It's not easy being a tiny REIT without the necessary operational scale to properly carry high administrative and regulatory costs. Wheeler Real Estate Investment Trust (NASDAQ:WHLR) IPO investors learned this lesson the hard way. WHLR only raised $16 million in the 9/21/2012 IPO at $5.25 per share. The good news is that WHLR has now achieved the necessary operational scale to succeed. The bad news is that raising additional capital was very painful for early investors. The market capitalization of WHLR has increased to $115 million even though the stock price has fallen to $1.70 per share.
In addition to selling common stock, $85 million par value of the WHLRP and WHLRD preferred shares were sold over just the last year. The newer WHLRD cumulative preferred convertible issue contains some unusual and exceptionally investor friendly covenants. Many income investors are especially fond of "failure to redeem" preferred stock issues. This article profiles WHLRD, compares it to WHLRP and provides 10 reason to consider this term preferred issue.
What is WHLRP?
WHLRP is a par $25 cumulative preferred convertible issue with a 9% coupon. Dividends are paid quarterly and WHLRP now yields 9.9% at a recent price of $22.70. WHLRP may be optionally converted to 5 shares of WHLR. However, the conversion option is of little interest with WHLR trading at just $1.70. WHLRP is a perpetual issue and is not callable. In the rather unlikely event that WHLR eventually rallies to $7.25, the company can force conversion of WHLRP to 5 shares of WHLR. See prospectus for additional details. There is $48 million par value of WHLRP outstanding and average daily trading volume is about 5,000 shares. Limit orders and patience are recommended when trading. WHLRP and WHLRD are equal in seniority.
What is WHLRD?
1.6 million shares of WHLRD were sold in the initial offering on 9/16/2016. An additional 637,000 shares were sold in a 12/1/2016 follow-on offering. WHLRD is a par $25 cumulative preferred convertible issue with an 8.75% coupon. Dividends are paid quarterly and WHLRD now offers a 9.1% cash yield at a recent price of $24.21. WHLRD may be called at par starting on 9/21/2021. Average daily trading volume is approximately 20,000 shares. Limit orders and patience are recommended when trading.
In an effort to entice new investors, WHLRD was created with far more favorable terms than WHLRP. WHLRD is what's commonly known as a "term preferred" or "failure to redeem" issue. If WHLRD is not redeemed by 9/21/2023, then the coupon will increase by 2% to 10.75%. If still not redeemed by 9/21/2024 then the coupon increases again to 12.75%. The maximum penalty rate of 14% would apply starting on 9/21/2025. The failure to redeem penalty is summarized on page #1 of the prospectus:
"Commencing on September 21, 2023, we will pay cumulative cash dividends on the Series D Preferred Stock at an annual dividend rate of the Initial Rate increased by 2.0% of the liquidation preference per annum, which will increase by an additional 2.0% of the liquidation preference per annum on each subsequent anniversary thereafter, subject to a maximum annual dividend rate of 14%."
These onerous penalties provide a very strong incentive for WHLRD to be redeemed by 9/21/2023. The 9/21/2023 "failure to redeem" date can almost be treated as a debt "maturity". At a recent price of $24.21, WHRLD is now trading at a 9.5% yield to "maturity". This was calculated using the Panick Value Research Report excel model.
WHLRD is a convertible issue. WHLRD holders have the option to convert their shares into 11.79 shares of WHLR. This conversion option at $2.12 per share could be of value if WHLR (now trading at $1.70) rallies significantly before WHLRD becomes callable on 9/21/2021.
WHLRD holders were also granted a 9/21/2023 "put option". Even if the company is short on cash it can be forced to issue common stock as necessary to redeem WHLRD at par. This covenant is summarized on page #1 of the prospectus:
"Commencing on September 21, 2023, the holders of the Series D Preferred Stock may, at their option, elect to cause us to redeem their shares at a redemption price of $25.00 per share, plus an amount equal to all accrued but unpaid dividends, if any, to and including the redemption date, payable in cash or shares of our common stock..."
What more could you possibly want? How about a protective covenant to prevent the company from becoming over-leveraged? Yes, that's included too. The company must redeem (or partially redeem) WHLRD shares if asset coverage drops below 2X. This is summarized on page #2 of the prospectus:
"If we fail to maintain an Asset Coverage Ratio of at least 200% (as defined herein), we will redeem a portion of our outstanding Redeemable and Term Preferred Stock (as defined herein), which may include, in our sole option, Series D Preferred Stock, in an amount at least equal to the lesser of (1) the minimum number of shares of Redeemable and Term Preferred Stock necessary to cause us to meet our required Asset Coverage Ratio and (2) the maximum number of shares of Redeemable and Term Preferred Stock that we can redeem out of cash legally available for such redemption."
