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A High-Yield Opportunity

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Companies that are going through periods of financial turmoil and, consequently, a declining stock price are often shunned by investors. The risk of buying the stock only to see it decline even further is deemed too great by many. But often this drop in stock price is accompanied by a drop in the market price of the company's outstanding bonds. This sometimes opens up an opportunity to lock in high-yield fixed payments without taking on the risk of owning shares.

AMD's Troubles

Advanced Micro Devices (NYSE: AMD) has been struggling as of late. As number two to Intel (NASDAQ: INTC) in the PC microprocessor market and with little presence in the mobile market AMD is facing the prospect of becoming irrelevant. Free cash flow has been negative for 3 of past 5 years and turned negative again in the third quarter of 2012. Q3 revenue decreased by 25% year-on-year and analysts expect continued revenue declines in 2013. Intel's year-on-year revenue is also down, but not by nearly as much. Intel processors will also be powering most of the Windows 8 Pro tablets which will be coming to the market shortly, giving the company a greater presence in the mobile space.

AMD owns ATI, a graphics processor company, which competes directly with NVIDIA. As of August 2012 ATI had a discrete graphics card market share of 40.3%, up from 37.8% a quarter earlier. NVIDIA, meanwhile, had a commanding 59.3% share, down from 61.9%. This bump in market share is about the only positive AMD has had all year.

The stock has completely tanked over the last year, falling from $8 per share to around $2 per share.

<img src="http://media.ycharts.com/charts/b3b12d73e0755c89f6586eecacc50d4c.png" />

AMD data by YCharts

The stock is tough to even consider at this point, but an alternative may be AMD bonds. If you're looking for fixed income in a world of ultra-low rates, these bonds may be just the ticket.

AMD Bonds

While AMD has various different outstanding issues, the one nearest to maturity is probably the best bet due to the company's ongoing struggles. This bond (CUSIP: 007903AL1) matures on 05/01/2015 and carries a 6% coupon rate. It's non-callable and pays interest semi-annually. The bond most recently traded at $94.375, a 5.625% discount to par.

The most useful value when it comes to bonds is the yield to maturity. This tells you your annualized rate of return from all interest payments as well as the final principal payment at maturity. Here's the calculation of yield to maturity for this bond.

<img src="/media/images/user_13886/amd-ytm-top_large.png" />

<img src="/media/images/user_13886/amd-ytm-bottom_large.png" />

The yield to maturity of this bond is 9.629%, well above the current yield based solely on the coupon payment. This is significantly higher than the current 10-year treasury yield of 1.86%.  

Can AMD Afford To Pay You?

As of the end of Q3 2012 AMD had $1.3 billion in cash and another $180 million in investments. The total debt, including capital leases, is about $2 billion, almost all of which is long-term. Our 2015 bond is the next bond due, with an outstanding amount of $780 million. So AMD has enough cash to pay the bond off right now, but there is some risk that negative cash flows will eat into the company's cash position. Maturity is only a little more than two years away, so AMD would have to lose quite a bit of cash annually for this to be a problem. The company should be able to simply issue new debt to pay the principal, so I think the default risk for the 2015 bonds is minimal. I would be a bit more weary about the longer-term bonds though.

Alternatives

AMD competitor Intel has a variety of bond issues but all of them have extremely low yields. An Intel bond maturing in 2016 has a yield to maturity barely over 1%. The AMD bonds offers a YTM more than 9 times that of this comparable Intel bond. Even more long-term Intel bonds, like one maturing in 2042, have yield to maturities around 4.4%. An interesting point here is that Intel stock offers a dividend yield of about 4.25%, so it's very difficult to justify a purchase of Intel bonds. The fact that the dividend yield is higher than almost all Intel bonds tells me that either the stock is cheap or the bonds are expensive, or possibly both. Either way, if you're looking for fixed income the AMD bonds are the way to go.

The Bottom Line

With the 10-year treasury currently yielding less than 2% and corporate bonds of companies like Intel yielding even less, there are very few fixed income opportunities with decent yields. AMD is one of them, and by buying a bond maturing in just two years the default risk is mostly mitigated. A yield to maturity of 9.629% for a company that has no real chance of defaulting on the debt makes for a great fixed income investment.


TheBargainBin has no position in any stocks mentioned. The Motley Fool recommends Intel and NVIDIA. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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