If Bonds Go Bust – Sherritt International

I might lose my entire bond

Bonds are usually safer than stocks. But it’s also possible to lose a lot of money in bonds if we’re not careful. Last year I blogged about buying $5,000 of Sherritt’s high yield bonds. I made this decision based on the attractive 8% annual yield! 😀 Sherritt International Corporation is a mining and energy company that operates in Canada, Cuba and Madagascar. Sherritt’s primary business is mining and refining nickel ore and similar base metals.  I expected the bonds would mature in November 2018 and I’d get back my principal. However, a lot of things have changed since 2014.

Sherritt bonds plummet in value

As with all mining companies, the value of Sherritt’s business depends heavily on the price of the underlying commodity it sells, in this case, nickel. When I bought the bond last summer the spot price of nickel was roughly $9 per pound. And it appeared to have stabilized. However, 15 months later, the price has now dropped in half to just $4.5 a pound. 😕 Below is a 5 year chart of the price of nickel.

Obviously this had a devastating impact on resource and mining stocks. Teck Resources and Freeport-McMoRan are both down about 50% year to date. And Sherritt is down 70%. I guess you can say these mining companies have hit rock bottom. ? Even though I don’t own any Sherritt stocks, I’m still a little concerned as a bond holder. With the common share price dropping this low, there’s a real chance that Sherritt could file for bankruptcy protection in the foreseeable future. And if the company’s board of directors choose to do that before my 2018 bonds are due then I may not get my $5,000 principal back. 😐

When I purchased the Sherritt bonds they were actually trading at above par. But today the bonds are selling for way below par, meaning that if I wanted to sell my holdings now I would have to accept a loss. Here’s how the balance is shown in my brokerage account. I currently have a paper loss of $2,124.

The “Price” refers to the current value of the bond out of an initial $100. As we can see, I’m currently losing 40.66% on this investment, lol. The reason it’s not worth the full value of $100 anymore is because other investors aren’t willing to pay as much for a bond that has a relatively high chance of defaulting. This means that the yield on this junk bond has gone through the roof. 🙂 If any speculator strongly believes that this mining company will eventually pay back the $5,000 it borrowed, then buying this bond today would be a great trade. Based on the evidence above anyone can basically pay $3,100 now, and get back $5,000 in a few years, plus interest. That’s why the annual yield to maturity is 26%. 🙂

This means that if Sherritt continues to stay in business until November 2018, the bond buyer today would make 26% annual return on this investment. However, the fact that the market has bid up the yield to 26% should be a red flag to anyone. Higher yield usually means higher risk. Greek government bonds were yielding over 20% a few years ago which lead to a default of principal payment earlier this year and the country had to restructure. There’s often a lot of parallels between the macro economy and corporate finance.

But I’m not too worried about my Sherritt bonds. I plan to hold my position until maturity. I think selling them at a loss now would be a mistake for me. The most I can lose is only $5,000 so it’s not like I’d lose any sleep over this, haha. Even if the bonds default I’ll simply write off the investment at $5,000 face value, which is worth less than 1% of my entire assets so it’s no big deal. 😉

Personally I think the chance of Sherritt going bankrupt before 2018 is still small. If the price of nickel drops to below $4/lb and stays there for a few years then that could be problematic for the company. Otherwise they should be able to meet all their debt obligations. 🙂 The 5 year stock chart of Sherritt looks quite bleak.

But Sherrit has a book value of $10.42 per share. This is the value of the company’s assets that shareholders would theoretically receive if a company were liquidated. Yet the stock is only trading at $0.82 per share. And financially speaking the business is not strapped for money either. It’s actually holding more cash right now than its total market cap is worth.

It’s too early to say how things will play out for my fixed income investment. Maybe I’ll be made whole, or maybe I’ll lose $5,000. Who knows? We’ll have to wait a few more years to find out. But in the mean time I’ll hang onto my bonds and continue to collect $400 of interest income each year. 😀

[Update] Sherritt has announced it will extend its debt to 2021. This means my bond is safe for now. Phew. 🙂  https://www.freedomthirtyfiveblog.com/2016/08/sherritt-international-debt-extension.html

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Random Useless Fact: 

Honey never goes bad. It was reported that archaeologists found 2000 year old jars of honey in Egyptian tombs and they still tasted delicious!