1. Significant insider ownership.
Chairman, CEO and founder Jon S. Wheeler controls 2.9 million shares of WHLR (a 4.3% ownership stake) as per this 12/20/2016 SEC filing. Note that this includes shares owned by his spouse, children and other indirectly owned shares. I have also included partnership units that are convertible into common stock. It's always reassuring to preferred stockholders to see insiders with a significant stake in the common stock.
2. Recession resistant business model.
Wheeler's focus on leasing to grocery stores makes it more recession resistant than most property REIT peers.
3. Increasing tenant rents.
Steady occupancy rates with increasing rents are an indication of strong business conditions. There has been no shortage of dire articles on WHLR such as Dane Bowler's 1/26/2016 PRO article titled "Wheeler REIT Is Going To Zero". Fortunately, improving recent operating results suggest otherwise. Increasing rental rates were highlighted on page #1 of the Q3 earnings report:
"Leasing spread of 7.5% on renewals-the 15th consecutive quarter of positive rent spreads".
4. Resistant to online competition.
No retail sector is totally immune from online competition. However, shipping grocery items (many of which are low priced, perishable, heavy and bulky) by mail order to rural areas is not an easy task even for tough competitors such as Amazon.com Inc. (NASDAQ:AMZN).
5. Growth reduces risk.
Growth reduces risk by creating operational and financial economies of scale. As WHLR grows it is becoming less dependent on the success or failure of individual tenants and properties. As of 1/15/2017 WHLR had 65 retail centers (excluding undeveloped land) as compared to 55 on 9/30/2016 and 45 on 9/30/2015.
6. Decreasing cost of capital.
Preferred stock sales, growth and diversification have enabled financing to be obtained on more favorable terms. Wheeler's weighted-average interest rate on debt declined to 4.46% on 9/30/2016 from 4.71% on 12/31/2015. Lower interest rate costs are an indication of decreasing credit risk.
7. Low interest rate risk.
The expected redemption by 9/21/2023 reduces interest rate. In the unlikely event that WHLRD is not redeemed by 9/21/2023, the coupon would increase rapidly to 14%. This "failure to redeem" covenant makes WHLRD trade more like a baby bond with a 7 year maturity than a traditional perpetual preferred stock.
8. Reducing the WHLR dividend would be a good thing.
WHLR has provided guidance that the common stock dividend will be fully covered. While this may be a critical issue for WHLR holders, it is largely irrelevant for WHLRD holders. Preferred dividends are senior to the common dividend. A reduction in the common stock dividend could actually be beneficial to preferred stock holders as more cash would be retained.
9. 2.6X preferred stock dividend coverage.
The annual common stock dividend expense totals $14.3 million based on 68 million shares of WHLR with an annual dividend of 21 cents per share. The annual WHLRP preferred dividend obligation totals $4.3 million based on 1.9 million shares of WHLRP with an annual dividend of $2.25 per share. The annual WHLRD preferred dividend expense totals $4.9 million based on 2.2 million shares of WHLRD with an annual dividend of $2.1875 per share. Common and preferred stock dividends now total $23.5 million annually.
The preferred stock dividends are senior to the common stock dividend. Based on the company's guidance for adjusted funds from operation, the common stock dividend is expected to be fully covered shortly. Full coverage of the common stock dividend would correspond to preferred stock dividend coverage of:
+23.5 / (4.3 + 4.9) = 2.6X
10. Good liquidity
Liquidity is always an important consideration for preferred stock holders. Cash was $23 million as of the 12/21/2016 pro forma financials. This includes the effect of recent acquisitions subsequent to the Q3 earnings report. The average debt term is 6 years and near term debt maturities are not an issue.
What are the major risks?
WHLR is a recession resistant company, but few companies are completely recession proof. An economic downturn would hurt results. Rural grocery anchored strip malls face less competition than most retailers, but there are still significant competitive threats. Potential tenant lease defaults or vacancies would impact operating results. The increasing number and geographic diversity of Wheeler properties helps to minimize these risks by spreading them over a wider property base.
Many income investors are cautious about perpetual preferred stocks due to fears of rising interest rates. While WHLRD is technically a perpetual preferred stock, it's unusual "failure to redeem" and "put option" covenants provide similar attributes to a baby bond. WHLRD offers an attractive 9.5% yield to "maturity" and has several excellent protective covenants to reduce risk. The recession resistant business model, growth and improving operating results are positive for income investors.
Note: My Panick Value Research Report is focused on high-yield preferred stocks, exchange traded debt issues and other undervalued high-yield opportunities. Members receive an advance look at all my articles as well as continued coverage. The WHLRD article was announced to members on 1/2/2017 with WHLRD trading at $23.50. Please read our outstanding subscriber reviews here.
Disclosure: I am/we are long WHLR, WHLRD,WHLRP.
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.