4 Big Preferred Stocks, Big Yields, For Uncertain Times

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Co-produced with “Hidden Opportunities”

Do you like watching movies? I especially love thrillers, and the best ones, in my opinion, are those that have a powerful villain with a well-scripted “evil” plot. After all, Die Hard wouldn’t have been so enjoyable without Hans Gruber, would it?

Mr. Bear Market is the villain of our story, much like those villains from the James Bond movies. His storylines often feel like the world is ending, and he has so far managed to wreak havoc, sending everyone running in fear. Then in the end, the evil plot falls apart and the dreaded destruction never occurs.

Fear and Greed Index

CNN – July 21

During recessions, investors are scared. Fear drives them to seek safety. Preferred shares have security implicit in their name – their dividends take priority (enjoy preferential treatment) over common stock dividends. In the event of the dissolution of the company, preferred shares receive priority treatment after bonds. Therefore, these securities are “safer” when our economy faces challenges. That being said, preferred securities also trade in the same market and may decline during bear markets. Yet their design gives them more protection (for income investors) than common stocks.

As income investors, we must use market inefficiencies to secure high returns and get paid to wait for Mr. Market to realize irrationality. This report discusses two pairs of preferred stocks with yields of up to 8% that you should add to your shopping cart.

Choice #1: Necessities, 8% Yield

The Necessity Retail REIT, Inc. (RTL) (known as American Finance Trust until February 2022) operates 1,029 freestanding single-tenant properties that are net leased to creditworthy tenants among America’s most essential retail businesses. (Source: May 2022 Investor Presentation)

Necessity retail favorites

May 2022 Investor Presentation

If you live in the United States, you’ve probably shopped at one of RTL’s tenants in the past month. 63% of annualized linear rents in RTL’s portfolio come from necessity-based commercial tenants who are expected to be more resilient to e-commerce and economic cycles than traditional retail. At the end of the first quarter of 2022, RTL had a portfolio occupancy rate of 91.4% and a weighted average lease term of 7.4 years.

Pro forma schedule of Necessity Retail leases

May 2022 Investor Presentation

With a weighted average debt maturity of 5.3 years and less than 1% of its debt maturing until 2024, RTL has great flexibility with its short-term cash flows.

Necessity Retail debt maturity

May 2022 Investor Presentation

Speaking of debt, you will be pleased to see that in the first quarter of 2022, RTL declared an interest rate hedge of 2.9x and that 84.2% of its debt is fixed rate. In addition, the REIT’s weighted average interest rate was 3.7%

Given that RTL has a healthy balance sheet, let’s now talk about its preferred stock, which is trading at an attractive discount:

  • 7.50% Cumulative Redeemable Series A Perpetual Preferred Shares (RTLPP)
  • 7.375% Cumulative Redeemable Series C Perpetual Preferred Shares (RTLPO).

FY2021 10-K tells us that RTL pays $21.3 million per year in preferred dividends. The REIT ended the first quarter of 2022 with $97.2 million in cash (and $255 million in cash), indicating 4.6x cash coverage for preferred dividends. Preferred dividends are cumulative, which means that if previous payments have been missed, dividends due must first be paid to preferred shareholders, before dividends can be paid to common stock. Today, RTLPO and RTLPP are up around 10% at redemption and offer yields of 8%.

Necessity retail favorites

Author’s calculations

With RTLPO, you have a solid opportunity to buy a well-hedged 8% yield from a REIT that caters to highly essential businesses – those with non-seasonal, non-cyclical demand and sheltered from recessionary pressures.

Pick #2: TDS Preferred Stock, Yield 7.3%

Telephone and Data Systems, Inc. (TDS) owns 83% of US Cellular (USM). As of the start of 2022, 77% of TDS’ revenue came from USM, which happens to be the 4th largest wireless company in the United States behind Verizon (VZ), AT&T (T) and T-Mobile ( TMUS), with 4.8 million paying subscribers. (Source: TDS Quarterly Report)

American

TDS quarterly report

First quarter performance shows that TDS’ Adj. EBITDA covers its quarterly interest payments of 11.2x. This indicates that the company has a healthy cash position and can comfortably meet its debts. 60% of TDS’ long-term debt is fixed rate, and its weighted average interest rate on debt at the end of the first quarter was 4.6%. Notably, about 2% of TDS’ $3.25 million in debt is due by 2026, indicating that the company has adequate flexibility with its short-term cash flow.

And TDS needs that flexibility. Being second in a mature market means USM must maintain high capital expenditure to stay competitive in the market, especially when everyone is spending aggressively to deploy 5G and improve the overall user experience. This would worry me if I were an ordinary USM (or TDS) shareholder, especially in this rising interest rate environment. However, I’m more interested in investing in TDS preferred stock:

  • 6.625% Preferred Perpetual Cumulative Redeemable Series UU (TDS.PU)
  • 6.60% Preferred Perpetual Cumulative Redeemable Series VV (TDS.PV).

TDS-U and TDS-V have cumulative dividends and trade at a significant discount to face value. Current price levels indicate a significant upside in capital should they be called.

Telephony and Data Systems Preferred Shares

Author’s calculations

Due to depressed prices, TDS preferred shares have a current yield of 7.3%. The yield from a taxable account would be even higher because “qualified” dividends benefit from favorable tax rates. TDS is expected to spend $68 million in preferred dividends this year, which is well covered by its cash and cash equivalents of c. $250 million (Note: TDS reported $549 million in cash and cash equivalents, but this includes USM cash that TDS cannot directly access).

Looking at TDS’ balance sheet and income statement, it’s clear that preferred distributions enjoy a high level of safety, despite our economy being on its rate hike path. Telecommunications is a stable business with inelastic demand, which makes TDS-U or TDS-V with 7.3% efficiency solid choices in these uncertain times.

The time of dreams

The time of dreams

Conclusion

Harry Potter wouldn’t be “The Boy Who Lived” if it weren’t for Voldemort. Likewise, we need antagonists to flavor our portfolios. Bear markets are the perfect antagonist for us to take appropriate enrichment action. Rather than running away from them out of fear, we should use them to increase our cash flow and enter the coming bull market with a stronger portfolio.

We particularly like preferred stocks in times of uncertainty. Thanks to this bear market, many are heavily discounted, and investing in them has several advantages for income investors:

  1. You pay less to buy big yields.

  2. You are well positioned for a significant capital upside as the market recovers.

  3. Your investment is better protected (from an income perspective) than common stock.

Love preferred securities and looking for more investment ideas like these? The HDO Model Portfolio has over 45 such stocks with high yields, carefully selected for consistent, predictable and reliable income in both bull and bear markets. This report discusses four favorite picks with returns of up to 8% so you can raise money through the chaos and emerge rich and victorious.

Garland K. Long