Felcor Preferred - A Cheap 8.20% Yielding Equity REIT Preferred That Can Never Be Called

| About: FelCor Lodging (FCH)

Summary

Felcor Lodging Preferred A (FCH-A) cannot be called, so it has significant upside potential.

FCH-A would trade a full $5.00 per share higher if it traded at a similar yield to the preferred stocks of Hersha Hospitality, another hotel REIT with similar leverage.

Felcor has been selling hotels and deleveraging its balance sheet. Preferreds of hotel REITs with less leverage sell at lower yields, so as investors feel more comfortable with.

For an equity REIT preferred, 8.2% is quite a high yield.

General

Felcor Lodging (NYSE:FCH) is a hotel REIT. As it states in the Yahoo Finance profile, FCH "primarily invests in hotels with a focus on the ownership of upper-upscale, full-service hotels and resorts". FCH-A is a par $25 preferred that comes with an annual dividend of $1.95, so at the current price of $23.75, it yields 8.2%. Dividends are paid quarterly.

Why FCH-A Can Never Be Called and Thus Has Significant Upside

FCH-A is actually a convertible preferred stock, so it has no call date. FCH can force FCH-A holders to convert their shares into common shares if FCH exceeds a price of $32.25 per share, but with FCH currently trading at $7.03, that is hardly a concern. So unlike most preferred stocks, FCH-A is not anchored to a $25 call price and can rise significantly above $25. EPR-E is an example of a par $25 convertible preferred issued by REIT EPR Properties (NYSE:EPR) that now trades over $35 due the fact that it cannot be called - and certainly also because it has a nice dividend, interest rates are low and investors feel that there is safety in the EPR-E dividend. EPR-E trades at the same yield as the non-convertible EPR-F so the $35 EPR-E price has little to do with the fact that it can be converted into EPR common and everything to do with the simple fact that it cannot be called.

How FCH-A Compares to the Preferreds of Hersha Hospitality

Hersha Hospitality (NYSE:HT) has three preferreds; HT-C with a 6.88% yield, HT-D with a 6.71% yield, and HT-E with a 6.67% yield. Both FCH and HT have similar ratios of liabilities (including preferred stock) to total enterprise value, so I consider them equally leveraged. A quick glance at the balance sheets of both companies might lead one to believe FCH is more leveraged, but that is because FCH has been around a long time and has depreciated its hotel assets (in accounting terms) to well below what the market is valuing its properties at. Additionally, Yahoo Finance states that HT operates in the mid-scale hotel segment which is generally less favored by investors as compared to the upscale hotels that FCH owns. If FCH-A is valued by the market like the HT preferreds, with a 6.8% yield, FCH-A would trade at $28.65, almost $5.00 per share higher than its current price.

FCH Is Deleveraging Which Should Benefit the FCH-A Preferred Stock

Some time ago, a new management team took control of Felcor. It has been on a mission to improve the balance sheet of FCH and is continuously selling off hotels. Since the beginning of 2014, its liabilities have been reduced by $356 million, and in addition to that, the management called all $170 million of its FCH-C shares which had a $2.00/share dividend. It may have wished that it could have also called the FCH-A, but it can't. The continued deleveraging, which is aided by the fact that FCH only pays out a relatively low 27% of FFO in common dividends, could eventually allow FCH to be comparable to less leveraged hotel REITs like Pebblebrook (NYSE:PEB) whose preferreds carry a 6.4% yield. At a 6.4% yield, FCH-A would trade at $30.50 per share.

Current Preferred Dividend Coverage

Analyst FCH estimates for 2017 FFO (before the preferred dividend payout) are around $146 million. The preferred dividend payout amounts to around $25 million annually, so FCH has almost six times coverage of the preferred dividends making it very safe.

Conclusion

Of course, there is always operational risk with any company that has issued preferred stock, and certainly a continued rise in long-term interest rates would be a headwind for FCH-A in achieving the large potential upside that exists there. On the other hand, lower interest rates would make FCH-A even more undervalued than it currently is. One large takeaway from this article is that if you own the preferreds of HT, you should swap to FCH-A. The upside is much superior since HT preferreds are anchored to the $25 call price, the current yield of FCH-A is much higher than the yields on the HT preferreds, and I believe that the high yield that FCH-A currently carries provides you with much better downside price protection should interest rates continue to rise.

Disclosure: I am/we are long FCH-A AND 15% HEDGED BY SHORTING HT-C.

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.

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