NXDT - NexPoint Diversified: Common Stock 9.2% Yielding Preferred Stock - Both Quite Undervalued

Summary

• NexPoint’s preferred stock (NXDT.PA) looks like a great value given its 9.2% yield, very low leverage and high total return potential as it sells 40% below its $25 par (liquidation).
• NexPoint Diversified REIT (NXDT) common stock currently trades at a whopping 55% discount to NAV and a very low PE (price to earnings ratio).
• NXDT and NXDT.PA are both very undervalued relative to sister company Highland Income Fund (HFRO) with similar investments, management and leverage.
• Now that NXDT is a REIT, it must pay out 90% of its earnings in dividends. This should result in a much higher yield in the future.
• The manager of NXDT has been scooping up NXDT common stock at a rapid pace which should also provide reassurance to preferred stockholders.

NexPoint Diversified REIT

NexPoint Diversified REIT ( NXDT ) was formerly a closed-end fund, but 2 years ago their shareholders approved a switch to a Real Estate Investment Trust ((REIT)) structure. Very recently they received SEC approval to become a REIT.

The reason given for the conversion to a REIT was to unlock value. NXDT was trading at a deep discount to NAV and management felt that as a REIT they would get more analyst coverage, be included in REIT indexes, and there would be demand for their stock by REIT ETFs and REIT funds. Although it’s been a very short time since they have been a REIT, the huge discount remains.

As the name implies, NXDT has investments across many real estate sectors and is also diversified between real property ownership and real estate finance. It is also geographically diverse.

As you can see from the above chart, their $1.03 billion in assets is divided up among various sectors of real estate with the heaviest weighting in single family rentals, self storage, multi family and office properties. The office property is actually one class A property as depicted below.

NXDT is renovating the property, which they call a “trophy property”, to include a 5 star hotel on the first 7 floors, and recently Neiman Marcus announced that this building will be their new headquarters. This property is likely to increase the earnings of NXDT in the future.

And below shows the geographic diversification.

NXDT Is Selling For A Large 55% Discount to NAV

The net asset value ((NAV)) of NXDT is around $27.70 per share. Thus, the stock is selling at less than half of NAV. You don’t see too many REITs selling that cheaply. In fact, maybe there are none.

And James Dondero, who runs NXDT, certainly believes the stock is undervalued and that there is money to be made here. He has been buying up NXDT stock relentlessly. And these are not small purchases. In fact, in the last 2 years he has bought about 2 million shares of NXDT and has a significant position in NXDT’s stock. It seems that he believes the stock is very undervalued and his large stock position also now aligns him better with the company.

Additionally, NXDT along with sister company Highland Income Fund ( HFRO ) won a large lawsuit against Credit Suisse. The result of the appeal should be known soon, and although the lion’s share of the proceeds will go to HFRO, this could be a catalyst to get NXDT’s stock price moving higher.

NXDT’s sister company, Highland Income Fund ((HFRO)), also tried to convert to a REIT but could not get shareholder approval. But HFRO is a very good comparison to NXDT. HFRO has similar management, virtually identical leverage and similar investments. In fact, some of their investments are identical. But NXDT currently sells at twice the NAV discount as HFRO again underscoring just how discounted is the current price of NXDT.

NXDT has actually performed very well of late. I looked at their NAV at the beginning of 2020 and it was $21.23. 2.5 years later it is now $27.70 for a 30% rise in NAV. And during this same period of great performance, NXDT’s stock price has actually fallen from $18 to $12.42 or 31%. So with a 30% rise in NAV combined with a 30% drop in the stock price, it is no wonder Dondero is buying up shares. The disconnect between NXDT’s performance and stock price has been quite large.

* This article was written at the close on 11/7/2022 and reflects those prices. The article was first seen by Conservative Income Portfolio subscribers.

Common Dividends Could Be Very Large and the PE Multiple Is Very Low

Currently NXDT is paying shareholders $0.15 quarterly in dividends for an annual yield of 5.6%. In my talks with the company, this distribution has been based on being a CEF or RIC (registered Investment company). But as a REIT, they must pay out 90% of their income in dividends. Net income before one time items was around $82 million or $2.21 per share in 2021. In the first half of 2022, it is even better, with NXDT having net income of $1.81 per share which annualizes to $3.60 per share. But even if normalized earnings are only $2.30 per share, the dividend should be at least $2.07 per share (90% of earnings). That would put the yield of NXDT at a very generous 13.7%, very high for a diversified REIT preferred stock. And as a REIT, U.S. taxpayers would get 20% of that dividend tax free.

