Article by Investment U
Bonds like ATP Oil and Gas provide a safe way to play record low natural gas prices and the coming boom in this fuel of the future.
I love it when things are bad! A 300- point drop in the market makes me feel like a kid at Christmas. In fact, I’m to the point where I won’t buy anything unless we have some sort of major correction or setback.
But the “wait for a market dump” philosophy presents a few problems for a bond guy like me.
The one thing about the bond market is that it doesn’t have as many wild swings as the stock market. And since there just aren’t as many sell-offs in the bond market, it requires a lot more patience to take advantage of good buying opportunities.
But there’s a very good buying opportunity in bonds, right now… It’s in an industry that is absolutely essential to our economic well being, and you definitely need to be a part of it.
Natural Gas Prices At Historic Lows
In case you don’t follow the energy markets, a glut of shale gas has driven NG prices to multi-year lows.
The Bakken, Eagle Ford, Utica and Marcellus shale gas fields are producing so much gas, developers have had to slow down and in some cases stop production. In many cases, drillers have shifted from gas drilling to shale oil drilling in the Bakken and the Utica areas.
There just isn’t the cash flow at the current market prices to justify further development of natural gas. And that’s the good news.
The slowdown in production and drop in revenue in natural gas have started showing up in the numbers of all gas developers, pipelines and sellers, and the bond and stock markets are reacting to them.
In the past few months, bond prices for most gas drillers have taken a big hit. Some of the price drops are understandable; you can’t have the bottom drop out of the market and not see a price correction in the underlying stocks and bonds.
But the bulk of the price fluctuations are the result of one of the saddest truths there is about the bond market.
The bond market is run by a bunch of hair-trigger cowards and “Chicken Littles.”
For two decades I watched bond traders, at the slightest hint of any bad news, run around like chickens without heads. I can’t count the number of times I was advised to avoid this bond or that bond, or to sell a bond just to watch it run right back up in price when the cackling finally quiets down.
In my experience, in every situation in the bond market where there has been any negative news, the traders have oversold and overreacted.
This Chicken Little attitude in the bond market is unnerving, but it creates excellent short-term buying opportunities.
Right now there are numerous gas company bonds at good discounts that are paying huge returns on very short maturities. If you’ve read any of my other articles, that description should sound very familiar.
Good companies, short maturities and discounts! Sign me up!
Here’s one I really like.
Unlike Dividends, Bond Yields Can’t Be Cut
The opening line in every research report about today’s Investment U Plus pick, and every other gas related company, is the same; they’ve been hurt by the glut of natural gas and the warmer-than-expected winter in North America.
This company missed its numbers, but management made some good decisions that improved seasonal spreads, and it upped its outlook for 2013.
But one of the reasons I really like this one is that it’s a partnership, and it can cut its payout to stockholders as necessary. So, as it claws out of this gas price pit, it can ease its fiscal burden by cutting the current $1.40 payout.
Oh, and it’s a BB- bond, which is just a hair below investment grade.
It’s an 8.875% bond that’s selling for about 94. It matures on 3/15/18, and its MEAR, minimum expected annual return, is listed below.
Twelve interest payments of $44.37, plus $60 capital gains, divided by our cost of $940, for a holding time 71 months, gives us a MEAR of 10.65%.
Keep in mind, the interest due on this bond cannot be reduced by the board. This is a legal contract between the company and the bondholders. Unlike the dividend payment on the stock, it’s written in stone and cannot be cut.
Since I know some of you won’t be satisfied with 10.6%, even though that’s 10 times what you made in the stock market over the past 12 years, and that’s assuming you did everything right. So here’s an idea for the folks out there who are looking for bigger returns.
This is a CCC- bond with an 11.875% coupon selling for about 75, or $750.
Higher Risk, Higher Reward
As with the last bond, ATP Oil and Gas has had a rough ride lately, but has lots of assets to offset even a worse case scenario in the gas business.
Here’s how the MEAR breaks down.
Seven interest payments of $59.37, plus $250 in capital gains, divided by our cost of $750, and our holding time of 36.5 months, for a MEAR of 29.17%.
Twenty-nine percent is huge, but this is a CCC-, which means it carries more risk than the BB- Investment U Plus pick.
In either case, these bonds are exactly what I live for; good companies in a beaten-up industry, high coupons, good long-term prospects, in this case, good gas assets and short maturities at a discount.
Natural gas is the fuel of the future. It will be one of our biggest exports, in the form of LNG and eventually it’ll be our primary transportation fuel. It isn’t a perfect play, there will be bumps along the way, but it beats the heck out of 2% from a 10-year treasury.
Good Investing,
Steve McDonald
P.S. Since bonds have a limited inventory, I wanted to make sure our Investment U Plus readers were able to take advantage of the BB- rated bond that I recommend in today’s article.
To access this bond and our other experts’ picks with each and every Investment U issue, click here.
Article by Investment U
