One of my corporate long-term debt holdings in R.R. Donnelley (NYSE: RRD) has been trading significantly higher since my purchase point in 2009. I had invested in the 6.625% October 2029 debenture, via a trust preferred security (NYSE: PYS), which has a coupon of 6.3%.
Although I had been sitting on large unrealized gains on the issue and was intending to dispose of it in 2011, the trading above 24 proved to be too tempting so I unloaded it and realized gains. Although it’s entirely possible the bonds will continue trading this high in a couple months, I didn’t want to take the gamble.
Mathematically, assuming a continuous yield (which the trust preferreds do not trade as; they trade “as-is”), the PYS security would have a pre-tax current yield of 6.5% and an implied capital gain over 18.9 years of 0.2%. This is below what you can get with some shorter duration fixed income securities, so disposing of this will be a good decision assuming I can deploy capital more efficiently in the future.
The equity in RR Donnelley at this moment appears to look like a better investment than its long-term debt – the company’s cash generation is significant and its debt is termed out properly and has been managed well, so there is unlikely to be a liquidity risk with the operation. Even if you assume they do absolutely nothing but earn income at the rate they have been doing in the past 9 months (a false assumption due to seasonality in their business), the equity will be yielding a minimum of 7.6% at present prices – a compensation of about 1% over debt. When you factor some very conservative growth assumptions, it skews significantly in favour toward the equity relative to the debt.
In terms of overall portfolio movement, my long-term debt holdings have shrunk again and cash has increased. If/when long-term government bond yields start to rise this should prove to be a good move.