ESGRO - Enstar Group's 2 Undervalued Preferred Stocks: The Best BB+ Rated Preferreds

Summary

• Enstar Group Limited is a superbly managed company with a BBB Investment Grade rating that has 2 preferred stocks that are relatively quite undervalued.
• Both Enstar preferred stocks pay a qualified dividend of around a 7.37% and have room to move higher in price.
• Most other preferred stocks with the same S&P rating as Enstar yield closer to 6%, making the 7.35% yield on Enstar preferred stocks a bargain.

Enstar Group Limited

At our Conservative Income Portfolio service, we offer a number of strategies for beating the market, but the most important thing I do is scour the markets for mispriced/undervalued securities. The ESGR preferred stocks definitely look to be undervalued based on ESGR's credit rating.

Additionally, we like to focus on stocks that fly under the radar. That's where you often find undervalued securities. ESGR preferred stocks haven't seen an Seeking Alpha article since I wrote about them 2.5 years ago, and there hasn't been an ESGR common stock article written since 2018 .

Enstar Group Limited ( ESGR ) is an insurance and reinsurance company that has been a public company since 1997 with a fabulous track record. Here is what Yahoo Finance says about ESGR:

Enstar Group Limited acquires and manages insurance and reinsurance companies, and portfolios of insurance and reinsurance business in run-off. It engages in the run-off property and casualty, and other non-life lines insurance businesses. The company also provides consulting services, including claims inspection, claims validation, reinsurance asset collection, syndicate management, and IT consulting services to the insurance and reinsurance industry. It operates in Bermuda, the United States, the United Kingdom, Australia, and other Continental European countries. The company was formerly known as Castlewood Holdings Limited and changed its name to Enstar Group Limited in January 2007. The company was founded in 1993 and is headquartered in Hamilton, Bermuda.

And here is a price chart of ESGR relative to other big-name insurance companies.

ESGR has risen 2200% since inception, dramatically outpacing other insurance companies including Berkshire Hathaway (BRK.A). Its stock price rise has only had temporary disruptions during the 2008 financial crisis, the COVID meltdown, and has sold off in this current bear market, although it is now in the midst of a massive rally.

Enstar's Preferred Stocks

ESGR has two preferred stocks:

1. Enstar Group Ltd Preferred E ( ESGRO ) shares have a fixed-rate coupon of $1.75 annually with non-cumulative dividends paid quarterly. ESGRO currently trades at $24.18 and has a stripped current yield of 7.36% . Shares can be called on 3/1/2024 at $25. Dividends are qualified for the low 15% tax rate.
2. Enstar Group Ltd Preferred D shares ( ESGRP ) are fixed-to-floating rate preferred stocks. They currently have a fixed-rate coupon of $1.75 annually with non-cumulative dividends paid quarterly. ESGRP currently trades at $24.12 and has a stripped current yield of 7.38% . Shares can be called on 9/20/2028 at $25. If ESGRP shares are not called on its call date, the dividend will become floating at LIBOR plus 4.015%. Dividends are qualified for the low 15% tax rate.

S&P considers ESGR to be an investment grade company and currently gives ESGR a BBB credit rating. The preferred stocks of ESGR are rated BB+ by S&P. ESGR is not rated by Moody's but Fitch actually rates the ESGR preferred stocks 1 notch higher than S&P at BBB-.

Large Relative Undervaluation of ESGRO and ESGRP

To be conservative, we will use the lower S&P rating rather than the higher Fitch rating and compare the yield on the ESGRO preferred stock to other qualified dividend paying fixed-rate preferred stocks with the same BB+ S&P credit rating. Here is the chart:

As you can see, the current yield of 7.36% on ESGRO is much better than similarly rated fixed-rate preferred stocks. The median yield of BB+ preferred stocks is around 6% with even the second highest yielding BB+ preferred stock having a much lower yield than ESGRO. Even if ESGRO traded over $26.00, it would still be the highest yielder in its class . So it appears that ESGRO has room to move higher in price and its oversized yield should also help mitigate downside price risk.

And at our Conservative Income Portfolio service, we are always looking for swaps to improve our portfolio's yield and sometimes recommend pair trades. The chart above shows some great opportunities such as selling FITBO and buying ESGRO or ESGRP. And there are a number of other preferred stocks on the above list that you should consider selling for something better.

ESGRO Versus ESGRP (I Prefer ESGRP)

Both ESGRO and ESGRP have similar current yields with ESGRP having only the slightest of an edge. The primary difference between fixed-rate ESGRO and ESGRP is that ESGRP is still far from its 2028 call date and will then float if not called. It will float at the LIBOR substitute plus 4.015%. But it is important to note than ESGRP will remain fixed-rate for more than 5.5 years so a comparison between ESGRO and ESGRP is quite fair.

If the LIBOR substitute is higher than 3% in 2028, ESGRP will experience a rise in its dividend. If LIBOR is lower than 3%, than ESGRP will experience a decline in its dividend. So, whether you choose ESGRO or ESGRP depends partly on your outlook for future interest rates. Here is how ESGRP compares to other LIBOR fixed-to-floating preferred stocks - again very undervalued to peers.

You can see the current yield "CY" stands out as relatively very high versus its peers and the floating rate of LIBOR plus 4.01% is also better than most of its peers.

But where ESGRP really has the advantage over ESGRO is with its 4.5 years more call protection versus ESGRO which gives ESGRP much more price upside potential. That is the main reason that I prefer ESGRP although some future interest rate protection can't hurt either.

One very interesting thing about the trading in these 2 securities is that even when LIBOR was very low, ESGRP traded way above ESGRO and way above par.

You can see that ESGRP traded all the way to $30 in the second half of 2021 while ESGRO peaked out at $28.00. That was almost certainly due to ESGRP longer call protection versus ESGRO. So ESGRP has much more potential price upside than does ESGRO which can be called in 13 months, although they both have room to move higher with ESGRP having the potential to move much higher as we see from its 2021 pricing.

So at current prices, I prefer fixed-rate ESGRP.

Huge Earnings Estimates For ESGR

As I wrote earlier, ESGR preferreds and the common stock fly mostly under the radar. There is only 1 analyst who has a 2023 earnings estimate. That estimate is a whopping $38.50 per share. I wish we had more confirmation from other analysts, but it sure shows massive coverage of ESGR's preferred stock dividends.

Summary/Conclusion

ESGR is an insurance company that is extremely well managed and whose common stock price has risen 2200% since inception. Yet it flies under the radar. The one analyst who covers ESGR estimates that they will earn $38.50 per share in 2023. Both S&P and Fitch rate ESGR investment grade with a BBB rating.

A comparison of the 2 ESGR preferred stocks relative to other preferred stocks with the same BB+ credit rating show ESGRO and ESGRP to be grossly undervalued. While the ESGR preferred stocks offer a qualified yield of around 7.37%, other preferred stocks with the same credit rating generally offer qualified yields closer to 6%. That is quite an extraordinary differential.

Thus, we believe that ESGRO and ESGRP are buys as well as a great swap opportunity if you should own FITBO or some of the other BB+ rated preferred stocks with much lower yields.

My personal preference is ESGRP, because it has call protection until 9/20/2028 and thus has significantly larger upside price potential, although both can certainly move higher from their current prices.

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