New Preferred Stock IPOs, October 2018

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Includes: AQN, AQNA, BC, BC.PA, DCP, DCP.PC, DLNG, DLNG.PA, DLNG.PB, OFS, OFSSZ, PRIF.PA, PRIF.PB, TCRD, TCRW, TCRX
by: Doug K. Le Du

Summary

Seven new preferred stocks were introduced during October, offering an average annual dividend of 7.0 percent.

There are currently 126 high-quality preferred stocks selling for an average price of $23.95 per share (investment grade, cumulative dividends).

89 of these high-quality issues are now selling below their $25 par value, offering an average current yield of 5.74 percent.

U.S.-traded preferred stocks are now returning an average current yield of 6.9 percent.

The U.S. Labor Department reported on October 31 that the long-awaited increase in household income is finally underway with third-quarter wages and salaries jumping by 3.1 percent, the largest increase in ten years. On that news, the Fed is more likely than ever to continue increasing interest rates in an effort to keep inflation in check. As rates go up, market prices of fixed-income securities (preferreds, bonds) come down, creating a buyer-friendly market for preferred stock investors.

For preferred stock buyers, the wage and salary news delivers a triple benefit: upward pressure on interest rates boosts the dividends paid by new issues; increasing your income and lower prices bring not only cash savings on your share purchases but higher yields, since you earn the same dividend income without having to invest as much of your cash; your income, cash balance and yield benefit as prices return to normal.

Over the past couple of months, the average market price of U.S.-traded preferred stocks fell by $0.95 per share, now sitting at $24.49, creating the best opportunity for preferred stock buyers that we have seen since 2016.

Importantly, note that $24.49 is below these securities’ $25 par value. Remember that the par value is what shareholders will receive in cash should the issuing company decide to redeem your shares, so buying shares below par sets you up for a downstream capital gain on top of the regular dividend income provided by these securities.

October’s new issues

October’s seven new preferred stocks are offering an average annual dividend (coupon) of 7.0 percent, compared to 6.4 percent from September’s new issues.

Note that I am using IPO date here, rather than the date on which retail trading started. The IPO date is the date on which the security’s underwriters purchased the new shares from the issuing company.

A special note regarding preferred stock trading symbols: Annoyingly, unlike common stock trading symbols, the format used by exchanges, brokers and other online quoting services for preferred stock symbols is not standardized. For example, the Series A preferred stock from Public Storage (NYSE:PSA) is “PSA-A” at TDAmeritrade, Google Finance and several others, but this same security is “PSA.PR.A” at E*Trade and “PSA.PA” at Seeking Alpha. For a cross-reference table of how preferred stock symbols are denoted by sixteen popular brokers and other online quoting services, see “Preferred Stock Trading Symbol Cross-Reference Table.”

There are currently 126 high-quality preferred stocks selling for an average price of $23.95 (October 31), offering an average current yield of 5.79 percent. And 89 of these high-quality issues are selling below their $25 par value, offering an average current yield of 5.74 percent. By high quality I mean preferreds offering the characteristics that most risk-averse preferred stock investors favor, such as investment grade ratings and cumulative dividends.

There are now a total of 907 of these securities trading on U.S. stock exchanges (including convertible preferred stocks).

About the new issues

BC-A (BC.PA), from Brunswick Corporation (BC), is a double-investment grade Exchange-Traded Debt Security offering a 6.5 percent coupon (green font in the above table). ETDS are bonds recorded on the company’s books as debt (rather than as equity, as in the case of preferred stock). As debt, the obligation to pay the interest on these bonds is cumulative. As bonds, ETDS are often seen as having lower risk than the same company’s preferred stock shares. ETDS are very similar to preferred stocks and are often listed on brokerage statements as such. The next time you’re hauling in a bass from a Boston Whaler or jumping a double wake behind a Bayliner with a big Mercury outboard, thank Brunswick. Or, while you are telling exaggerated stories of your greatness over a game of pool, don’t forget to notice that the table is almost certainly made by this company. BC is the Procter & Gamble of recreational products - there’s very little outdoor or indoor fun you can have without coming into contact with something the company makes. Established in 1824, this $5.1 billion company is headquartered in Mettawa, Illinois.

