Red Lion Hotels (RLH) is an owner, operator and franchisor of midscale hotels in the western part of the US. The company has had some very public shareholder fighting with management over the past few years and the company's spotty operating results have led the common stock to languish. However, income investors can take advantage of RLH's strong balance sheet and cash flow through its Red Lion Hotels Capital Trust 9.5% Trust Preferred Securities (RLH-A, could differ depending on your broker). In this article, we'll take a look at RLH-A to see if it is a good fit for your income portfolio.
To begin, we'll define exactly what RLH-A is. RLH-A is a trust preferred security, meaning it has some of the characteristics of traditional preferred stock but with a couple of important differences. RLH-A pays regular quarterly distributions just like a preferred stock, however, unlike a preferred stock, RLH-A has a stated maturity date. Since RLH-A is backed by a debt issue through a trust that issues shares and uses the proceeds to buy RLH debt, RLH-A matures the same day the underlying debt matures. In this case, RLH-A is due to mature in 2044, assuming RLH-A doesn't call the remainder of the issue.
Speaking of calling the issue, RLH performed a partial call on this security in 2006 so RLH isn't necessarily opposed to calling the issue if it can obtain better financing terms elsewhere. The call option is in effect from now until the security matures so that is something to keep in mind if you are planning to get long.
Since owning RLH-A is essentially the same thing as owning RLH debt, albeit through a trust vehicle, one unfortunate result of this is that RLH-A is ineligible for the preferential dividend tax treatment. This means that holders of RLH-A in a taxable account could potentially see much lower after-tax returns on RLH-A than a comparable issue that is eligible for the preferential treatment. Everyone's tax situation is unique so you'll need to figure out if this is a sizable negative for you or not but it is something to be aware of. And of course, if you hold RLH-A in a retirement account it doesn't matter at all.
This issue is cumulative, meaning that if RLH were to miss distributions on RLH-A it is obligated to make them up. Thus, barring bankruptcy your distributions are virtually guaranteed. This is important because RLH actually has the option to defer distributions on RLH-A for up to 20 consecutive quarters, at which time it must make them up. However, the ability to defer distributions is a sizable negative for some investors but at least the distributions are cumulative. Without that feature, RLH could essentially just stop paying on RLH-A with no consequences. However, that is not the case and distributions should be safe with RLH-A.
RLH-A was issued at $25 per share and with annualized distributions of $2.375, made in quarterly installments, the coupon yield of RLH-A is a very strong 9.5%. However, shares currently trade at a small premium to the issue price at $25.74 so the current yield is a bit lower at 9.2%. That is still a very high yield and given RLH's balance sheet strength and restructuring in an effort to raise cash, I don't see any repayment risk that would justify that high of a yield. Thus, I think the market may be a bit too pessimistic on RLH's prospects at present, offering a yield to investors on RLH-A that could end up being a great buy.
There is risk in owing RLH-A, as there is owning any other security. RLH's restructuring may not work as planned and the company could cease operations in the future due to poor operating results. While I don't think this will happen it is a possibility and owning RLH-A means you need to keep a close eye on RLH's restructuring process. In addition, there is the inherent interest rate risk of owning any income security; RLH-A will likely move up and down as interest rate expectations change among market participants. This could lead to capital gains and losses on any RLH-A positions and that is something you must be okay with before jumping in to own RLH-A or any other income security.
On balance, RLH-A offers investors a chance to get a very strong 9.2% yield from a payer that I believe has engaged management and is committed to restructuring a business that isn't functioning all that well right now. As a result, I think the market is mispricing RLH-A into junk territory when RLH's ability to pay is better than that. If you can stomach the potential capital losses due to interest rate swings and if you agree RLH is on better footing than it is being given credit for, RLH-A could be a nice addition to your income portfolio.
Additional disclosure: I may initiate a position in RLH-A at any time.