This article is what I hope to be the first in a series of mis-priced dividend opportunities. In this article I will be discussing the preferred L shares of the cooperative CHS. CHS is in the agriculture business but also has interests in the refining and energy distribution businesses. CHS has 5 preferred issues, 2 fixed to floating rate preferreds and 3 fixed rate preferreds. (NASDAQ:CHSCL) is of the fixed rate variety.
CHSCL recently traded around $27.39, but given that it is going ex-dividend on December 13th with a qualified dividend that I consider worth 59 cents per share pre-tax at the top tax rate, I am using a price of $26.80 for yield calculations. At $26.80 the current yield is 7.0%. For those in the top bracket of 39.6% who pay a 20% tax on qualified dividends, your after tax yield will be 5.6%. To achieve a 5.6% after tax yield in a bond or in a preferred stock of a REIT like (NYSE:NNN), top taxpayers would need to find a bond or REIT preferred that has a 9.27% yield; certainly impossible to come by in any company that is not distressed. For those in the 28% bracket, your after tax yield will be 5.95% which is equivalent to a pre-tax yield of 8.26%. Additionally CHSCL is not callable until January of 2025. Yield to call is a qualified 6.35% which equates to a pre-tax yield-to-call of 8.42% for those at the top tax rate and 7.5% for those at the 28% tax rate. Those in between the 28% rate and the top rate will obviously be somewhere in between those 2 rates.
Not only do I believe that CHSCL is mispriced relative to REIT and trust preferreds, but CHSCL is also quite mispriced against the other preferreds of CHS. For this article, I am going to compare CHSCL to the other fixed rate CHS preferreds, (NASDAQ:CHSCO) and (NASDAQ:CHSCP), but I also believe it CHSCL is a better value than the (NASDAQ:CHSCM) and (NASDAQ:CHSCN) fixed to floating rate preferreds, due to its higher yield and yield to call. Here is a "yield to call table" that is for comparison purposes only as it does not include the tax benefit of the qualified dividend nor the value of next week's dividend payment so it understates the real yield-to-call of the 3 CHS preferreds:
Symbol Recent Price Dividend Call Date Yield to Call
You can see in the "Yield to Call" column that CHSCL is quite undervalued relative to the other CHS fixed rate preferreds. This is not only a signal to go long CHSCL, but also an opportunity for owners of CHSCO and CHSCP to swap and greatly increase their yield to call. Those into long/short pairs trading may also find this of interest. CHSCL is also down to an after-dividend price of $26.80 from a high of $31.34 in August, so upside price potential is certainly there, and it has clearly been hit much harder than the other CHS preferreds without cause. CHSCL has even traded higher than CHSCO at times during the year but it now trades $2.00 below CHSCO.
Because CHS is a cooperative and does not have common shares that trade on an exchange, I cannot determine a debt to enterprise value number which I would normally use to determine the company's leverage. But what I can do is look at the cash flow and income statements of CHS (from the August 2016 annual report) and see that EBITDA is around $1 billion while net interest expense is only $75 million and, as a cooperative, they pay very little in income tax. This leaves more than $900 million in cash flow to cover annual preferred dividend payments totaling $163 million; a very strong 5.5 times coverage in what was a tough year for CHS due to difficult commodity pricing. I expect even better coverage this coming year with commodities strengthening. Additionally, like (NYSE:PSA) and (NYSE:PSB), CHS raises a large amount of their capital via issuance of preferred stock and have more preferred stock outstanding than long term debt. Although not in the same league as PSA/PSB, who almost exclusively use preferred stock, CHS preferred stock is higher up in the capital structure than any other REIT preferred that I am aware of, therefore adding to the already high level of safety that these preferred shares offer. Additionally, I feel that the fact that investors are willing to pay so much over par for CHS preferreds is a strong vote of confidence that CHS is solid and has very little risk of dividend default going out many years.
CHS Management's Extraordinary Gift To Its Preferred Stockholders
Back in 2013 the $2.00 CHSCP preferred was callable. Instead of calling it at $25 or leaving open their option to call CHSCP in the future by selling lower yielding preferreds, CHS management actually added 10 years of additional call protection to this preferred stock, receiving nothing in return, so CHSCP now trades over $31/share instead of having been called at $25. Whereas most managements will shaft preferred holders in any way they can if it helps common stockholders, this management seems to treat the preferred stockholders like real owners of the company. Possibly due to the coop structure of CHS, preferred stockholders are considered more like owners, or possibly members of the coop are large holders of CHS preferred stock, but for whatever reason, CHSCL may not be called when it is due and their safe 9.27% current effective pre-tax return could go on indefinitely and may be a more appropriate measure for CHSCL than yield to call. CHS has again shown its generosity toward their preferred stockholders by giving them 10 year call protection at IPO time rather than the usual 5 years. It seems that once preferred stock is issued, management is in no hurry to call them.
To put it simply, CHS preferreds are very safe and well-covered by cash flow, CHSCL is undervalued relative to the other CHS preferreds, it offers a very high after tax return considering the safety of these preferreds (especially to those in higher tax brackets), has a call date that is unusually far into the future, offers swap and arbitrage opportunities, and offers a quick qualified dividend capture if one buys this stock in the next few days. I am an active trader and arbitrager, but I only trade vehicles that I believe are good long term investments as well. CHSCL qualifies as a good trade and a good investment.
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Disclosure: I am/we are long CHSCL AND PARTIALLY HEDGED WITH A SHORT POSITION IN CHSCO AND CHSCM.
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.