CA - TC Energy Preferred Stocks: Better Than Any U.S. Preferred Stocks

2023-10-23 12:00:00 ET

Summary

• TC Energy (TRP) preferred stocks are investment grade rated BBB- by S&P with yields that are far superior to U.S. preferred stocks of similar quality.
• TRP-E (TRP.PR.E) and TRP-D (TRP.PR.E) are reset-rate preferred stocks that are set to have their yields take a huge jump in 2024 when the dividend is reset.
• At the current Canadian government’s 5 year note yield of 4.25%, TRP-E and TRP-D will reset to yields of 12.06% and 11.06% respectively with yields locked in for 5 years.
• TRP's preferred stock dividends are “qualified” (tax benefitted) and thus they will generate very large after tax yields.
• As their reset dates get nearer, I expect strong price upside for these preferred stocks generating a large total return on one’s investment.

This is the second public article that I am publishing on Canadian reset-rate preferred stocks. The first one was on 2 Enbridge preferred stocks . One of the recommendations, symbol [[EBGEF]] ( ENB.PF .V on IBKR), is up $2.48 just since we recommended it to our members in September and up $1.75 from where we recommended it in a public article in early October. We have sold EBGEF and have moved on to these TRP preferred stocks. We suggest that readers might want to sell EBGEF and buy these TRP preferred stocks as EBGEF will reset at a yield of only 9.18% given Friday’s closing price versus 12.06% for TRP-E and 11.06% for TRP-D and all 3 are rated BBB- by S&P. The price upside potential for these TRP preferred stocks is very strong, similar to what the ENB preferred stocks had from the last article.

At our Conservative Income Portfolio service we take pride in the fact that we cover all preferred stocks, all baby bonds, and all traditional bonds, not just in 1 or 2 sectors but in all sectors. Additionally, we cover Canadian preferred stocks. In order to know which fixed-income securities are the most undervalued, you really need to do the work of covering all of them. And currently Canadian preferred stocks provide the best values in the investment-grade preferred stock space and we are currently recommending some of these great values to our subscribers.

TC Energy

TC Energy ( TRP ) was formerly known as TransCanada Corporation. It is a large Canadian energy company that has assets all over North America including close to half in the USA. Its operations include natural gas pipelines and liquids pipelines as well as natural gas storage facilities. Additionally it operates in the power generation business. So you get geographical and operational diversity which adds to safety.

There is a way of investing in TRP where you can achieve a higher yield, greater safety, and very possibly more price upside than you get with the common shares. That is by investing in their reset-rate preferred stocks. TRP has a strong investment grade credit rating of BBB+ which puts the rating on these preferred stocks at BBB-, still investment grade. When you consider the credit quality of TRP, the yields on their preferred stocks are just enormous and far outpace the yields on U.S. preferred stocks.

TC Energy Preferred Stocks

Not only do TRP reset-rate preferred stocks provide higher yields and more safety than the common shares of TRP but they also give you interest rate protection as they have some preferred stocks that have their interest rates reset every 5 years based on the GOC (government of Canada) 5 year treasury note. Once the dividend is reset on one of these preferred stocks, they cannot be called for another 5 years at which time the rate will be reset again. And these preferred stocks trade way below par making a call quite unlikely and a bonanza win if they should be called.

So How Undervalued Are TC Energy Preferred Stocks?

To give you an idea of the undervaluation of TRP preferred stocks I have screened all U.S. fixed-rate preferred stocks that have the same S&P BBB- rating as TRP and that also pay a "qualified" dividend. I have excluded those preferred stocks that have a Moodys’ rating 2 notches or more below BBB- and those trading over par.

As you can see, the average yield for BBB- preferred stocks tends to be around 6.5% with the maximum being 7.31%. Now let's looks at 2 TRP preferred stocks to see just how much better they are compared to these U.S. BBB- preferred stocks in the above chart.

TC Energy Series 9 Reset Rate Preferred Stock

Tickers TRP-E ( TSE ) and TRP.PR . E (At Interactive Brokers)

The preferred stocks that I am covering in this article trade on the Toronto Stock Exchange ((TSE)) and are denominated in Canadian dollars.

Last Trade $13.77 CAD

Current Yield 6.87%

Resets 10/30/2024 at the Canadian 5 Year Note plus 2.35%

At the current Canadian 5 year note rate of 4.25%, TRP-E would reset at a yield of 12.06%

Qualified Dividend

Par $25

S&P Rating BBB-

The current stripped yield of 6.87% is better than the typical 6.5% on U.S. BBB- preferred stocks, making it a bit undervalued. So you are doing fine while you wait for the rate to reset. But what really makes this an extremely undervalued preferred stock is that the dividend is going to reset much higher with an announcement in around 11 months assuming no total crash in the Canadian 5 year yield. With the Canadian 5 year note currently at 4.25%, the dividend reset would jump the yield from its current 6.87% all the way to 12.06% at its current price. This is a massively better yield than the typical 6.5% on equivalent U.S. preferred stocks and given that TRP-E (TRP-E) dividends receive a tax benefit (qualified), the after tax yield on this preferred stock will likely be huge.

