Sell Ford, Buy Ford Trust Preferred

Includes: F
by: Vox Rationalis

IMPORTANT: The author has retracted most of this article based on a comment in the comment stream following the article.

Back in March of 2009, at the bottom of the bottom, I advised that Ford’s Trust Preferred shares (F.PS) were absurdly undervalued, and that there was no reason to own the Ford common stock (NYSE:F). We’re there again.

Quick definitions: F.PS is a trust preferred that pays quarterly dividends of $0.8125 per share, and is convertible at the holder’s option into 2.825 shares of F. The F.PS dividend can be deferred by Ford at any time for a period of up to 5 years, at which point all accumulated deferred dividends are due.

The price of F.PS should be the price of the common, times the 2.825 conversion rate, times a premium for the dividend payment. This premium should be negatively correlated with the risk-free rate of return (reflecting the opportunity cost of holding F.PS) and with the risk that the company will become unable to pay the dividend. In normal times, the F price is a decent proxy for this last variable, as it’s a barometer of the company’s prospects.
Ford Common Charted Against the Ford Preferred Premium

(Click to enlarge)

The graph above shows that the inverse relationship between the premium (in blue, right scale) and F (in red, left scale) held from the issuance of F.PS in 2002 through 2005, when the market started to have concerns about Ford’s viability. Then, the correlation was still fairly strong to late 2008, until the October 2008 market crash when the premium reflected the shakes of the greater market. As the market bottomed in March 2009, Ford began to defer F.PS dividends, conserving cash as the economy crumbled. For a time, the preferred traded at (or, absurdly, below!) its conversion rate. I advised that if Ford survived, it would be far better to own F.PS than F, as the deferred dividends would eventually be paid (with interest). By the fall of 2009, as Ford looked better and better, both the common stock and the premium recovered, and now we appear to be back to the inverse correlation of the early 2000s.

Ford has done very well since 3/09, avoiding the government dole and making enormous market share gains. On June 30 of this year, Ford reinstated the F.PS payment, paying a touch more than $5 per share of accumulated dividends. At the open on July 1, while $1000 invested in F on 3/11/08 was worth $5,219, the same investment in F.PS was worth $8,115, including more than $900 in dividends. F.PS outperformed F by more than 55%.

In early September, I started paying attention to the F.PS premium, and decided that at a rate much higher than the then-current 40%, it would be time to swap out of F.PS and into F. Unfortunately for me, it didn’t again hit my 45% trigger, instead falling through September and October, reaching a meager 10.8% at Monday’s close. If I had been smarter and switched when the F.PS premium was at 40% in early September, I would be up more than 25%.

So now the premium is at 10.8%. With the exception of the tumultuous 2008-09 bottom, the premium has never before been below 18%. Looking at the historical data, I think the "normal" range is about 30%-40%, though with interest rates lower than the 2002-2005 period, it should probably tend to be a little higher.

There are a couple of ways to play with F.PS:

If you’re an owner of Ford common, or if you like the Ford common at this level, you can buy or hold 565 shares for $9,272. Or, for $1,000 more, you can choose 200 shares of F-PS, convertible into the same number of common shares. For that extra $1,000 you get annual dividends of $650, or 65%.

If you think you missed the recent move, or that F’s gotten ahead of itself, F.PS may offer a second chance or a cushion, since the common would have to fall below $14 for the F.PS premium to reach 30%, which I consider to be the lower end of a normal range.

Or you could do some arbitrage, shorting F and buying F.PS. The downside is limited to 10.8%, and the upside is 18%-27% if the premium reverts to a normal level. Meanwhile, the 6.3% F.PS dividend covers the cost of carrying the trade.

I still like Ford. I think the stock has room to grow with the economy and the company’s vastly improved public image and market position. So I’ll be staying in the preferred – at least until the premium again swells to the 40% level.

Disclosure: Author long F.PS.

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