Meet the Street: Picking Some Junk Bond Winners and Losers

As more investors turn to the high-yield market to get better returns on their money without having to endure the whipsaws of the stock market, evaluating these bonds becomes increasingly important.

After all, most junk bonds are issued by fallen companies that carry lower-grade credit ratings and are at some risk of default. In return for that risk, the average high-yield coupon rate runs about 12%.

Matt Zolin High-Yield Technology Bond Analyst, Lehman Brothers

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Here to share his view on the high-yield market and to pick a few underappreciated companies, as well as some to steer clear of, is Matt Zolin, a high-yield bond analyst for Lehman Brothers. Zolin's research spans all of technology, from chips and manufacturing outsourcers to software and network gearmakers. The analyst has been sorting through the junk bond and fixed-income market for nine years, previously with Bankers Trust and SG Cowen.

TSC: We know how the stock market is doing, but we don't usually have much of a read on the high-yield market. What's going on there?

Zolin: There's been a lot of cash inflows which have improved the technicals of the market. When cash comes in, things go up. And certain bonds have been moving higher, which causes the yield to go down.

So to a degree, generally there's been a split between the haves and the have-nots. You have companies without liquidity and accounting problems that are trading at around 9% yields, where other sectors like wireless and telecom are trading at much higher yields between 20% to 50%. But the problem there is that many of those bonds are going bankrupt and will ultimately end up as worthless.

TSC: Great, that leads me to my next question: Are there some sectors doing better than others?

Zolin: Surprisingly, the electronics manufacturers like Flextronics(FLEX), Solectron(SLR) and Celestica(CLS), which have seen a loss of favor in the equity market, have been well-received in our market. Their earnings and revenues have slowed, which is why the stocks have been under pressure.

But the good thing that's happened to these companies in the downturn is that they've slimmed down their balance sheets to better generate cash and pay down debts. We've also seen the semiconductor manufacturers improve. There's a segment of the high-yield market that feels the semiconductor business has bottomed, and some of the companies that aren't overleveraged are positioned to improve as the cycle improves.

High-yield investors want to know what the downside is and how bad things can get. If they can get comfortable with that, know there's a bottom and collect a 12% coupon, that's a pretty good return for a high-yield investor.

TSC: Have you seen anything that's surprised you about the high-yield market, in terms of sectors falling in or out of favor?

Zolin: I have to say, I am a little surprised by the high-yield market's ability to look forward. This market has typically been known to look in the rearview mirror. I've been surprised at how early it has stepped into the semiconductor sector while it's still shaking out the excesses of 1999 and 2000. The market's been able to look past the down cycle and look ahead to the up cycle.

TSC: Name three underappreciated companies.

Zolin: I think ChipPAC (CHPC) is a name we like. It's a chip-manufacturing outsourcer with good fundamentals. It will benefit as the semiconductor cycle turns. And they just raised $66 million in equity, which is a nice event for bondholders.

We also like certain short-term notes within Xerox(XRX). We believe, short term, the company has plenty of liquidity to meet two- to three-year maturities. And we like the near-term credit story.

The third company we like is Amkor Technology (AMKR) -- they are similar to ChipPAC; they test and outsource chip production. Improving semiconductor trends will help this company.

TSC: Of course the last question, what are some companies you'd stay away from?

Zolin: One company, Viasystems (VG) will be challenged to make it through this down cycle. We think it's potentially a bankruptcy candidate.

I think that anything in the telecom-equipment area is risky. Not that they are bankruptcy candidates, but we think the bonds can get cheaper. It's a matter of timing, [but] there's probably more downside than upside ahead right now.

Another company to avoid is Acterna (ACTR), a seller of testing gear to network service providers. Their main customer base is telecom companies, and anyone selling to phone companies is going to have a really tough year this year.

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