Here Are 3 Investment-Grade Corporate Bonds With Strong Franchise Value

The best opportunity in bonds right now is investment-grade credit. While almost everything that isn't a Treasury bond is trading at a yield gap that is historically attractive, no other sector combines a level of safety with such a large upside opportunity. Here are some thoughts about how to play this opportunity. Investment-grade credit still has 6%-10% upside, even outside of troubled sectors Every company is going to be impacted by this severe economic contraction. Not only is the depth of this recession likely to be as bad as anything since the Depression, the length is completely unknown. We will probably start reopening the economy to some degree within a month or two, but it is likely that some segments will be operating at less than full capacity for an extended period. We might not see full restaurants and full airplanes until there is a vaccine, which could be 18 months away or more. One nice thing about investing in debt securities is that you don't need your borrower to thrive, you just need them to survive. Within the investment-grade corporate bond world, there are a large number of companies where you can feel comfortable about mere survival. This would include some companies that are only mildly impacted by Covid-19, such as Oracle . Or companies that are fairly impacted but where there is likely still free cash flow as well as strong balance sheet liquidity, such as Toyota or Disney . There are others in spaces like technology, utilities, and even real estate where there are still excellent opportunities. All three of these companies issued new debt in late March. Each of those new deals have already appreciated significantly, each around 7%. However if the spread (or yield gap vs. Treasury bonds) were to retreat to where they were in late February, these bonds still have 6%-10% of upside. And in each case, you are getting paid 2%-3% while you wait. I am focused on buying longer bonds, mostly in the 10-year maturity range. These bonds have more price upside than shorter bonds, and since this trade is about price return, I want to make sure I get enough bang for my buck. The safety of these holdings is high, making you less timing dependent I think we'd all agree that these three companies have enduring franchise and brand valued by their customers. Also by issuing new bonds in late March, essentially the worst corporate new issue market since September 2008, these firms have proven their ability to get funding if they need it. Wall Street (and investors) will continue to fund companies even if they are burning cash, as long as there is confidence that the company will survive. Admittedly this is a catch-22. Disney will survive because investors will fund Disney. So you want to look for companies where the franchise value is so strong that the ability to raise fresh funds is patently obvious. How long might it take for the spreads on bonds like this to return to February levels? I don't know, but with these companies, it is only a matter of time. These companies are strong enough that actually default isn't a consideration, so it is merely a matter of how long until bond market liquidity returns to normal. Not a matter of how long before the recession is over. What about riskier companies? I'd split this into two groups. One is quality companies that are in more effected industries, such as investment-grade travel companies. There you need to really look at the liquidity. Those companies could be in a negative cash flow position for much longer than the full social distancing period. As I said above, airplanes/hotels/restaurants might not be full for a long time, either because of behavior change or just continued public health mandates. Airlines can't operate profitably with half-full planes. In this group, you can buy companies where there is plenty of balance sheet liquidity or better visibility into cash burn. But you really need to pick your spots. Delta said they are burning $100 million per day right now, and although they are working to mitigate this, that's a lot of cash need. The other group is generic high-yield bonds. Right now the spigot is wide open for junk bonds to come to market. That's a great sign for the market generally, but be careful shopping among these issuers. Most new high-yield bonds are coming with 5-years to maturity, but the bond is callable in the 2nd year. What this means is that even if the economy recovers, you are only getting the price upside of a 2-year bond. But if the company deteriorates, you take the full brunt of the decline in bond value. That's a terrible trade off right now. I've mostly been a better seller of junk bonds into strength. If you feel strongly about a particular company, try to buy an older bond that is discounted. That way at least you get the full upside if you are right. If I want to use ETFs, what's the play? The ETF is the closest thing. The only trouble is that it doesn't drill right into the kinds of companies I'm favoring, but it provides enough diversity to get the general thrust of corporate bonds recovering. There are plenty of others out there, just look for ones that are all investment-grade and have a relatively long average life. (Disney is a holding in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells DIS? Learn more now.)

Here Are 3 Investment-Grade Corporate Bonds With Strong Franchise Value

I'm focused on buying longer bonds, mostly in the 10-year maturity range.

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