And if you look at the type of earnings they’ve shown over the last 18 months, the PE multiple looks to be a mere 5 times earnings. That PE is much lower than the PE multiple on similar HFRO.

NXDT Preferred Stock

NXDT has one preferred stock outstanding with symbol NXDT.PA (NXDT.PA). Here are the details:

Current Price $15.10

Current Yield 9.2%

Call Date 12/15/2023

Cumulative Yes

Liquidation Value $25

Fixed-Rate

NXDT’s 9.2% Yield and Total Return Potential Is Very High Relative to Its Safety

As I wrote, NXDT’s sister company, HFRO, is very similar to NXDT – same leverage, similar management, and similar to identical investments. The primary difference between the 2 companies is that NXDT converted to a REIT and HFRO failed in its attempt to convert to a REIT. HFRO is currently “A1” rated by Moodys. If NXDT had remained a CEF, presumably it would also carry an A1 rating.

Part of the reasons CEF preferred stocks get high credit ratings are due to their diversification as well as legal leverage limits that they must adhere to. Although, theoretically, NXDT is now allowed to take on more leverage, it has had 2 years to do so since they received shareholder approval to convert to a REIT. But it has not. In fact, as a CEF, it could have taken leverage up to 50% but instead it has chosen to operate at much lower leverage – around 10%. So NXDT still retains the same safety that it had when it was a CEF. Of course, like every investment, leverage levels should be monitored.

Here is NXDT’s balance sheet from their 2 ^nd quarter SEC filing.

As you can see from the balance sheet, NXDT has $1137 million in assets and only $25 million in liabilities. If we add the $83 million in preferred stock to that, we get $108 million of liabilities which amounts to less than 10% of assets. Some of their investments are in funds which may contain some leverage, but that is also true of “A1” rated HFRO and other “A1” rated preferred stocks.

Currently sister company HFRO’s preferred stock, HFRO.PA, has a current yield of 7%. And most CEF preferred stocks have an even lower yield than that. This makes NXDT’s current yield of 9.2% look extremely generous. Additionally, as a REIT, 20% of NXDT.PA’s dividends are tax free. That is not the case for HFRO.PA. So I believe NXDT.PA is an excellent value at current prices, and it certainly doesn’t hurt that it has more than 60% of potential price upside to par, although I don’t see it going back to par. For those owning HFRO.PA, they may want to consider a swap to NXDT.PA.

I believe a conservative reasonable yield on NXDT.PA is around 8%. That is still higher than many REIT preferreds that have less diversification than NXDT. Should NXDT.PA trade at an 8% yield, the price would be $17.30, or close to 14% higher than its current price. Thus, I would not be surprised at all if NXDT.PA achieves greater than a 20% total return over the next 12 months (price gain plus current yield). And if the dividend is anywhere around where it appears it will be, the total return could be higher.

Summary

In terms of the preferred stock, the 9.2% current yield plus its large discount from par could well lead to a 20% to 25% total return or more over the next 12 months. This 9.2% yield is very high relative to the safety of NXDT given its very low leverage of 10%. NXDT retains the very low leverage it had when it was a closed-end fund ((CEF)) while currently other CEF preferred stocks tend to average a yield of around 6.5%. And while NXDT.PA offers a 9.2% yield, its sister company, HFRO, with its very similar profile and leverage, yields only 7.0%. So I believe that NXDT.PA is a very good value here with significant upside price potential.

NXDT common also looks to be extraordinarily undervalued. While NXDT has grown its NAV by 30% since the beginning of 2020, the stock price has actually fallen 30%. That is a massive disconnect and now NXDT trades at a massive 55% discount to NAV. Not surprisingly, the manager of NXDT has been a constant buyer of NXDT stock in the open market and has now gathered a sizeable position in NXDT stock.

Additionally, the PE ratio of NXDT is extremely low, and now that NXDT is a REIT, the requirement to pay out 90% of earnings in dividends should lead to a huge rise in its yield. The potential price upside here looks sizeable.

For further details see: