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  1. Home
  2. / Investing
  3. / Energy

High Yield Energy Bonds Are Very Attractive

The former pariahs are now highly sought-after alternatives to low interest rates.
By SHAM GAD Aug 17, 2016 | 03:30 PM EDT
Stocks quotes in this article: CRK, XCO

Earlier this year, when the energy industry was in deep turmoil as oil was trading below $30 a barrel, the bonds of many energy companies were trading at historically distressed valuations. Investors were able to obtain better returns than on equity by owning a more secure asset. However, security selection was absolutely critical, since many energy companies were heavily in debt. The outsized returns available from such bonds had to be considered alongside the possibility of a default.

But with such bonds trading as low as pennies on the dollar, two things stood out to me. First, in an event of a default or bankruptcy, it was quite possible the bonds would be worth more than the quotation at the time. Secondly, the yield to maturity on such bonds was such that investors would recoup the entire cost of their investment in as little as two years, provided that coupon payments were made.

Thus the key consideration was trying to find high-yielding bonds belonging to companies that had a low cost production structure and debt that was manageable during the pricing environment at the time, until prices stabilized.

Back in March, I wrote about Comstock Resources (CRK) and the Company's April 2019 7.75% unsecured senior notes (CUSIP number 205768AH7), which at the time traded for 13 cents on the dollar. Today the bonds are trading for nearly 60 cents on the dollar, or a gain of over 300%. During the past five months, holders have gotten one coupon payment as well.

Unfortunately, it's the end of the road for these bonds: the Company is attempting to swap them out for new convertible bonds that do not pay cash interest but instead pay in-kind. Nonetheless, the bonds are actively trading, so exiting them at a very prosperous gain is possible.

Gone are the days of finding these bonds for 10-15 cents on the dollar. Still, there are interesting choices. Exco Resources  (XCO) has a tranche of September 2018 7.5% (CUSIP 269279AD7) notes that currently trade for approximately 50 cents on the dollar. Recently, EXCO announced a tender whereby the company will buy up to $40 million of its 2022 bond tranche at 45 cents on the dollar if tendered early.

Shareholders are not required to tender and I believe patience will pay off in this case. Exco has ample liquidity to support these bonds but it's possible that another tender in the coming months will occur. In the meantime, a yield to maturity north of 30% is on the table.

Energy companies will do what it takes to support these bonds to ensure the survival of their businesses. Companies like EXCO and Comstock have reduced their cost structure and increased production, actions that will continue to enhance the value of the bonds.

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At the time of publication, Sham Gad was long Comstock's April 2019 7.75% unsecured senior notes and long Exco September 2018 7.5% notes, although positions can change at any moment.

TAGS: Fixed income | Investing | Rates and Bonds | Markets | Energy | Renewable energy | Corporate Bonds

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