Bear Stearns convertible analysts recommend the Kerr-McGee/Devon mandatory

By Ronda Fears

Nashville, Tenn., Feb. 11 - Bear Stearns & Co. convertible analysts recommend the Kerr-McGee 5.5% mandatory convertible that exchanges into Devon Energy for exposure to the oil and gas name while picking up high current yield, significant price appreciation with the underlying stock and an overall attractive risk/reward profile.

Ellen Hannan, Bear Stearns' oil and gas exploration and production analyst, has a buy on the underlying Devon stock with a target price of $52. At current prices, Devon stock trades at 3.6 times the equity analyst's 2002 price-to-cash flow estimate and 5.9 times her enterprise value-to-2002 EBITDAX estimate but she believes the stock should achieve a better multiple over time as management has a long track record for achieving growth on a per share basis while maintaining financial flexibility.

With the lukewarm outlook for the equity markets in general, and the energy sector in particular, Bear Stearns analysts recommend the convertible as an alternative to the equity for investors who want to have exposure to Devon. The DECS structure is short dated and gives an enhanced income component in exchange for giving up some of the stock's upside potential.

"You buy a DECs type structure when you like the long-term fundamentals of a company but in the near term you believe that the stock might be treading water and you want to be paid while you wait for things to swing in your favor," said Yaw Debrah, head of convertible research in a report Monday.

The Kerr-McGee/Devon convertible was trading at 34.7 versus a stock price of $36.5, offering a high current yield of 5.3%, which is 471 basis points more than the common yield of 0.55%. The investment grade credit rating of BBB/Baa1 provides comfort that the company will be able to make good on its obligations, the analyst pointed out.

On a price appreciation and depreciation basis, the convertible is currently showing 70% movement with the underlying equity, Debrah said. On a risk reward basis, Bear analysts estimate that the convertible will provide 90% participation with the underlying equity on a total return basis over the next year for a 25% upward move in the stock, but only 65% participation with the equity on the downside for a 25% movement down in the stock.

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