American Finance Trust: A Good Result Makes The Preferred Shares Safer
Summary
- 2020 was a difficult year for almost every REIT, but American Finance Trust performed rather well.
- The REIT issued a new class of preferred shares, which will increase the outflow related to preferred dividends to in excess of $20M.
- Despite this, and even assuming the REIT's performance doesn't improve in 2021, the preferreds have a dividend coverage ratio exceeding 500%.
- That being said, I will rotate my AFINP position into the new AFINO issue, as it simply makes more sense given the current share prices of both issues.
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Introduction
American Finance Trust (AFIN) is a triple net REIT whose share price has increased by in excess of 50% since my September article. However, this article will discuss the preferred shares issued by American Finance Trust: the A-shares are listed with (AFINP) as ticker symbol and have a preferred dividend of 7.5% of the face value while the C-shares are a newly listed category have (AFINO) as their ticker symbol. As of the end of 2020, there were 7.84M shares of AFINP and 3.54M shares of AFINO outstanding.
Source: Yahoo Finance
Before diving into the preferred shares, we need to check on AFIN’s performance
This article is not meant to provide a deep dive into the financial results of American Finance Trust and will predominantly focus on the two existing classes of preferred shares, but it still is important to have a look at the performance of AFIN to determine how well-covered the preferred shares are.
Perhaps the best metric to judge a REIT on is its Adjusted Funds From Operations. As you can see in the image below, American Finance Trust generated a total AFFO of just under $98M. Despite the unprecedented economic crisis in 2020 due to the COVID pandemic, the AFFO fell by just 7% compared to 2019.
Source: AFIN annual report
Also keep in mind the starting point of the FFO and AFFO calculation is the net loss attributable to the common stockholders of AFIN. That’s important because this means the preferred dividends have already been deducted from the entire calculation. Looking at the income statement of American Finance Trust for FY2020, we see the company paid out approximately $14.8M in preferred dividends (see below).
Source: AFIN annual report
This has an important implication for the coverage ratio of the preferred dividends as the AFFO adjusted for preferred dividend payments isn’t $98M but almost $113M.
That being said, the total amount of preferred dividend payments will increase this year, simply because there are more preferred shares outstanding. The 7.84M shares of AFINP will pay $1.875 per year (14.7M USD) while the 3.54M new AFINO shares will pay $1.84375 per year (6.5M USD). This means the total cash requirement to cover the preferred dividend payments will increase to just over $21M.
Assuming the AFFO before preferred dividends remains unchanged (a conservative scenario considering AFIN can deploy the proceeds from the AFINO issue which will result in either more income producing assets or a lower interest expense, and considering AFIN refinanced its debt at a lower rate in 2020), the coverage ratio of the preferred dividends was approximately 532%.
So even in the unlikely event the AFFO drops by 50%, the preferred dividends are still covered and that makes this asset class quite interesting.
After a recent offering, there are now two classes of preferred shares
Originally, American Finance Trust had just one class of preferred shares: the A-preferreds which are trading with AFINP as their ticker symbol. These cumulative preferred shares have a yield of 7.5% on the $25 par value and the preferred dividend is paid out in quarterly tranches of $0.46875. American Finance Trust has the right to call these preferred securities in March 2024 at the par value of $25/share. There currently are
For about two years, this was the only preferred issue available to AFIN shareholders. This changed in Q4 2020 when AFIN floated a new class of preferred shares: the new preferred shares C are listed with AFINO as ticker symbol and have a slightly lower cumulative preferred dividend yield of 7.375% or $0.4609 per quarter per preferred share. AFIN can call this class of preferred shares in December 2025.
I have owned the AFINP preferred shares for a while but I have recently been making the switch to sell my AFINP and move the cash proceeds into AFINO as AFINO seems to offer a better risk/reward ratio.
We can look at the preferred shares from two perspectives. The first perspective is the current yield, assuming the unlikely event none of both issues will ever be called. AFINP pays a $1.875 preferred dividend per share per year, which means that anyone who buys the preferred shares now at $26.55/share gets a preferred dividend yield of 7.06%.
Meanwhile, the annual preferred dividend of $1.84375 for the AFINO preferred shares results in a yield of 7.41% thanks to the securities trading slightly below par.
That being said, I think it’s more fair to calculate the yield to worst (or in this case: the yield to call) for both securities, assuming American Finance Trust will actually exercise its right to call the securities. In this scenario, AFINP will be called at $25 in March 2024, while AFINO will be called at the same price in December 2025. Based on the current share prices and the respective call dates, AFINP has a yield to worst of approximately 5.3% while AFINO has a yield to call of approximately 7.4%.
On both accounts, AFINO seems to be the best choice for an investor interested in preferred shares of American Finance Trust.
Investment thesis
I have owned the AFINP preferred shares for a while now, but I will be making the switch to AFINO. Yes, the preferred yield is slightly lower (7.375% versus 7.5%) but this really represents just about 0.8 cents per share per quarter, or about 3.2 cents per share per year. Meanwhile, if I sell AFINP at $26.50 and buy AFINO at $24.90, I am unlocking $1.60 in immediate cash gains which is sufficient to cover the lower preferred dividend for about 50 years.
From both the perspective of a perpetual preferred share (anticipating none of both issues will be called) as well as the perspective from a yield to worst perspective, it makes more sense to prefer AFINO over AFINP at the current levels. I’m not sure what’s causing this discrepancy but at this point AFINO should be preferred over AFINP.
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This article was written by
The Investment Doctor is a financial writer, highlighting European small-caps with a 5-7 year investment horizon. He strongly believes a portfolio should consist of a mixture of dividend and growth stocks.
He is the leader of the investment group European Small Cap Ideas which offers exclusive access to actionable research on appealing Europe-focused investment opportunities not found elsewhere. The a focus is on high-quality ideas in the small-cap space, with emphasis on capital gains and dividend income for continuous cash flow. Features include: two model portfolios - the European Small Cap Ideas portfolio and the European REIT Portfolio, weekly updates, educational content to learn more about the European investing opportunities, and an active chat room to discuss the latest developments of the portfolio holdings. Learn more.Analyst’s Disclosure: I am/we are long AFINP. 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.
I have a long position in both AFINP and AFINO, but I will likely sell AFINP and rotate the proceeds into AFINO.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (16)
My AFINP dividends were non-qualified. I hold position (now AFINO) in Roth IRA.
Best Regards, Rog 🐾
Larry
