Value Investing

Rare Benjamin Graham Article: Bargain Hunting Through The Bond List [Pt. 2]

Continued from part one…

In this article, I’m coving an article written by Benjamin Graham called “Bargain Hunting Through The Bond List,” which gives us a great insight into his analytical mind.

Bargain Hunting Through The Bond List

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Up next are the Chile Copper Convertible 6s, due 1932. Following the end of the First World War, the value of these bonds had slumped to 84 ½, giving "a straight yield of over 7%, which the amortization of the large discount brings up to about 8%." This low price is a result not of the company's poor financial situation, but it's time of issue:

"The cause of this exceptionally low price can be traced primarily to their ill-times offering at par in April 1917. The sudden collapse of the bond market at this juncture left most of the issue in the hands of the underwriters, and the process of investment absorption, or "digestion," has necessarily been slow. There is no doubt, also, that the foreign location of the property has been held against it by the conservative."

Graham goes on to calculate the company should generate more than enough funds to be able to meet its obligations to bondholders. "Current production is approximately 100,000,000 pounds per annum," he writes. "The projected output is 300,000,000 lbs. Since the interest charges on the $35,000,000 6s and the $15,000,000 prior 7s aggregate $3,150,000, a profit of three cents per lb. on the present scale of only one cent on the ultimate output, will serve the funded debt," Graham goes on to conclude. He also notes that around 50% of the 6s has already been paid, substantially reducing the company's total debt obligation.

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The next issue to be considered is the Union Bag and Paper 1st 5's. Here, Graham very quickly concluded that this bond is a reasonably safe investment:

"A few years of great prosperity can entirely transform the status of a company's bond issue. The Union Bag and Paper Company of the old days was an overcapitalized, more or less shaky enterprise-a speculative proposition pure and simple. But the reorganized Corporation has worked itself into ean xcellent condition of late; and the first mortgage 5's due 1930 stand well up under critical analysis-although they are selling at 87 to yield 6.70%. First there are only $3,000,000 left of the original issue of $5,000,000, and the remainder are being retired at a steadily increasing rate-now about $170.000 per year. Secondly, they are fully covered by net current assets, which fact is one of the best possible assurances of ability to repay. "

The final bond issue considered in the article is an unlisted bond. Graham believes it offers substantial value and can find no reason why it trades below par. The issue is the First Mortgage Notes of the Peerless Truck and Motor Corp., which he writes "are now selling at 87 ½ to yield about 8 ¼ %."

The article goes on to investigate what issues with the business could justify such a low valuation. Looking at the balance sheet and income statement, the Dean of value investing struggles to find anything that may concern creditors. "The company's accounting methods seem to have been extremely conservative," He writes before going on to note that interest charges have been earned at least five times over since the bonds were issued in 1915. There is also plenty of liquid capital on the balance sheet to meet any outstanding obligations. The last annual report available for the company, for the year to the end of 1917, shows "cash assets alone exceed all current liabilities."
The overall balance sheet is exceptionally robust:

"Considering the fact that the bonds were covered one and one-half times over by net current assets entirely outside of the Plant Account it is difficult to imagine how they could ever get into trouble.

But most important of all is the fact that the company last year retired well over $1,750,000 of these bonds, leaving hardly more than $3,000,000 now outstanding. The funds were obtained by the sale to the Government of the unprofitable Long Island plant."

After considering all of the fundamentals, Graham writes "it is difficult to understand the extraordinarily low price at which the notes have sold since shortly after their issue." He then goes on to say that after investigating the affairs of the company "as thoroughly as available data will allow" he has been "totally unable to discover an adequate reason for the large discount at which the notes are now selling."

Finally, he concludes:

"Either there is a particularly elusive dusky gentleman hidden in this wood-pile-or else the Peerless 6s are one of the greatest bargains to be found in the wide realm of corporate bonds."

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This originally appeared at ValueWalkPremium.com