Published:
December 11, 2007
11% Citigroup
ELKS linked to Nucor (AMEX: ENQ,
$9.65) is a stock/bond
hybrid issued by Citigroup that
tracks steel maker Nucor. It first started trading on October 24, 2007 at $10 a share and will
mature on November 6, 2008. Over the life of the security, ENQ will pay
total distributions of $1.1306, for a yield of 11.7% ($1.1306/$9.65).
This payout consists of $0.4798 in interest income and $0.6598 in option
premium. Payments will be doled out in May 2008, as well as when ENQ
matures in November 2008.
If shares of NUE stay above the "trigger price" of $44.91 during the
life of the note, then ENQ investors will receive $10 in cash at
maturity. But what happens if underlying shares of Nucor fall sharply?
The exact terms of these equity-linked securities can be tricky to
understand, and ENQ is no exception. There are two key concepts: the
"trigger price" and the "exchange ratio."
The trigger price represents the dollar value the underlying shares must
stay above in order for ENQ investors to receive the full $10 issue
price at maturity. For Nucor, this amount is $44.91 and is calculated by
taking 72.5% of the $61.94 price of NUE shares when the ELK was issued
($61.94 x .725).
But what if NUE falls below that price? That's where the exchange ratio
comes into play.
The exchange ratio for Nucor is 0.16145. That ratio is determined by
dividing the $10 face value of ENQ by the issue price ($61.94) of NUE.
This exchange ratio represents the amount of common shares the holder
will receive at maturity if NUE's stock falls below $44.91 at any time
between now and November 6, 2008. For example, if NUE dipped to $40 per
share tomorrow and stayed at that price until ENQ matures, then come
next November ENQ investors would receive NUE stock worth $6.46 ($40 x
0.16145), generating a substantial capital loss, at least on paper.
What the investor needs to weigh is the juicy yield offered by ENQ
against the risk that shares of NUE will drop below the $44.91 trigger
price. With NUE currently trading in the $61-range, there is close to a
35% margin of safety "insurance policy" against this kind of decline.
Further, Nucor's stock would have to become very cheap on a
price/earnings basis in order for it to fall below the $44.91 threshold.
As the third-largest U.S. steel producer, Nucor manufactures products
such as rebar, beams, joists and girders. Currently, 15 analysts follow
the stock (a substantial number). Over the last 90 days, these analysts
have hiked their consensus earnings estimates for 2008 from $5.43 to
$5.64 per share.
For NUE to fall below $44.91, the stock would have to trade below eight
times projected earnings ($44.91/$5.64 = 7.96). This low multiple is
unlikely, since the company is projected to grow at a healthy +15% pace
next year
In a volatile market, however, anything can happen. We suspect if NUE
did trade below $44.91, then it would bounce back very quickly. In
August, for example, the stock bottomed near $43 per share, only to
bounce back to near $65 by October.
Action To Take ---> ENQ's juicy
11.7% yield must be weighed against the possibility of having to take
shares of NUE at a reduced price at maturity. For those willing to
shoulder that risk, this unique security might be worth a closer look.
Carla Pasternak
Editor
High-Yield
Investing
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