retail sectors in response to concerns about consumer spending, post Sept. 11, 2002, consumer spending uncertainty and declining real wages and consumer confidence," Dia noted.
"We recommend de-emphasizing the more economically cyclical names and focus on defensive food and drug retailers."
Duane Reade's convertible represents an attractive outright purchase for investors who believe the equity is stuck in a trading range over the 12 months, he said. With volatility of 50% and a spread of 680 basis points over Treasuries, he said the Duane Reade issue is trading at a 15% discount to theoretical value. At current trading levels, he said, it is an attractive credit and risk/reward situation for swap equity holders or outright buyers.
For investors that believe the contagion is over at Fleming, Dia said the convertible bonds offer an attractive current yield and expected return compared to the equity. However, he advised clients that go long the convertible to hedge their positions.
"We are under the belief that continued credit weakness [at Fleming] will persist over the next six months," Dia said. "In the downside scenario, we would advise clients to long the senior notes and short the convertible, given the amount of senior debt ahead of you in the capital structure."
Gap's convertible offers a yield advantage over the equity of 460 basis points, Dia said. Under the Merrill convertible model, using an implied volatility of 41% and a spread of 613 basis points, it is at a 3% discount to theoretical value. In a one-year horizon on a 25% move in the equity, it would show a 13% return on the upside and a -9.5% return on the downside.
Sonic Automotive is an attractive opportunity for convertible investors to buy a growing, yet stable cash-flow business with ample liquidity to weather a potential slowdown in promotional incentives by the OEMs, Dia said. He said it is a good trade for outright investors or as a swap idea out of the high-yield paper, as the convertible offers a more attractive upside potential compared to the 11% senior subordinated notes.
Supervalu is a stable core holding, he said, noting the convertible has modest 50% participation on the upside in the equity but is not trading high relative to its investment premium of 8.5%. Using the Merrill convertible model, an implied volatility of 34% and a spread of 330 basis points, it is trading at a 6.6% discount to theoretical value.
At current levels, he said the Supervalu convert is appropriate for the equity holder who is concerned about industry trends and vendor deduction spillover, or for outright convert investors looking for a solid improving credit with equity participation.
Duane Reade 2.1478% due 2022
| Price: | 45
|
| Conversion premium: | 79.97%
|
| Current yield: | 4.77%
|
| Yield to next call: | 7.78%
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| Call: | April 16, 2007 at 57.28
|
| Yield to put: | 7.78%
|
| Put: | April 16, 2007 at 57.276
|
| Ratings: | Ba3/BB-
|
|
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| Fleming 5.25% due 2009
|
| Price: | 51.88
|
| Conversion premium: | 120.56%
|
| Current yield: | 10.12%
|
| Yield to maturity: | 18.14%
|
| Yield to next call: | 58.55%
|
| Call: | March 22, 2004 at 103
|
| Ratings: | B2/B+
|
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| Gap 5.75% due 2009
|
| Price: | 107.75
|
| Conversion premium: | 37.85%
|
| Current yield: | 5.34%
|
| Yield to maturity: | 4.37%
|
| Call: | March 20, 2005 at 102.46
|
| Yield to next call: | 3.59%
|
| Ratings: | Ba3/BB+
|
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| Sonic Automotive 5.25% due 2009
|
| Price: | 79.75
|
| Conversion premium: | 72.39%
|
| Current yield: | 6.58%
|
| Yield to maturity: | 9.41%
|
| Yield to next call: | 15.99%
|
| Call: | May 07, 2005 at 103
|
| Ratings: | B3/B+
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| Supervalu 0% due 2031
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| Price: | 29.44
|
| Conversion premium: | 44.75%
|
| Current yield: | 0.00%
|
| Yield to maturity: | 4.24%
|
| Yield to next call: | 2.64%
|
| Call: | Oct. 2, 2006 at 32.747
|
| Yield to put: | -2.54%
|
| Put: | Oct. 1, 2003 at 28.654
|
| Rating: | Baa3/BBB
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