Three Preferred Yields for the Bumpy Ride Ahead
All good things must eventually come to an end; the current economic expansion and bull market in stocks are no exceptions.
I’m not suggesting that it will happen next month or even, necessarily, next year. Still, we’re obviously not in the early stages of the economic and investing cycles.
There aren’t many obvious bargains left, and stocks that seem such are usually marked down for a valid reason. That doesn’t preclude further capital gains, but does increase the draw of a decent and sustainable yield not correlated with the S&P 500.
Which brings me to the trio of preferred stocks I’m about to recommend. Like other preferreds, they tend to take their cues from bonds rather than stocks, faring best when yields are moving down. That means they’re not as cheap as they were nine months ago at the peak of the last outburst of economic optimism. But they’re plenty attractive still relative to the available alternatives and with yields backing up have some momentum on their side.
The Wells Fargo Series L Preferred (WFC-L) wasn’t issued by Wells Fargo. It’s an artifact of Wachovia’s efforts to shore up its capital before it was purchased by Wells for inexplicably lavish consideration during the dark days of October 2008.
It yields an annualized 5.6% via quarterly installments of $18.75 per $1,000 of face value (vs. a recent market price of $1,327.) That’s quite generous for a mega bank that’s almost certainly still too big to fail despite all the assertions to the contrary.
Wells Fargo, of course, is in no danger of coming anywhere close to failing for the foreseeable future. But it’s no more likely to quadruple its share price above $200, which is what it would take to allow it to buy back the perpetual Series L. So this issue is in no danger of getting redeemed the way so many other bank preferreds have been since banks started swimming in excess capital.
Bank of America is in the same unsinkable boat as Wells Fargo as a bank too large to fail, and it too has a perpetual preferred that’s not going away any time soon. At a recent market price of $1,316, Bank of America Series L Preferred (BAC-L) was yielding an annualized 5.5% via quarterly payments of $18.125. Bank of America’s common stock would have to rise from the current $23 to $65 before the preferred could be mandatorily converted into common.
The field of master limited partnership preferreds has been thinned out a lot too just as with banks, only instead of getting redeemed many MLP preferreds went belly up when the drilling partnerships that issued them filed for bankruptcy.
Targa Resources (TRGP) was never in that boat. It is a large and well-diversified midstream operator involved in gathering and processing natural gas, gas liquids fractionation and a fuel export terminal.
Like other pipeline and gas processing plant operators it’s been hobbled but not crippled by low energy prices. This year’s cash flows are expected to cover 95-100% of Targa’s common dividend, which currently yields an annualized 8%. Common shareholders aren’t entitled to a penny unless Targa keeps paying out $0.1875 monthly on its Targa Resources Partners Series A Preferred (NGLS-A), currently trading at $26.50. That works out to an annualized yield of 8.5%.
The preferred shares are redeemable at Targa’s option for face value of $25 starting on Nov. 1, 2020, a possibility that currently looks remote. On that date the coupon converts from a fixed 9% annually to a spread of 7.71% over the one-month LIBOR (currently at 1.23%).
While there is some risk of an eventual redemption at $25 this is a secure 8.5% yield shielded from the risk of a dividend reduction on the common. I’m bullish on energy prices in 2018 but not so bullish as to dismiss that possibility in Targa’s case. The preferred shares, on the other hand, still look like a solid value.
The risk for any and all preferred stocks is that bond yield rise decisively, which would force preferred yields higher as well by means of capital depreciation. But we’re not so early in the economic cycle that higher rates are a foregone conclusion. And when growth and the stock market falter these there preferred issues will provide a safer harbor.