by Roger Choudhury
In lieu of disappointing earnings from Chinese companies, this recent downturn provides the perfect opportunity to pick up preferred shares as the markets cool off. Preferreds offer a safe alternative for
investors and often provide stronger investment opportunities. Below, I will discuss three undervalued financial preferred stocks that investors should consider for 2012.
Citigroup (C) (Capital XI, 6% Capital Securities)
Recent Price | $23.64 per share |
Callable? | Yes, at $25 per share, since Sept. 2009 |
Dividends | $0.375 per quarter Next dividend payment is on June 27 Record date is in the third week of June |
Current yield (After-tax yield) | 6.2% (4.0%) Does not qualify for 15% tax rate |
S&P Rating | BB+ |
Ticker symbol (Yahoo! / Google / Fidelity) | C-PQ / C-Q / C/PQ |
Citigroup has a ratio of earnings to fixed charges and preferred stock dividends is 1.59. The company has made progress since 2007, when it was 1.01. Moreover, total fixed charges have also dropped by 67.6% to $24.771 billion since then. As such, the debt to equity ratio has come down dramatically from 5.07 in 2008 to 1.89, currently. All in all, I believe that the company will continue to make all interest and dividend payments for the medium term.
According to an HSBC analyst, Citi common shares are 7% overvalued. After all, the assumed growth rate is only 10%. This may lead probably to a temporary readjustment downwards of the Citigroup common shares over the short-term. So, this preferred stock will follow in kind. I would look to purchase this over the next few days.
Due to rising gas prices, the University of Michigan consumer sentiment figures may tamp down market optimism. Also, the KC Fed Manufacturing survey number was much lower than consensus, and the Chicago PMI is also forecast to come in lower. So the ISM number may put further downward pressure on the markets. In sum, there may be a flight to safety over the next week, resulting in appreciation in the price of this security. Your window to buy is slim. Retirees should stay away from this, until it becomes investment grade.
Goldman Sachs (GS) (Depositary Shares Floating Rate Non-Cumulative Preferred Stock, Series D)
Recent Price | $20.42 per share |
Callable? | Yes, at $25 per share, since May 2011 |
Dividends | $0.255560 was most recent quarterly dividend The floating rate will be equal to the greater of 0.67% above LIBOR or a minimum of 4.00%. Next dividend payment is on May 10 Record date is in the third week of April |
Current yield | 5.0% |
S&P Rating | BB+ |
Ticker symbol (Yahoo! / Google / Fidelity) | GS-PD / GS-D / GS/PD |
The firm's ratio of earnings to combined fixed charges and preferred stock dividends is a 1.32. This is marginally acceptable, and considering the debt to equity ratio of 2.62, the BB+ rating is justified on this instrument. However, Goldman has made significant headway to reduce fixed charges by 73.5% to $8.146 billion since 2007. I expect the company to continue to make preferred dividend payments over the medium term, but keep your eyes peeled for adverse events over the next several years.
Regulatory uncertainty has also hampered the firm's operations. One area of contention between the SEC and CFTC is what the threshold should be to determine which companies are categorized as swap dealers. Such a company will be required to set aside more capital and margin. Goldman Sachs is heavily involved in swaps, and such lack of clarity is affecting potential deals and behavior toward entities that are tangentially involved with these derivatives. A broad rule will impact the profitability of the company, and pose undue risks to smaller firms. In part, I believe that this is a reason why Goldman preferred shares trade significantly below par value. This uncertainty will continue to ensure that these shares will trade below par value. Thus, an income investor looking for more yield has the next few months to pick up this issue.
Morgan Stanley (MS) (Floating Rate Depositary Shares Series A Non-cumulative Preferred Stock)
Recent Price | $18.76 per share |
Callable? | Yes, at $25 per share, since July 2011 |
Dividends | $0.252780 was most recent quarterly dividend The floating rate will be equal to the greater of 0.70% above 3-month LIBOR or 4.00%. Next dividend payment is on April 15 Record date is in on March 30 |
Current yield | 5.3% |
S&P Rating | BB+ |
Ticker symbol (Yahoo! / Google / Fidelity) | MS-PA / MS-A / MS/PA |
Despite its preferred stock trading at such a discount, Morgan Stanley's ratio of earnings to fixed charges and preferred stock dividends is an adequate 1.8. The company has also scaled back fixed charges by 87% to $7.551 billion. However, its debt to equity ratio is 3.38. This is the likely culprit behind the BB+ rating and 25% discount to par value. Yet, consider that in 2007, this ratio was excessively high at 6.32. I would also point to revenues having almost returned to 2006 levels at $32.4 billion. Adding this all up, I think that the firm will continue to make dividend payments over the next few years.
Morgan Stanley is also in the midst of expanding revenue sources, while its competitors are closing up shop in emerging markets. The Global Private Equity division is forging a partnership with OSF Merchant Banking to seek out investment opportunities in Brazil. Both firms will look for firms with high growth potential and sustainable superior operating margins. As Brazil matures into a developed economy over the next decade, Morgan Stanley is right to plant its foot in the PE arena in South America.
The company needs to branch into other areas because a recent study indicated that the firm is losing market share among high net worth individuals. For the top four brokers, Morgan Stanley Smith Barney, Merrill Lynch, Wells Fargo Advisors, and UBS Wealth Management Americas, this market share reached an all-time high at 56%, dropped to 45% in 2011, and is projected to fall to 42% by 2014. This should be troubling to the company because the assets from such people has fallen in the post-Lehman aftermath, and not because more rich folks have been minted.
Holistically, I believe that this security has already priced in the latter piece of news a long time ago. As for expanding into Brazil, I feel that the shares will continue to be buoyant around the $18.50 mark. Regulatory pressures and slowing growth in China should provide you an opportunity to get in at this attractive yield. I recommend this for investors that are seeking a modest amount of risk, due to the firm's mixed financial shape.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
