Tuesday, March 13, 2012

Arch Coal ACI Can you image 7.75% income?

Dear Income Investor:

Today I am profiling a bond that I have been considering. Bonds pay interest and have been a key component of the portfolios of income investors forever. Lately bonds have been so expensive that they do not provide much value but as with every market, things change. As I researched this bond, it reminded me that the ordinary investors used to buy and hold bonds all the time. Investors who control their own investments, I believe, enjoy lower costs and have a better handle on their holdings than investors who use pooled investments like bond mutual funds.

I came across this bond because I have been interested in buying one or more coal stocks. Coal stocks have suffered so much lately. They are at all time lows. At least one stock, Arch Coal (ACI) has an impressive dividend yield and dividend history. With a three percent dividend yield, ACI meets at least one of my dividend machine criteria. However, it does not meet them all so I looked at their bonds.

ACI has a bond with a coupon of 7.25%. You know I would love to have all my money in, laddered, government guaranteed 7% bonds but they do not exist. So, we have to use dividends, covered call options, and corporate bond interest to boost our income. The ACI bond fills the bill. This bond matures October 1, 2020. An 8.5 year bond duration is about as long in duration as I like to buy. Provided that I buy the bond at par (the amount I will be paid when it matures) or at a discount to par, I will not lose money on the bond even though I know the price of the bond will vary over time.

Every bond is identified by a CUSIP number. You need to know the CUSIP number in order to ask your broker for a price. You should have already research the corporation that is issuing the bond. One statistic that a bond buyer must know is the company’s interest coverage ratio. This ratio is calculated by dividing earnings, specifically EBIT (earnings before interest and taxes) divided by interest expense. If the ratio is one, do not buy the bond. If the ratio is 1.5, this is better but barely. You want to highest ratio you can get. ACI’s ratio is 1.7. This means the company can pay the interest on their date from their earnings 1.7 times. You also need to know the price at which the bond is trading. Use the Sifma site to find current trading prices. Simply type in the CUSIP number and you will see the most recent trades. You want to buy your bond at $100 or less.

The ACI bond I bought today is identified by CUSIP number 039380AC4; coupon is 7.25%; maturity is October 1, 2020. I paid $96.75 per bond which is a yield of 7.75%. Use this post to learn how to research and buy corporate bonds.

Very Truly Yours,