Looking for More Yield? Try This Bond

Glaser: So what are some of the things that could go wrong here?

Tauber: Well, a couple key risks I guess. One, it's still a cyclical company, even though they've diversified over the last few years. Obviously, they're tied to primarily an industrial economic cycle.

Secondly, as I mentioned, they have grown via acquisitions. They've done this with good discipline, and they've used both debt and equity, but the risk here would be that they would potentially do a big debt-financed acquisition, which would leverage the company up.

Glaser: For bond investors, what does the fact that we think it's investment-grade and think that the spread should maybe be a little bit tighter than they are now. What does that mean for them in terms of actually go out and investing in this idea?

Tauber: There's two approaches, here. One is the spread on this bond is about 400 off on the six and seven-eighths bond I'm referring to, which is right in line with double-Bs. A weak triple-B might be in the 275-spread area.

You're getting paid an additional say 100-plus basis points, relative to the amount of risk you're taking, as we rate it as a BBB- rating. So you can just buy the bond, sit on it, and basically be overcompensated for your risk.

Secondly, we look at what are potential catalysts that could drive those spreads to tighten up towards investment-grade, and that would then lead to appreciation of the bond price. Those are both situations to consider, which we think makes this bond cheap.

Glaser: Now, some of their outstanding debt are convertible, so you would have an option to convert it to equity. Do you think that that convert option could be exercised?

Tauber: Sure. That's definitely something that we're factoring in and is one of the catalysts that I was talking about. We have a constructive view of the equity here. The interesting thing, again, about this company is the strike price on their converts is right around $20, and the equity is trading right around $21, so they're very close.

Which means these bonds are callable in November. They're also puttable. If the stock continues to move up, it's quite possible that the company will call them, and the debt will convert to equity, which will basically take debt out of the capital structure, and improve the credit overall.

Glaser: So for bond investors who maybe are looking for a little bit more yield, but maybe don't want to take on a ton more risk, this could be an interesting opportunity.

Tauber: Yeah, absolutely.

Glaser: All right, great. Rick, thanks so much for speaking with me today.

Tauber: Appreciate it.

Glaser: For Morningstar.com, I'm Jeremy Glaser.