Let Me Share a Secret
Let me share a secret... When a 'risky' investment is really 'money-good'... Our ace in the hole... How to make 25%-30% a year...
Let me share a secret about the bond market...
In today's Friday Digest... you may be relieved to know that I won't be discussing my "Big Trade" or anything risky.
Instead, I'd like to show you a strategy you can use to earn double-digit yields on your safe capital, even though interest rates are still near all-time lows. For a lot of investors seeking income, the chance to earn 11% safely is even more important than earning 15% or more in capital gains. That's because capital gains imply capital risk, something that a lot of people, especially anyone who is retired, simply can't afford.
And really, this idea should appeal to anyone. After all, if you can make a higher return on a safe bond than you're likely to make in the stock market, why would you take on the extra risk?
Here's the story.
Kratos Defense & Security Solutions (KTOS) isn't a stock we'd recommend.
The business has a mediocre history. It started during the telecom boom of the early 2000s. Back then, it was called Wireless Facilities. As capital spending in telecom collapsed, the company changed its name and its focus. It still does communications and technology. But today, almost all of the company's business is with the government.
The company's core business is missile-control systems. And while that business has been steady, it hasn't grown. The company tried to spur growth through $1.2 billion worth of acquisitions. But that hasn't worked. Over the last 10 years, the company's stock price has fallen from $26 a share down to less than $7. Clearly, the acquisition strategy hasn't worked. The company's $400 million market cap shows you just how bad these investments worked out.
But... recently... the company has gotten into drones. Its extremely high-tech drones have a lot of potential military applications. This new business strategy might work out well.
In August, the company announced that it won a $40 million contract with the Air Force's Low-Cost Attritable Strike Unmanned Aerial System (UAS) Demonstration (LCASD). Kratos beat out six other competitors, proving it can compete in the sector. This was a competitive, single-award contract to research and develop prototypes. And it has potential production volume worth more than $100 million.
There's a good chance the military's determination to build weaponized drones will lead to sustained growth for Kratos. But with the company's heavy debt load, it's a risky bet for equity investors to make.
For bondholders, though, it's a different story.
Kratos has one outstanding corporate bond, a $625 million issue that matures in 2019. As the company focuses its future on building drones, it's selling other assets to pay down this bond debt. Last year, it retired $175 million in principal. So the balance remaining when we recommended the bond in September was $450 million.
Even so, a lot of investors were skeptical this bond was "money good." Looking only at Kratos' results last year, you could understand their skepticism. The company didn't earn enough money to cover its interest costs.
We believed that it would be able to do so going forward, thanks to growth in its drone business, asset sales, and cuts to overhead spending. (The company announced plans to cut overhead by $40 million, allowing it to easily cover its interest expense for 2017.)
We also knew the company's assets were worth at least $250 million in a liquidation or a bit more in a reorganization. In other words, we didn't have to risk 100% of our investment in this bond. Even if the company were to fail, we could recoup something around $0.50 on the dollar.
With the bond trading around $0.90 on the dollar and a yield to maturity of 11%, we believed the upside was worth the risk, even though this is one of the riskiest bonds we've recommended so far in our bond-focused advisory, Stansberry's Credit Opportunities.
We had an ace in the hole...
David Xia, one of the 10 analysts on my team, noticed something virtually nobody else in the market picked up on. He saw that Kratos was in a "quiet period."
Companies normally enter quiet periods when they won't speak to investors just before earnings announcements. This helps make sure all market participants receive important information at the same time.
But as David noted, the company wasn't scheduled to release earnings for months. As a result, we knew something was happening – something important. And given Kratos' precarious financial position, we doubted the news would end up being another acquisition or additional debt.
We figured the company would raise a lot of money by selling new shares. As we wrote to our Stansberry's Credit Opportunity subscribers in September:
... there is likely some big event in the works. But given the company's current leverage, it's unlikely it will issue more debt. Issuing stock is the more likely scenario. That would be bad for stockholders, but it would be great for bondholders. The cash could be used to retire debt, which would make our bond safer and would substantially improve Kratos' liquidity.
Kratos' bond has traded higher since we recommended it.
And Kratos' stock has fallen. Today, shares are down another $0.50 or so, a drop of more than 7%. Last night, the company announced it would sell around 12 million more shares of stock for only $6 each. When companies need to raise capital quickly, they frequently offer large amounts of new shares at a discounted price to the existing trading range.
Raising another $70 million will help insure that bondholders get paid. I wouldn't be surprised if we soon see our bond trading for more than its $1,000 face value (or "par"), as the company's prospects for refinancing that debt continue to improve thanks to big reductions in overhead, revenue growth, and additional cash on the balance sheet.
Did we have "inside information"? No, of course not.
We just have a great team of experienced analysts who know how to look for unique situations, like Kratos and our Iconix (ICON) bond trade last year (where we made total returns of more than 14.1% in about six months... on another "money good" bond that the market hated.)
