In today's report, we recommend buying the preferred stock of the Washington Prime Group (WPG), a mall REIT. The two preferred shares are:
- Washington Prime Group, 7.50% Series H Repayment Preferred Securities (WPG.PH) or WPG-H – 10.2% Return
- Washington Prime Group Inc. 6 7/8% Cum Red Pfd Series I (WPG.PI) or WPG-I – 10.4% Yield
These two issues are OUR HIGHEST CONVICTION Preferred Stocks among High Yield Preferred Stocks. They are currently trading at very attractive valuations as one of the largest Preferred Stock ETFs (1
In this report, we will explain why these two preferred companies are among the largest robust preferred stocks out there. Despite all the negative news on the Mall REITs, the WPG preference shares are highly secure and suitable for conservative income investors.
More information on WPG
The issuing company WPG has experienced its stock price under siege as malls are increasingly bankrupt. The last is Sears Holding Company (OTCPK: SHLDQ), although Eddie Lampert has been successful in his quest to keep the company up and running, several locations are still closed.
The closure of Sears Stores offers the WPG a chance to redevelop it, but also involves risk and effort. The price of ordinary shares has fallen dramatically as many fear that the dividend will be cut to pay for the new development.
For WPG, closing Sears stores offers a chance as Sears is generally well below market rents due to contracts signed when mall owners really wanted a Sears location. The anchor concept was based on the idea that a big name store would attract traffic to the mall, and that traffic would benefit the inline stores.
Today, Sears can not gain much traffic, and mall owners believe that the space can be better used by new tenants. Bulls argue that new tenants will be more attractive to modern shoppers, which benefits all the mall's stores, and that the new tenants will pay a higher rent, which directly benefits the WPG.
The risk is that the Sears room will be reused
The WPG plans to invest $ 300 million to $ 350 million to rehabilitate 28 properties. It is clear that cash flow alone will not be enough to finance these expenses. Therefore, the WPG will opt for other options such as debt, real estate sales or joint ventures.
In addition, the common dividend is approximately $ 224 million / year. Management has argued that it is not intended to cut or suspend the common dividend, which is a great source of cash flow that can be accessed.
In 2017 and 2018, WPG's joint dividend was protected by the 90% payout rule. In order to qualify as a REIT, the WPG must distribute at least 90% of its taxable income in the form of annual dividends. Due to large profits from real estate sales and lenders, the WPG was close to this line. In 2019, it is less clear whether the taxable income of the WPG will be so high that it can not reduce the common dividend.
Although we believe that the WPG is likely to be able to maintain its common dividend, we also acknowledge that this is not the case the same protection as in recent years. We also recognize that lowering the common dividend could be a tempting source of capital, especially if significant retailers file for bankruptcy.
For investors who want to avoid the volatility associated with common stock, preferred issues are WPG.PH and WPG.PI, which provide an opportunity to receive a more stable dividend. The Series H and Series I preferred shares also had price pressures both trading at 25% + at face value and both paying over 10%. This sell-off is over the top and offers investors the opportunity to earn double-digit returns over many years.
The Benefits of the Preferred
The preference shares offer investors the opportunity to achieve a more secure income stream and participate in some positive aspects of a successful reorganization program.
The preference shares are a relatively insignificant obligation for the WPG . With a total of 7.8 million outstanding units the preferred dividends are only $ 14.27 million per annum . Common dividends can not be paid until the preference dividends are paid.
In order to suspend the preferred dividends, the WPG would first have to suspend the common dividend, a free cash flow of approximately $ 224 million and then they would have to earn a taxable annual income of less than $ 16 million , We believe that this is an incredibly unlikely event.
In other words:
- The preference stock dividend is paid 25 times before the common dividend.
- Even after paying the common dividend, the case is still covered about nine times.
It's kind of crazy, if you would prefer to trade with such a discount. The preferred dividend is a rounding error for WPG. From the company's perspective this is a rather irrelevant part of their capital structure.
In addition to the dividends, which are well protected by cash flow, the value of the assets that would help the preferred shareholders to regain their capital even in an extreme scenario of bankruptcy or liquidation is significant.
If we look at the addition to Q3 2018, we can see how the WPG based on its most restrictive obligations. The strength of WPG's balance sheet is that they have a considerable amount of unloaded properties and the unloaded properties tend to have higher value and more valuable properties.
