Actuant’s Investment Opportunity

Jeremy Glaser: I'm Jeremy Glaser with Morningstar.com. Morningstar recently
launched corporate credit ratings as an extension to our existing
equity research services.

I'm here today with the credit analyst Rick Tauber to discuss a
bond issue that he's found that seems like it's attractively priced
right now. Rick thanks so much for joining me.

Rick Tauber: I appreciate it.

Jeremy Glaser: So the company that we're talking about today is Actuant which is
an industrial manufacturer. Right now, we have the credit rated
BBB-. Can you talk a little bit about what went into that rating?

Rick Tauber: The credit ratings are derived directly from our forward-looking
equity model. Once we put the model together, we basically
determine four different pillars which calculate to the credit rating.

Those pillars are business risk, solvency score, cash flow cushion,
and distance to default. Basically, the inputs to the model end up
basically calculating the rating which came out as BBB-. This
rating was then taken to the Credit Committee which approved that
rating.

Jeremy Glaser: How does this rating differ from maybe some of the other rating
agencies that are also looking at this debt?

Rick Tauber: The interesting thing about Actuant is we've got our BBB- rating,
which is the lowest investment-grade rating. But the other two
rating agencies rate it at mid-BB which is a high junk rating. So
we're two notches higher than the rating agencies.

Jeremy Glaser: So we're right on that border between what's considered a junk
bond and what's considered investment-grade. What gives you the
confidence to say that this is definitely investment-grade versus
some of the competitors?

Rick Tauber: There's I guess a couple of things I'd highlight. One, we think this
company is very well positioned. It's built itself up over the last
several years via both internal growth and with acquisitions to
establish a competitive advantage in its niche businesses. We think
this gives it a narrow economic moat which will allow it to
generate some economic profits that are sustainable over time.

Secondly, as I mentioned before, we are using forward-looking
data and modeling. Right now, the company is in the trough of its
recessionary cycle and going forward. We would expect operating
earnings to improve substantially and credit metrics to follow
along in the same direction.

Jeremy Glaser: So what are some of the things that could go wrong here?

Rick Tauber: Well, a couple key risks I guess. One, it's still a cyclical company,
even though they've diversified over the last few years. Obviously,
they're tied to primarily an industrial economic cycle.

Secondly, as I mentioned, they have grown via acquisitions.
They've done this with good discipline and they've used both debt
and equity. But the risk here would be that they would potentially
do a big debt-financed acquisition and which would leverage the
company up.

Jeremy Glaser: For bond investors, what does the fact that we think its investment-
grade and think that the spread should maybe be a little bit tighter
than they are now? What does that mean for them in terms of
actually going out and investing in this idea?

Rick Tauber: There are two approaches here. One is the spread on this bond is
about 400 off on the six and seven-eighths bond I'm referring to
which is right in line with double-Bs. A weak triple-B might be in
the 275 spread area.

You're getting paid an additional—say 100-plus basis points,
relative to the amount of risk you're taking, as we rate it as a BBB-
rating. So you can just buy the bond, sit on it and basically be
overcompensated for your risk.

Secondly, we look at what are potential catalysts that could drive
those spreads to tighten up towards investment-grade and that
would then lead to appreciation of the bond price. Those are both
situations to consider which we think makes this bond cheap.

Jeremy Glaser: Now, some of their outstanding debts are convertible, so you
would have an option to convert it to equity. Do you think that that
converts option could be exercised?

Rick Tauber: Sure. That's definitely something that we're factoring in and is one
of the catalysts that I was talking about. We have a constructive
view of the equity here. The interesting thing, again about this
company is the strike price on their converts is right around $20.00
and the equity is trading right around $21.00, so they're very close
which means these bonds are callable in November. They're also
potable.

So if the stock continues to move up, it's quite possible that the
company will call them and the debt will convert to equity which
will basically take debt out of the capital structure and improve the
credit overall.

Jeremy Glaser: So for bond investors who maybe are looking for a little bit more
yield, but maybe don't want to take on a ton more risk, this could
be an interesting opportunity.

Rick Tauber: Yeah, absolutely.

Jeremy Glaser: All right, great. Rick thanks so much for speaking with me today.

Rick Tauber: I appreciate it.

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser.