SPLP - Bargain 10.4% YTM On Term Preferred Stock From Steel Partners Holdings

2023-11-09 13:00:00 ET

Summary

• Steel Partners Holdings (SPLP) Preferred “A” shares (SPLP-A) currently offers a 10.4% yield to maturity with a relatively short maturity date of 2/7/2026.
• SPLP is a big cash flow generator that easily covers its preferred stock dividend as well as its interest expense.
• SPLP owns several businesses in different sectors so sector risk is minimal. This diversification adds a lot of safety to a company that is already making large profits.
• Given the high level of safety that SPLP offers, the 10.4% YTM looks to be a bargain as its price has lagged the recent fixed-income market rally.
• The lag in the price of SPLP-A versus other fixed-income securities has now made SPLP-A my favorite fixed-income security.

Steel Partners Holdings

Steel Partners Holdings ( SPLP ) is a diversified global holding company that owns a number of businesses in the following sectors: industrial products, energy, supply chain management, defense, banking and youth sports.

The industrial companies that they own manufacture niche engineered industrial products that are leaders in their niches. These products include joining materials, tubing, building materials, performance materials, electrical products, metalized films and a blade business for meat packing. Their industrial products are sold worldwide.

In SPLP’s most recent quarterly report, they reported strong profits of $2.44 per share with revenues up 13.5% from the same quarter of 2021. Adjusted EBITDA came in at $73.6 million up from $59 million.

And SPLP management clearly views their common stock as undervalued and has repurchased 46% of the outstanding common shares over the years and continues to repurchase its stock.

Steel Partners Holdings Term Preferred “A” Shares

Steel Partners Holdings Preferred “A” (SPLP.PR.A) is a term preferred stock. It matures on February 7 ^th , 2026 and offers a 10.4% YTM.

If you aren’t familiar with term preferred stocks , most preferred stocks are “perpetual preferred stocks” which means that they have no maturity date and can potentially remain on the market forever. But like bonds, “term preferred” stocks have a maturity date. Having a maturity date basically eliminates interest rate risk if you hold until maturity. In other words, when you buy a “term preferred” stock, you know exactly what your total return will be if you hold it to maturity and thus you can sleep easy.

On February 7, 2026, you will receive $25 in cash or common stock. Since the company is continuously buying back its common stock and views it as undervalued, it is very unlikely that you will receive $25 worth of common stock. But in the very unlikely event that happens, you can just turn around and sell your common shares. And if you have a concern about this, you can always sell SPLP-A a couple of months before its maturity date as the price is likely to be close to $25 at that point.

Here are the details on SPLP.PA:

Current Price: $23.12

Yield To Maturity 10.4%

Cumulative Yes

Annual dividend $1.50

Maturity Date 2/7/2026

Taxation K-1

Ex-dividend Date End of this month

Before I get into the safety of this preferred stock, I want to warn foreign investors that the withholding on U.S. partnership preferred stocks like SPLP-A is extremely punitive and I recommend avoiding SPLP-A. This term preferred should only be purchased by U.S. investors .

Safety

First off, SPLP common stock was an amazing performer during the 2022 bear market and has continued to hold up very well due to its powerful earnings. The common stock price is up 7 fold over the last 3 years and yet the company continues to repurchase its common stock. And it’s no wonder as if we annualize the last quarter’s earnings they are earning close to $10.00 per share with a common stock price that is only $41.00. These share repurchases are a big vote of confidence by management in SPLP and its future prospects.

3 Year Price Chart of SPLP

In terms of coverage of debt and preferred stock, adjusted EBITDA was $78 million in the most recent quarter which annualizes to $312 million. Annual interest expense is around $48 million while preferred dividends come to $9.6 million. Combining these 2 numbers gets us to $58 million annually which is covered 5.4 times by EBITDA . This is very strong coverage of combined interest and preferred dividends. Some authors simply show coverage of the preferred stock when writing about preferred stocks and that coverage is 32 times but I really don’t subscribe to that. But the preferred stock dividend SPLP must pay on SPLP-A is clearly negligible for a company generating such strong cash flow.

But it is really better than this because SPLP is a huge free cash generator. If we annualize the most recent quarter’s free cash flow of $29.5 million, that is $118 million. So even free cash flow covers the combined interest expense and preferred expense by 2 times.

And as I mentioned above, the diversification over a number of different businesses in different sectors provides great security against sector risk. If one sector is problematic, the impact on SPLP will be much reduced versus a typical company who operates in just one industry.

Tax Benefit

Although as a partnership, the preferred dividends are not qualified, there is a hidden tax benefit. Because the current yield is relatively low at 6.57%, your annual taxation will be much lower than if you were buying a 10.4% yielder at par and having to pay taxes on 10.4% each year. The rest of your annual return, 3.83%, will not be taxed until 2027 and then at the long term capital gains rate which is the same rate as if that portion was a qualified dividend. Taxation on 3.83% of your annual return is a large part of your total return to be able to defer until 2027 and then pay taxes on that at a low rate.

Undervaluation

So often I see baby bonds and term preferred stocks that have relatively low current yields be quite underpriced relative to equivalent securities with the same YTM. Investor’s failure to understand that current yield is not the right metric to look at when it comes to term preferreds or baby bonds which often gives more sophisticated investors some excellent bargains. And as I just wrote, the taxation is better on term preferred stocks when the current yield is lower so you get a double benefit –a higher YTM (total return) and lower taxes.

Given the big rally we had in fixed-income, SPLP-A is now my number one pick as it has completely lagged the rally and should play “catchup”.

Summary

Term preferred stock SPLP.PA currently offers a 10.4% YTM and matures on February 7, 2026.

Steel Partners Holdings is a partnership that owns several other companies in various sectors providing great diversification, mostly eliminating sector risk.

And having a maturity date that is relatively near basically eliminates interest rate risk if you are willing to hold until the maturity date or close to the maturity date. You know that you will receive a 10.4% total return and don’t have to worry about the market’s interest rate gyrations.

SPLP common stock has been a great performer over the last 3 years, rising more than 7 fold.

EBITDA coverage of combined interest plus preferred dividends is a very strong 5.4 times and SPLP generates massive amounts of free cash flow.

SPLP continues to buy back its own common stock, so the management clearly sees SPLP as having a bright future.

I believe that SPLP.PA is quite undervalued and it also provides the deferral of taxes on 35% of your total return until 2027 and then that portion is taxed as a long term capital gain.

I believe this is a great value, in fact it is currently my favorite fixed-income security. But unfortunately not for foreign investors who should avoid this security .

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