As of the third quarter of 2018, the WPG had less than $ 2 billion in unsecured debt, and its unencumbered assets are more than twice as high. The secured claim of the WPG is exclusively "recession-free". This means that the WPG has the opportunity to hand over the keys of the property to the lender. If the sale does not cover the mortgage, the lender has no recourse to the balance requirement.
Even assuming that every mortgage-backed property has a zero value above its mortgage, the unencumbered assets of the WPG are more than twice as high as their unsecured debt. This $ 2 billion buffer can absorb a significant drop in value and liquidation costs. The current face value of the outstanding preferred stock is only $ 195 million.
In other words, the coverage of the assets of preference shares is ten times, which is enormous. With such a significant difference between the value of unencumbered real estate and unsecured debt, there is a high probability that preference shareholders could regain par value even in the event of an unlikely liquidation event.
Both WPG Preferred Stocks WPG-H and WPG -Im among the safest preferred stocks issued by real estate REITs when we look at dividend coverage and asset coverage. We believe that any kind of bankruptcy or liquidation is highly unlikely. And even if a Black Swan event occurs, the preference shares are well covered by the WPG investment value.
The Big Opportunity
The iShares US Preferred Stock ETF is one of the largest preferred stock ETFs large holdings in WPG-H. Not so long ago the PFF decided to reposition its portfolio by switching to a new tracking index. Why is the PFF changing the index it tracks? This new index appears to give more weight to "convertible preferred stock" and "baby bonds", which is why the PFF must sell some of its non-convertible preferred stock to make the switch
It is important to note that the new Index has a lower association with WPG-H. The PFF was forced to sell its preferred WPG, and it dumped a huge number of shares. Note that this is in no way a negative assessment of the preferred WPG as it is based solely on an index tracking decision. Let's look at the details of the PFF sale:
As we can see from the table above, PFF has a large number of shares (over 400,000 shares) between November 9, 2018 and February sold 12, 2019, or 93% of its stocks . This would have put enormous pressure on the preference shares of the WPG. The latest data we have on the PFF website is available for February 12, 2019. We monitor the PFF positions daily and they no longer offer any of the WPG H shares since February 6, 2019 So it looks like the sale is over.
While most of the preference shares have regained their old trading levels since their sell off on the market in the last quarter of 2018 (or nearby), WPG-H and WPG-I are compared to the time they reached In September 2018, shortly before the market correction were traded, very cheap.
- WPG-H was traded at a price of $ 23.30 / share at that time, compared with only $ 18.90 today (19459003) or rose 23% higher from here ).
- WPG-I was traded at a price of $ 21.20 at the time, compared to only $ 17.40 ( or higher 22% from here ).
WPG-H Pricing Chart for Six Months
Source: Yahoo Finance
Price Graph for WPG-I for Six Months
Source: Yahoo Finance
As can be seen from the charts above, the preference shares are at not as high as before the market correction, which we attribute to the sale of shares by PFF. In comparison with other Mall REITs, CBL & Associates Properties (CBL) Preferred Stocks and Pennsylvania Real Estate (PEI) we compared relative performance of previous year with PFF ) Preferred Stocks:
- CBL-D is around YTD at by 30% .
- CBL-E has increased by YTD by 31 %
- PEI-D has risen by by 32% .
- PEI-B is at 29% .
- WPG-I has risen by only 12%
- WPG-H has risen by only 12% of YTD.
With this significant underperformance compared to other Mall REITs we conclude that it is the big sale of PFF that prevents the WPG benefits from gathering much
Given the recent positive news about the Sears situation and the fact that the PFF sells its shares in the WPG, we believe that the preference shares of the WPG will rise sharply.
If a preferred stock can be picked up for + 25% below par it's hardly a dreadful event that the stock will be redeemed. Both issues are above their release date and theoretically could be redeemed every day. However, it is very unlikely that either issue will be cashed in the near future.
The WPG expects increased investment by 2023, and it is unlikely that the management will provide redemption of preferred stock until full Sears reorganization. Based on the current price, the market is right.
Whether the eradication occurs or not depends on various variables beyond 2023, such as: For example, market interest rates, the impact of the recovery on cash flow and the strength of common equity.
