Why Kenya Power preference shares get the numbers

 

By RUFUS MWANYASI

Many investors go out of their way to find the highest yields for their investments. Yet many investors never look at high-yield preferred stock as an alternative to other income-oriented options.

Let’s take a closer look at the only tradable preferred stocks listed at the Nairobi Securities Exchange (NSE): KPLC Preferred Stocks.

The energy stock has two preferred issues: KPLC-P4 and KPLC-P7 yielding four per cent and seven per cent respectively on offer prices.

As of December 3, 2015 prices of the two preferreds or preference shares ranged between Sh5.3 and Sh6.7 effectively placing their yields between 14.5 per cent and 25.5 per cent respectively.

With KPLC’s common stock trading at a dividend yield of 3.8 per cent, these yields look extremely attractive.

But first, before I explain any further why I think KPLC preferreds are so attractive, let me explain what these securities are. A preferred stock is a stock that has certain rights which are senior to common stock. This may be in the payment of dividends or the liquidation of assets.

The major objective of a preferred stock is to provide a much higher dividend than by common stocks. However, preferreds usually have no voting rights.

Furthermore, just like bonds, preferred stock prices would bop around in response to interest-rate gyrations (interest rates are a dominating factor since most preferreds have maturity dates 20-30 years in the future.)

For instance, when Treasury yields rise, the attractiveness of the incrementally higher income from preferred stocks is diminished because of the presumed incremental step up in credit risk.

Lastly, dividends are often cumulative. That is, if they are not paid in a given year, they accumulate and are owed in future years.

Now, what makes KPLC preferreds so attractive? First, beyond the fixed-dividend rate and the yield, the key number is their Sh20 issue price — the price at which KPLC can redeem or call back the shares. Since to purchase KPLC-P4 preferred costs Sh5.5 a share, investors are getting a significant bargain from the initial offer price per share.

Inflation risk

Similarly, the company’s KPLC-P7 preferred are also trading at the same price. In total, this means, investor stand to realise a gain upon redemption or, if the issuer never redeems, receive a better yield than one would have received had they bought the preferred when they were issued.

More importantly, is even after considering the risks of inflation, rising rates and default, KPLC yields are so compelling. Inflation is still mild (although the government fears it may rise as a result of the El Niño rains).

Even if one senses rates getting ready to surge, they can easily sell a preferred as easily as they would a regular stock. As for default risks, yes, it’s true that the claims of bondholders precede those of preferred investors in case of bankruptcy. But investing involves making choices between risk and reward; in this case, with Treasury bills rates currently yielding 9.218 per cent (as of November 30), KPLC preferreds clearly look like a better choice.