Believe It Or Not: This Highest-Rated Qualified Dividend Preferred Stock Is One Of The Highest Yielders

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About: KKR (KKR), KKR.PA, KKR.PB, Includes: APO, BX, C, CG, MS, NTRSP, SCHW.PC
by: Rida Morwa

Summary

The article focuses on the 2 preferred stocks of KKR and Company.

KKR has converted to a corporate structure and now pays a qualified dividend and for tax purposes now issues a 1099 rather than a K-1.

KKR preferred stocks have the highest S&P safety rating of any qualified dividend paying preferred stock, yet they have a better yield than inferior qualified dividend paying preferred stocks.

We believe that both KKR preferred shares are mispriced and are currently the best preferred stock value in the market right now.

This article was jointly produced with Seeking Alpha author Preferred Stock Trader.

KKR & Company

KKR & Company (KKR) is one of the largest private equity and real estate investment firm. It specializes in acquisitions, leveraged buyouts, management buyouts, credit special situations, growth equity, mature, mezzanine, distressed, turnaround, and middle market investments. In real estate, the firm seeks to invest in private and public real estate securities, including property-level equity, debt and special situations transactions and businesses with significant real estate holdings, and oil and natural gas properties. KKR's competitors are companies like The Blackstone Group (BX), The Carlyle Group (CG), and Apollo Global Management (APO).

KKR typically manages and invests in a series of funds which it controls. The investors in these funds are generally very high net worth individuals, insurance companies, pension funds, university and other endowment funds, and other institutional investors. The funds specialize in various types of investments ranging from debt securities to energy and international equity investments. For example, private equity funds actually take over companies, restructure their finances, improve management and generate profits by reselling them or simply reaping the increased cash flow. KKR earns percentage management fees and additionally reaps performance awards depending upon the success of the various funds it manages. Investments in its funds tend to be "sticky" because of restrictions upon withdrawals and investor loyalty. The business has been successful and should continue to grow because of an expanding investor base (more high net worth individuals) and migration from a public equity market which has appreciated enormously. Although KKR's performance fluctuates from year to year depending upon the performance of its funds, the diversity of fund strategies and the continued generation of management fees regardless of fund performance lend a great deal of stability to KKR's long-term results.

Conversion from LP to C-Corp

Not long ago, KKR converted from an LP structure to a corporate structure, turning their preferred units into very attractive tax advantaged qualified dividend paying preferred stocks. KKR is a large and very strong company by reputation and its common stock has been trading strongly.

KKR's common stock currently sells for around $27 per share. According to financial analysts, earnings for KKR are expected to be $1.69 per share this year and $1.88 per share in 2019. According to SEC filings, KKR has over $23 billion in equity with which to cover a mere $500 million worth of preferred stock. This level of safety is why S&P has given KKR a solid investment grade rating of rating of BBB+.

Source of Chart: Etrade

KKR Preferred Stocks

KKR has 2 preferred stocks outstanding. Here are the relevant statistics:

1- KKR & Co., 6.75% Series A Non-Cumulative Preferred Stock (KKR.PA)

  • This is a non-cumulative preferred stock with an annual qualified dividend of $1.6875.
  • At the recent closing price of $25.70, KKR-A is currently yielding 6.56%.
  • It is callable at the option of the company after June 15th, 2021.
  • Its approximate ex-dividend dates are 2/28, 5/28, 8/28 and 11/28.

2- KKR & Co., 6.50% Series B Non-Cumulative Preferred Stock (KKR.PB)

  • This is a non-cumulative preferred stock with an annual qualified dividend of $1.625.
  • At the recent closing price of $25.57, KKR-B is currently yielding 6.31%.
  • It is callable at the option of the company after September 15th, 2021.
  • Its approximate ex-dividend dates are 2/28, 5/28, 8/28 and 11/28.

More info on KKR Preferred A and Preferred B from Quantumonline

Note that Quantumonline has yet to drop the "LP" from the name of the company, but it has at least made the update showing that the dividend is now qualified for the 15% tax rate.

