Entergy Corporation (ETR) is a large regional utility in the southeast US that provides electricity to 2.8 million customers. The common stock is hovering around its 52-week low but it still pays a very nice dividend. However, in this article we'll take a look at one way investors can take advantage of ETR's strong and stable cash flows without the market risk of owning the common stock. EDT is an exchange traded debt security based on the company's 7.875% Series Mortgage Bonds Due 2039 and we'll take a look at it to see if it is right for your portfolio.
Investors new to income securities often mistake exchange traded debt securities for preferreds and the mistake is easy to make, as the price and distribution activity can look very similar. However, exchange traded debt securities have important differences from preferreds including the types of distributions made, maturity dates and the fact that preferreds generally have no debt issue backing them. In essence, an exchange traded debt security is just a way to buy a company's debt on a stock exchange in small lots instead of on a bond exchange in lots of $1,000 or more, as is traditional with debt.
Since this security is backed by a debt issue, the company's bonds due 2039 in this case, it has a stated maturity date. Of course, the maturity date for EDT is the same as the underlying bond so if you are planning on getting long EDT, just know it is set to mature 25 years from now. Beginning this June, however, ETR has the option to redeem EDT if it so chooses as the call option becomes active on June 1, 2014. If it chooses to do so ETR will have to pay the full $25 call price, the same price this security was issued at, in order to redeem it.
Speaking of the price, EDT closed at $25.85 yesterday, a slight premium to its call price of $25. This means that if EDT is called sometime after June 1st, holders who initiate positions now will potentially be subject to a capital loss of 85 cents per share, or just over three percent. This is something to keep in mind if you are thinking of getting long EDT; no one knows if it will be called but in the event that it is, you will be subject to a small capital loss.
EDT makes quarterly interest distributions totaling $1.96875 annually for a coupon yield of 7.875%, matching the interest distributions from the underlying debt. However, with the price of the security trading slightly higher than the issue price, the current yield is actually a bit lower at a still-robust 7.6%. This is a very strong yield and particularly from a strong, stable payer like ETR. This is a full 220 basis points higher than the common stock and without the market risk inherent in owning common stocks.
Unfortunately, since distributions made from this security are interest and not dividends, it is ineligible for the favorable dividend tax treatment dividend paying security holders enjoy. This could be a sizable negative for those considering EDT for a taxable account as the after-tax yield on this security will be significantly lower than it would be for a similar security that makes dividend distributions instead of interest payments. However, if you're holding EDT in a retirement account, it doesn't matter. It's just something to keep in mind if you are planning on holding EDT in a taxable account; you must understand the tax implications of doing so before pulling the trigger.
While EDT is in danger of being called as early as six months from now, it still represents a decent opportunity to get what I consider to be a pretty safe 7.6% yield. Entergy is a very strong utility with robust financials supporting its huge common stock dividend and ample cash flow to service its debts, including EDT. If you can get past the potential call of the issue, this Baa2/A- rated debt issue could be a nice jolt of income for your retirement portfolio.