DCP-C (DCP.PC), from DCP Midstream, LP (DCP), is a B1/B rated traditional preferred stock using the fixed-to-floating dividend rate structure. This is DCP’s second new income security issued within the past five months. With this structure, this security offers a fixed 7.95 percent coupon until its October 15, 2023, call date. At that time, the coupon varies based on the three-month LIBOR rate (currently 2.39813 percent) plus 4.882 percent. Dividends from DCP-C are cumulative, meaning that if the company misses a dividend payment to you, it still owes you the money (its obligation to pay you accumulates). Note that DCP is a limited partnership, meaning that DCP-C shareholders will receive a K-1 at tax time, rather than a 1099 form. The $6 billion (market cap) company, based in Denver and founded in 2005, collects, sells and transports natural gas.

On October 4, THL Credit, Inc. (TCRD) introduced TCRW (TCRW), an unrated ETDS offering a 6.125 percent coupon. $45 million of the $50 million raised by the new security is going to redeem all outstanding shares of the company’s TCRX. TCRX, paying 6.75 percent, became callable last November. While this refinance maneuver does not deliver a huge interest expense savings to TCRD, it does push the maturity of $45 million in debt by two years from 2021 to 2023. TCRD is a business development company providing debt and equity financing to middle-market companies.

AQNA (AQNA), from Algonquin Power & Utilities Corp. (NYSE:AQN), is an ETDS with a BB+ speculative grade rating from S&P. This security uses the fixed-to-float rate structure, offering a fixed 6.875 percent coupon until its October 17, 2023, call date. The coupon will then float, being equal to the then-current three-month LIBOR rate plus 3.927 percent. Because utilities have an enormous amount of infrastructural equipment (and debt on that equipment), I always find it a bit more challenging to assess their financials; AQN is no exception. AQN has a market cap of $4.8 billion, so that’s what investors are saying the company is worth, even though its balance sheet claims that the property, plant and equipment are worth $6.3 billion with $3.5 billion in long-term debt. And it only reports about $38 million in cash (explaining the company's massive negative $211 million in free cash flow). Throw in the huge seasonal gyrations in revenue that most utilities experience and AQN’s recent 25 percent acquisition of Atlantica, and assessing the risk of AQNA becomes more of a science project than most preferred stock investors will be interested in pursuing. AQN is headquartered just upstream of Niagara Falls in Oakville, Ontario.

OFSSZ (OFSSZ), from OFS Capital Corporation (OFS), is another Exchange-Traded Debt Security. OFS is a relatively small closed-end management investment company incorporated as a business development company with a $150 million market cap. It provides primarily debt capital to middle-market companies. OFSSZ is unrated and becomes callable in October 2020, a relatively short two-year call protection period compared to the more common five years. It is the company’s second ETDS issued within the past six months. The company is headquartered in Chicago.

DLNG-B (DLNG.PB) is an unrated, traditional preferred stock from Dynagas LNG Partners LP (DLNG) offering 8.75 percent fixed-to-floating cumulative dividends. This is the company’s second income security, with DLNG-A (DLNG.PA) introduced in 2015. The company’s assets are held primarily in the form of six LNG tankers. The $300 million company posted declining revenue and negative profit for the quarter ending June 2018 with significantly negative cash flow (hence the new preferred stock). DLNG was founded in 2013 and is headquartered in Monaco.