What I love about our work in Stansberry's Credit Opportunities...
Even though these investments are largely ignored by individual investors, they offer outstanding returns and little risk. Of course, as I explained in the webinar this week, these opportunities are better and a lot more plentiful when investors are scared, volatility is up, and credit spreads are wide. When you buy these kinds of bonds in those conditions, you won't make 11% a year... You'll make 25%... or 35%... or even more.
Stansberry's Credit Opportunities is like the "flip side" of our Big Trade strategy.
When risk is low and volatility is cheap, we want to buy "insurance" on stocks, via the options market. And when volatility is way up and risk is rampant, we'll take the opposite trade, going against the crowd by buying risk in the form of corporate bonds trading at wide discounts to par.
You can think of both products as riding the capital-markets seesaw. When risk is up, we have clear opportunities in bonds, as we've proven again and again over the past year. And when risk is very, very low, we'll have even better opportunities to buy risk via put options on companies with very weak credits.
Putting the strategies together can give you an unbeatable advantage in the markets. And I can't wait to prove it to you over the next year, just like I did last year with Stansberry's Credit Opportunities. I hope you'll join me. And to make it easy to do so, we're offering a huge discount on Stansberry's Credit Opportunities to anyone who subscribes to Stansberry's Big Trade.
Learn more about this special offer right here.
New 52-week highs (as of 11/17/16): American Financial (AFG), Berkshire Hathaway (BRK-B), WisdomTree SmallCap Dividend Fund (DES), Freddie Mac (FMCC), Fannie Mae (FNMA), short position in Hertz Global (HTZ), iShares Core S&P Small-Cap Fund (IJR), Nuveen Floating Rate Income Opportunity Fund (JRO), PNC Financial Warrants (PNC-WT), Gibraltar Industries (ROCK), Spirit Airlines (SAVE), and W.R. Berkley (WRB).
The feedback on our "Big Trade" webinar continues to pour in. Did you join us? We'd love to hear from you, too. Let us know what you thought at feedback@stansberryresearch.com.
If you missed this week's BIG event, be sure to watch our limited-time video replay here.
And if you're interested in becoming a charter subscriber to Stansberry's Big Trade, you can get immediate access right here. (Please note: This link does not lead to a long sales video.)
"Porter, I was about to launch a note of lavish praise for your thinking, for your commitment to us, and for the great presentation. As I read the other notes, I find it has all been said, and said well. Just add me to the list of grateful clients." – Paid-up subscriber George M.
"Outstanding, clearly presented, actionable!!" – Paid-up subscriber Tom D.
"Porter, I would like to compliment you on last night's presentation. I had read much of the data you had put out before, but the presentation tied it all together... I want to thank you and your team for all of the hard work you have done... " – Paid-up subscriber Jerome L.
"Porter, I joined the Big Trade seminar this week and stayed on for the entirety (rare for me with similar events, usually get bored and feel like I'm being sold something – from other services, of course) plus I've got a short attention span...
"Coincidently, watched The Big Short for the first time on Netflix Monday night. Deja Vu perhaps?
"Excited to see how these play out over the next several months as we head into 'interesting times.' Thank you, I look forward to working the program with you and the team." – Paid-up subscriber Russ F.
"Thank you, Porter and team for the months of research identifying the most likely subprime default suspects. I've spent 52 years seeking and placing large commercial loans for institutional investors, the first twenty with a life insurance company, the last 32 with my own company and was blessed by not having a single default or foreclosure in all 32 years. I'm happily retired now at age 80.
"J.P. Morgan (the man) was absolutely right. It's not difficult to recognize a person's character. It does require experience background checks, reputation in the industry, and knowing where the borrower intends to employ the money. It does take patience to cherry pick the right customers. Provided you use proper due diligence and serve them well they will trust you and the profits will come.
"Despite having an MBA and degree in economics and long business experience, I had not taken time to understand options until becoming a lifetime member of Stansberry and a student of Dr. Eifrig. I've learned a great deal from your educational material... I think your introduction of the Big Trade couldn't be better timed and I hope I'm better prepared. Thanks again to all your team for their professional wisdom." – Paid-up subscriber Wayne S.
"What I learned really was how to go beyond fear and greed by understanding what speculation really is and where greed can lead when we chase popular stocks with their false promise to rise to the sky. In subscribing to both services as complementary tools of this unique strategy, I believe it will bring peace to my investment heart...
"It materially changed the way I look at investing as my horizon was uniquely in the stock picking arena. Also for the first time I understand that one can safely earn good returns in bonds provided that someone does the research for you! And I believe you can be trusted in this respect.
"To sum up... I am confident that the 10-plus years ahead (I am close to 88) will be more satisfying than the last 60 in terms of return on investment! Thank you Porter for bringing all that wisdom to my awareness... To bring it just before Thanksgiving is a good omen. With gratitude." – Paid-up subscriber Marcel T.
Regards,
Porter Stansberry
Baltimore, Maryland
November 18, 2016