We have developed a process to screen, review, select, purchase and monitor high yielding corporate bonds. Each week we screen thousands of separate corporate bond listings to find what we believe are currently the best corporate bonds for investors needing or seeking higher yields with the least amount of risk as possible. The following is our review process, along with supporting documents, showing why we believe this 6.61% 5-year Seagate Technologies (STX) corporate “junk bond” may just be a star performer in a conservative fixed income portfolio.
Step 1 - Assessing the Yield Curve
In recent months, we have seen many portfolios with large cash positions. Typically these funds (cash and/or money markets) yield very little, making the current low interest rate environment not only frustrating, but often times quite confusing. Why? Because at the same time we are being rewarded little or nothing on our savings, there is a legitimate concern about what effects inflation (currently 3.8%) may have on the real value of any long term fixed income holding. With a current yield nearly 3% higher than inflation, and promises of low rates for at least two more years to come, there appears to be sufficient headroom in this five year bond to stay ahead of even a moderate rise in the Consumer Price Index.
Step 2 - A look at the issuer
Seagate Technologies designs, develops, markets and manufactures solutions for hard data storage. Their product line includes disc drives and hard drives for desktop and laptop computers, mobile computing, digital video recording (DVR), and gaming counsels. Their clientele includes a wide spectrum from private personal use to large corporate applications.
After reviewing Seagate’s most recent earnings release, we find that its underlying business, if anything, has improved from one year ago when we first examined its 2016 bond.
Step 3 - We like companies that are profitable
Seagate had 579 million in pretax profit or $ 1.09 per share fully diluted for the year ending July 1, 2011. With Steve Luczo CEO of Seagate claiming “Because hard disk drive storage is a fundamental technology for cloud service providers, data centers and all other network-based content providers, total industry demand grew almost 40% in fiscal year 2011.” Year over year their fourth quarter revenues were up over 7% but margins were lower.
Step 4 - Interest Coverage Ratios
Seagate generated $511 million from earnings before interest tax and amortization or EBITA for the quarter recently ended. They owed $ 214 million in interest expense on the debt they have outstanding meaning they produced two times over their interest costs. This is a healthy ratio and we like seeing this kind of buffer should the business environment deteriorate.
Step 5 - We like companies with lower debt to cash ratio
Seagate reported long term debt of $3.51 billion. Cash and short term investments grew to $3.15 billion. Long term debt is slightly higher than cash on hand meaning they would almost be able to pay off their debt were a catastrophic unforeseen event to occur. Considering that this note matures in 10 1 2016, one realizes that Seagate has enough cash on hand to repay debt if needed.
Step 6 - We like companies that have flexible balance sheets
They currently have a market cap of about $4.9 billion while long term debt is slightly above $3 billion. A debt to equity ratio of just above .6 is higher than we would prefer to see, but think it to be still quite manageable, as banks have currently explained they prefer to loan at a .50 debt to equity ratio.
Step 7 - We like high yields
This issue of Seagate currently has a 6.61% yield to maturity with the corresponding U.S. Treasury yielding 0.90%. Although the credit ratings are different, we believe there should not be this large of a spread between the yields given the moderate risk.
Step 8 - Risks Considerations
Seagate is the world's largest producer of hard drives. Revenues have started growing again, but they still are under margin pressure. Fortunately, the cloud computer cycle growth has helped them combat the constant erosion they have endured for years as a result of the migration from the personal computer (that have hard drives) to smaller mobile devices (that often don’t).
Summary and Conclusion
This is a very good yield considering the relative short five-year time frame. Even though this bond doesn't have an investment grade rating, the large cash position, strong free cash flow, and profitability of Seagate illustrates a growing business that survived the very tough economic period that occurred prior to achieving top line growth from their increased cloud based business. All things totaled make it a compelling addition to our high yield Foreign and World Fixed Income holdings.
Additional Seagate Technology information such as financial ratios, Charts and News is available here.
Coupon 6.8%
Ratings Ba1/BB+
Maturity 10/01/2016
Price $100.8
Yield to Maturity 6.61 %
Yield to Call 6.61 %
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