Alcoa: A 4.7% Yield For Your Retirement Portfolio

Feb.24.14 | About: Alcoa, Inc. (AA)

Alcoa (NYSE:AA) is the famous materials producer that was long a part of the benchmark Dow Jones Industrial Average (NYSEARCA:DIA). While AA has been a household name for decades, as an income stock, it is surely lacking. AA's 1.5% yield is well below that of the Dow at 2.2% and even at that yield, would hardly qualify as an income stock. However, there is hope for those wanting exposure to AA but also current income. In this article, we'll take a look at Alcoa's $3.75 Serial Preferred Stock (AA-P, ticker may differ depending on your broker) to see if it could be a good fit for your income portfolio.

To begin, we'll define exactly what AA-P is. AA-P is a traditional preferred stock, meaning it has no maturity date and no debt issue backing it. Issued at $100 per share, this preferred pays annualized distributions of $3.75 on a quarterly basis, good for a coupon yield of 3.75%. However, with the price of this preferred trading at $79 as of this writing, the current yield is actually much higher at 4.7%. This is roughly four times the yield of the common stock and more than double that of the Dow, meaning it is a great option for income investors.

Since this is a traditional preferred it means the dividends are eligible for the preferential dividend tax treatment. All else equal, this means AA-P could provide a materially lower after-tax yield than a similar issue that is ineligible for the favorable tax treatment. For those holding AA-P in a taxable account, this is a significant positive. It can allow holders to reinvest dividend proceeds without taking a significant tax hit in the process.

As I said before, AA-P has no maturity date. However, it does have a call date that passed in 1987. As such, this preferred is unlikely to be called at any point. Consider also the longevity of this issue; it was first issued in 1947 and is still around today. Distributions have been safe for the past 65+ years and I don't think anyone has any doubt that AA will continue to pay the 94 cent quarterly distributions on AA-P.

While we can assume that AA has no plans to call AA-P, in the event that it did, holders would receive a $21 capital gain on their shares, good for a 26%+ boost on the current price. And you actually don't need AA to call AA-P to realize a capital gain on AA-P; shares have traded as high as $100 in just the past year. I'll caution you that this preferred does move around a decent amount as interest rates move so that is something you must make peace with before pulling the trigger. This is not unique to AA-P; any perpetual preferred is going to suffer the same fate. However, with shares near their 52 week lows, AA-P offers good value for certain investors.

AA-P's history of faithfully paying dividends is an attractive trait for income investors. In addition, AA-P's nice yield is more than double that of the Dow, offering relative value. The issue's preferential tax treatment is a bonus for those holding AA-P in a taxable account and the discount to par provides investors with a way to accumulate shares at a much higher yield than the coupon rate. If you can stomach the volatility due to interest rates, AA-P offers you a unique opportunity to get exposure to AA without having to accept the common's diminutive yield.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.