PRIF-B (PRIF.PB) is a traditional preferred stock issued by the Priority Income Fund offering 6.25 percent cumulative dividends. The fund is managed by Priority Senior Secured Income Management, LLC, which, in turn, is part of the Destra Capital Investment, LLC stable. On its website, the fund’s objectives are stated in the most non-specific terms possible as “Priority Income Fund seeks to generate current income and long-term capital appreciation by strategically investing in broad pools of senior secured, floating rate loans made primarily to U.S. companies. The Fund's goals are to increase income and portfolio diversification and reduce correlation to traditional fixed-income assets” (make some investments and make some money). PRIF-B is the fund’s second preferred stock offering in the past four months, with the nearly identical PRIF-A (PRIF.PA)) being issued last June. Neither Destra nor Priority Senior Secured Income Management, LLC are publicly traded.

(Sources: Preferred stock data - CDx3 Notification Service database, PreferredStockInvesting.com. Prospectuses: BC-A, DCP-C, TCRW, AQNA, OFSSZ, DLNG-B, PRIF-B)

Tax treatment

The tax treatment of the income you receive from income securities can be a bit confusing, but it really boils down to one question: Has the company already paid tax on the cash that is being used to pay you or not? If not, the IRS is going to collect the full tax from you; if so, you still have to pay tax, but at the special 15 percent rate.

Traditional preferred stock dividends are typically paid out of pre-tax profits, so are taxable as regular income; you pay the full tax, since the company has not (PRIF-B). The same is true for dividends received from companies taxed as partnerships, where each partner is responsible for their own tax obligations (DCP-C).

Companies incorporated as REITs are required to distribute at least 90 percent of their pre-tax profits to shareholders. Doing so in the form of non-voting preferred stock dividends is the most common method of complying, and because these dividend payments are made from pre-tax dollars, dividends received from REITs are taxed as regular income (i.e., they do not qualify for the special 15 percent dividend tax rate).

Interest that a company pays to those loaning the company money is a business expense to the company (tax deductible), so the company does not pay tax on the interest payments it makes to its lenders (i.e., interest payments made to lenders are paid with pre-tax dollars). Since Exchange-Traded Debt Securities are debt (BC-A, TCRW, AQNA, OFSSZ), ETDS shareholders are on the hook for the taxes. Income received from ETDS is taxed as regular income.

Lastly, if a company pays your preferred stock dividends out of its after-tax profits, the dividend income you receive is taxed at the special 15 percent tax rate. Such dividends are referred to as “Qualified Dividend Income,” or QDI. QDI preferred stocks are often seen as favorable for holding in a non-retirement account due to the favorable 15 percent tax treatment. Looking at the Status column in the above table, only one of October’s new issues pays QDI dividends (DLNG-B, since Dynagas has elected to be taxed as a corporation even though it is a partnership).

In Context: The U.S. preferred stock marketplace

The following chart illustrates the average market price of U.S.-traded preferred stocks over the past twelve months.

Many things affect the market prices of these securities, such as the proximity to their call or maturity date, proximity to their next ex-dividend date, industry and/or overall health of the issuer, perceived direction of interest rates, pending government regulatory or policy changes, cumulative versus non-cumulative dividends and tax treatment of dividend payments. So, what we really need to look at is current yield, which calculates the average annual dividend yield per dollar invested (without considering re-invested dividend return or any future capital gain or loss). Current yield is a “bang for your buck” measure of value that normalizes differences in coupon rate and price to give us a single, comparable metric.

Moving down the risk scale, the next chart compares the average current yield realized by today’s preferred stock buyers when compared to the yield earned by those investing in the 10-year Treasury note or 2-year bank Certificates of Deposit.

U.S.-traded preferred stocks are currently returning an average current yield of 6.9 percent (blue line), while the annual return being offered to income investors by the 10-year treasury is 3.1 percent and that of the 2-year bank CD has recovered nicely to 2.8 percent.

For comparison, I have set the Yield column in the first table above to show the current yield of the new October preferreds on October 31. It is into this marketplace that October’s new issues were introduced.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The CDx3 Notification Service is my preferred stock email alert and research newsletter service and includes the database of all preferred stocks and Exchange-Traded Debt securities used for this article.