If and when the preferences are redeemed, it is likely that the WPG.PH will be repaid first as the interest rate is 62.5 basis points higher.
Given the expected capital requirements of the WPG it is highly unlikely that the issue will be preferred will be redeemed before 2023 .
Change Of Control
One factor that investors should consider is a case of a change of control to an unlisted unit z as a private equity fund. Both preference shares contain a provision for the WPG to repay the preference shares at face value plus accumulated dividends in the event of a change of control. If the WPG redeems the preferred stock in this situation, the price would be $ 25 / share and shareholders will be rewarded with huge capital gains based on today's prices.
However, if the WPG does not retire the shares, the preferred stockholders then have the option to convert into ordinary shares . For both series, the number of ordinary shares into which each preference share can be converted is calculated on the basis of the liquidation preference division of $ 25 plus the accumulated dividends from the ordinary share price. However, there is a Stock Limit which limits the maximum number of common shares that can be obtained per Converted Preferred Stock. For the WPG-H the share capital is 4.99 ordinary shares. The series WPG-I has a stock cap of 4.3745.
The difference in the equity ceiling between the two issues could make a difference if the WPG was acquired by a private equity firm. Imagine a scenario in which a private company made a $ 5 / common share offer for WPG and the preference shares are not redeemed.
- WPG-H shareholders could convert each share into 4.99 common shares, worth $ 24.95 ($ 4.99 * 5).
- WPG I shareholders would receive only 4.3745 common shares for each worth $ 21.8725 ($ 4.3745 * 5).
Next to the coupon was the difference The upper limit of the conversion rights is the biggest difference between the two issues. The cap only affects if the WPG is purchased by a non-traded company at a price below the current price. While this is an unlikely scenario, WPG-H stocks are somewhat superior to WPG-I in certain circumstances.
Our short-term price target for these two preferred shares are the prices traded around just before the market correction and before sale by PFF .
- For WPG-H our target price is $ 23.30 per share ( or 23% higher) from here ).
- For WPG-I our target price is $ 21.20 per share ( or 22% higher than the current price ). Our longer-term goal, given the level of safety, these two Preferred Shares should, in our opinion, be traded very close to the respective face value or 30% to 40% above the current price . 19659072] Conclusion
Following the market correction we experienced in late 2018 and the loss of tax sales, the vast majority of preference stamps preferred ks retreated. Although most have recovered, there are some opportunities that investors overlook. We have published a series of articles on undervalued high-yield preferred stock.
In our report we highlighted the preference shares of the WPG which, because of their great preference, were held at an artificially low price share ETF (& # 39; PFF & # 39;) has the index it tracks and the new index does not seem to take into account the preference shares of the WPG. As a result, the PFF has dumped massive quantities of WPG preference shares.
Now that the sale is over, WPG's preferred stock should recover very quickly and reach our short-term target prices, resulting in + 22% profit. More importantly, as income investors, we achieve safe long-term returns of + 10%.
As already mentioned these WPG preference shares are very solid in terms of both dividend coverage and dividend payment as they are insignificant in terms of the company's balance sheet. The support of preferred stock is the value of the assets. WPG has a significant portfolio of unencumbered assets, and its bond covenants ensure that they maintain a high value-added potential over their unsecured debt.
- The dividend is covered 25 times by cash flows.
- Capital Secured Ten Times
- Additional security features include accumulated dividends and WPG's obligation to pay out 90% of taxable income in order to maintain REIT status.
All of these preferred stocks are among the safest preferred stocks Investors can access both dividend coverage and asset coverage.
The WPG preferred shares offer a great opportunity for income-oriented investors to achieve over 10 years of 10+ returns, which offer tremendous coverage through both cash flow and assets. With new developments completed and the current climate of anxiety abating, we expect trade prices to move towards par which yields an upside potential of 30% to 40% . These preferred stocks represent an incredible opportunity and are among our best beliefs today.
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<img src = "https://static.seekingalpha.com/uploads/2018/12/15/16392-15449154740326161.png" alt = "https://static.seekingalpha.com/uploads/2018/10 /6/16392-1538869967283426.png Revelation: I am / we are long WPG.PH, WPG.PI, WPG, PEI.PD. I have written this article myself, and he expresses mine I do not get any compensation for it (except from Seeking Alpha) .I have no business relationship with any company whose inventory is mentioned in this article.