Fund DuPont short with Nalco long, suggests Citi

In its latest High Yield Weekly report, Citi says that with investment grade credit trading at near long-term averages while high yield still has room to tighten, it is a good time for investors to consider carry-neutral compression trades.

It suggests, for example, going long double B rated specialty chemical company Nalco by selling protection at the equivalent of a 300 basis point spread. This can fund a short on single A rated DuPont, which trades at 67bp, at a ratio of 4.5 to one. This trade, which is a net short from a DV01 perspective, expresses the view that DuPont will be more pressured in any sell-off that the high-yield name.

The report points out that Nalco has globally diverse sales and good scope for international expansion. Improved margins and productivity could allow it to beat expectations when it announces fourth quarter results in February. Further, the recent redemption of Nalco’s 2011 bonds has improved its leverage (now 4.2 times) and liquidity.

DuPont, on the other hand, is a cheap short, says Citi. It is on negative outlook from all three rating agencies, and the company’s chief executive says he has not ruled out acquisitions, even if they lead to lower ratings.