Broken Stocks but Healthy Bonds – What’s the Message?

By: The Financial Lexicon

(July 2012) Have you seen the stock charts of Peabody Energy (BTU), Cliffs Natural Resources (CLF), and Baker Hughes (BHI) over the past year or so?  If you only look at the charts of these stocks and nothing else, you might assume these companies are on the fast track to bankruptcy.  Peabody Energy, which was trading at $73.95 on April 4, 2011, touched $20.67 just a few days ago.  That’s a drop of 72.05%.  Cliffs Natural Resources was at $102 less than a year ago, on July 20, 2011.  In recent weeks, it’s been spending a lot of time trading under $50.  Baker Hughes was also trading significantly higher less than one year ago, at $80.995 on July 26, 2011.  Just a few days ago, it touched a 52-week low of $37.0812, a drop of more than 54% from last summer’s high.

With drops like that, surely bond investors are feeling some pain as well.  Yes, benchmark Treasury yields have fallen significantly since April and July of 2011, and that would provide some support to corporate bonds.  However, when companies are in serious trouble, not only does the stock price take a hit, but bond spreads widen, downgrades follow, and the bonds fall in price.  But when it comes to the bonds of the companies mentioned above, all of them are holding firm with asking prices recently above par. Furthermore, none of the debt has been downgraded since the onslaught in the stocks began.  And, despite each of the three stocks touching 52-week lows in June, the debt of those companies avoided the same fate.

In fact, Baker Hughes’ long-term bond, CUSIP 057224AZ0, has been rallying significantly during the entire massacre in its stock. Cliffs Natural’s long-term bond, CUSIP 18683KAC5, despite pulling back a couple points during the month of June, is still asking prices in the secondary market more than 10% above its 52-week low.  Peabody Energy’s corporates are also showing strength. Even the recent four-trading-day 15.46% sell-off in the stock (June 21 through June 26) wasn’t enough to budge the bonds.  While the stock was getting hammered, the bonds did a whole lot of nothing, remaining firmly over par.

If you want to know about the health of a company, you should certainly do the typical fundamental research commonly associated with investing.  However, as part of your research, it may be useful to examine the performance of a company’s bonds.  Bondholders reside above the equity in a company’s capital structure and care significantly about a return of their money rather than just a return ontheir money.  Bondholders have done their homework as well, and if a company is truly struggling to survive, you will see stress in that company’s bonds.  When it comes to Peabody Energy, Cliffs Natural Resources, and Baker Hughes, the kind of stress you might assume the bonds would be under as a result of the collapse of their stock prices simply isn’t showing up.  For now, the market is sending the message that growth, not survival, is the problem with these companies.  That can always change over time, and if you want to keep abreast of any changes, don’t forget to keep your eye on the corporate bonds.

Just because earnings take a hit doesn’t mean the company is at risk of failing.  Stocks can lag for years without the bonds having to take a hit.  That’s one advantage to being senior to the shareholders of a company.  The equity will likely have more upside during good times, but it’s not a guarantee that the stock will always outperform the corporate bond.  If it were guaranteed, everyone would just buy stocks.

 

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