Comparing KKR Preferred Stocks to Other Qualified Dividend Paying Preferred Stocks

Of all the qualified dividend paying preferred stocks in the market, only 2 are rated BBB+ by S&P. Those are the KKR preferred stocks and the preferred stock of Northern Trust Preferred C (NTRSP) which yields 5.9%. There are none with ratings higher than BBB+, so KKR preferred stocks are the pinnacle of safety. There are no qualified dividend paying preferred stocks in the whole market with an S&P safety rating higher than KKR's BBB+ rating. These preferred shares even have a higher credit rating than those issued by Citigroup (C) and by Morgan Stanley (MS)!

Thus, in order to compare the KKR preferred stocks to their peers, we only have inferior peers to choose from. The chart below compares the BBB+ rated KKR preferred stocks with all BBB rated qualified dividend paying preferred stocks. We have eliminated from this chart those preferred stocks which are callable now or will be within a couple of months.

https://static.seekingalpha.com/uploads/2018/10/8/16392-15390227589281318.png

Chart by Author

As can be seen from the above chart, with the exception of PartnerRe Ltd., 7.25% Series H (PRE-H), KKR-A is the best yielding preferred stock. PRE-H yields 6.9% and KKR-A yields 6.56%.

Logic would dictate that the lower rated stocks being compared to KKR-A would have higher yields, but the very surprising thing is that the highest rated KKR-A preferred stock also has the best yield, making this preferred stock clearly an exceptional value. Additionally, in comparison to the one other BBB+ stock, Northern Trust Preferred C (NTRSP), KKR-A has a higher yield and longer call protection. NTRSP yields 5.9%.

This next chart shows the "yield to calls" (YTCs) of these same stocks; however, we have eliminated the stocks selling below par as the YTCs for those stocks distort the chart and are misleading.

https://static.seekingalpha.com/uploads/2018/10/8/16392-15390227590186183.jpg

Chart by Author

As can be seen from the above chart, the KKR preferred stocks also are standouts when it comes to YTC (yield to call). They also have a significantly better YTC than PRE-H, the one stock with a higher current yield than KKR-A. This is because PRE-H sells for a higher price than KKR-A and so will lose more value when it is called at $25. Also, the call date on PRE-H is sooner than the call dates for the KKR preferred stocks.

Although Charles Schwab Corp. 6% Preferred C (SCHW.PC) has a higher YTC, that is simply a function of a lower price and call protection of only a little more than 1 year. The current yield of SCHW-C is only 5.96% versus 6.56% for KKR-A, and don't forget that KKR-A has a higher safety rating than SCHW-C.

Comparison of KKR Preferreds to BBB- Bank Preferred Stocks

Just to show how exceptional the KKR preferred stocks are, we ran one more chart comparing KKR preferreds to even lower rated BBB- traditional fixed-rate bank preferred stocks. One would think that investors would certainly expect a higher yield when buying a BBB- preferred stock than when buying a BBB+ preferred stock. Even more surprisingly than in the previous chart, BBB+ rated KKR-A has a higher yield than all BBB- bank preferred stocks.

https://static.seekingalpha.com/uploads/2018/10/8/16392-15390227597690585.jpg

Chart by Author

Which KKR Preferred Stock to Buy

We think that both KKR-A and KKR-B represent extraordinary value for those with taxable accounts looking for very safe and high yielding preferred stocks.

Bottom Line

We believe we have identified an extraordinary mispricing in the market that rarely comes along. Possibly the market is missing the fact that KKR is now a corporation and is paying a qualified dividend on its preferred stock. But for whatever reason, when the preferred stock with the highest S&P safety rating has better yield metrics than inferior preferred stocks, that spells opportunity.

KKR-A is currently paying a 6.56% qualified (tax advantaged) dividend. Due to this tax advantage, the yield on KKR-A is equivalent, on an after-tax basis, to a 7.6% bond or a 7.6% yielding REIT preferred stock.

KKR-B is currently paying a 6.31% qualified (tax advantaged) dividend. Due to this tax advantage, the yield on KKR-B is equivalent, on an after-tax basis, to a 7.3% bond or a 7.3% yielding REIT preferred stock.

We believe that with the high safety and after-tax yield that comes with KKR-A and KKR-B, you can and should make them one of your core fixed-income holdings if you are a conservative income investor. These preferreds come with a lower price volatility which is a great plus in today's turbulent market. This kind of investment is a "buy and hold" for the long term.

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Our special thanks to author Arbitrage Trader for allowing us to use his proprietary software to generate the charts above.

Disclosure: I am/we are long KKR.PA.

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.