Go long on Penske's 3.5% convertible due 2026 in volatility trades, Lehman recommends

By Kenneth Lim

Boston, Feb 21 - Penske Automotive Group Inc.'s 3.5% convertible senior subordinated notes due 2026 suit an actively managed volatility trade that is long on the bond on a full delta, Lehman Brothers' convertible desk recommended in a research note.

Bloomfield Hills, Mich.-based Penske, the auto retailer formerly known as the United Auto Group, should have a volatile stock for some time and its convertibles are relatively cheap, wrote Lehman analysts Venu Krishna and Manoj Shivdasani in the note.

Penske beat market expectations on Tuesday with an adjusted fourth-quarter profit of $31.8 million, or $0.34 per share. A range of factors will likely keep the company's stock volatile, the analysts wrote. Those factors include macroeconomic events, consumer spending concerns, monetary policy, erratic market expectations and economic weakness in the United Kingdom, a major Penske market.

The 3.5% convertible currently trades at an implied volatility of about 32.4, "a large discount to both realized vol (44.5) and listed implied vol (39.6)," the analysts wrote.

The convertible also appears attractive on other fronts. Penske's credit quality appears stable, and although the convertible's put in 2011 places it before Penske's 7.75% senior subordinated note due 2016, the convertible's option-adjusted spread of Libor plus 554 bps is slightly wider than the Libor plus 543 bps spread for the straight debt, the analysts explained.

The convertible has a high bond floor of 87 and trades at a low premium of 19.4% over the bond floor. The bonds have an "adequate equity cushion with reasonably healthy underlying operating fundamentals" and the carry is only slightly negative at 0.73 points over a one-year horizon, the analysts said.

"The bonds are cheap relative to benchmark credit and vol," said the analysts, who reckoned that the convertible was 1.27% cheap using a volatility assumption of 35 and a Libor plus 475 bps credit assumption.

© 2015 Prospect News.
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