Thus, I expect a large rise in the price of TRP-E ( TRP.PR .E) over the next 11 months as we close in on the October reset date. And so I expect a very large total return over the next year. It seems investors are not looking ahead with this preferred stock and are simply looking at its current yield. But with perpetual preferred stocks, they must be evaluated on their likely return over a decade or more.

The current reset yield for TRP-E is 7.81% above the Canadian 5 year yield which is a ridiculously large spread over treasuries for an investment grade security (12.06% versus 4.25%). Thus, no matter what happens to the yield on the Canadian 5 year note over the next year, TRP-E’s yield will be relatively super good and we can expect sizeable price upside regardless of where the 5 year note yield goes between now and its October reset date. If you want a preferred stock with super protection against interest rate moves, whether rates go higher or lower, this would be a top pick.

Some may make a mistake when they add up the current Canadian 5 year yield of 4.25% with the fixed portion of 2.35% and think the yield will be 6.6% when TRP-E resets. But that yield is at par. With TRP-E trading 45% below par, the yield is 12.06%.

If you are concerned about the currently rising interest rates, this is a place to be as the reset rate yield will be even higher than 12.06% if treasury rates continue to rise.

TC Energy Series 7 Reset Rate Preferred Stock

Tickers – TRP-D ((TSE) ) and TRP.PR .D (At Interactive Brokers )

Last Trade $15.08 CAD

Current Yield 6.51%

Resets on 4/30/2024 at the Canadian 5 year note yield plus 2.38%

At the current Canadian 5 year note rate of 4.25%, TRP-D would reset at a yield of 11.06%

Par $25

Qualified Dividend

Rating BBB-

I won’t repeat the write-up that I did for TRP-E for TRP-D as these preferred stocks are very similar and both very undervalued. The primary differences are that TRP-D resets 6 months sooner than TRP-E so you start collecting a higher yield sooner. At the current Canadian 5 year note yield, the reset rate would be 11.06% and currently the yield is 6.51% while you wait for the reset in April. I will compare the 2 preferred stocks further and give my preference later in the article.

Why I Expect a Large Rise in the Prices of TRP-D and TRP-E

When I looked at these preferred stocks, I was very surprised to see what will likely be future yields that are massively better than other preferred stocks with similar credit risk. It seems that probabilities don't matter to investors and looking at probabilities are really what stock picking is all about. It seems that investors are simply looking at current yield which is an absurd way to analyze reset-rate preferred stocks. And if they are not looking at current yields only, then they must be assuming a crash in the Canadian 5 year note yield between now and April of 2024. If you have such certainty of this, shorting the Government of Canada’s bonds would make you a killing. And you should probably exit all your stock positions because if rates crash like that it will almost certainly be a result of a financial panic or a sudden big downturn in the economy. So anyone who shuns these preferred stocks is really taking a position that disaster is about to hit and should not be in the market outside of treasury bonds.

I believe that when the reset dates get nearer and investors become more certain that the current yields will rise steeply when the dividends are reset, prices should move higher and significantly so. And even if the 5 year note yield falls a fair amount between now and the reset dates, I still expect these preferred stocks to move nicely higher in price. This is because if yields drop, that means that we are in a lower interest rate environment and the reset yield, although it may be somewhat lower, will still be significantly better relative to other preferred stocks than it is now. What matters in pricing is not the absolute yield but the yield relative to other similar investments. And for investment grade securities, the huge spread over treasuries that exist with TRP-E and TRP-D matters greatly.

So if the Canadian 5 year note yield falls from 4.25% to 3.5% before we lock in the new reset yield for 5 years, the reset yield on TRP-E will drop to 10.7%. But that yield will still provide a 7.2% spread over the 3.5% treasury yield. Thus, TRP-E will still be ridiculously undervalued. This 10.7% yield will still be an incredible value relative to what will likely be a 6% yield on similar BBB- rated preferred stocks. So even if rates move down rather significantly between now and the reset dates, I still expect a strong price rise in these preferred stocks. The market just doesn’t seem to get that.

TRP-E Versus TRP-D

At current prices, I have a small preference for TRP-E over TRP-D. Although you have to wait an extra 6 months for the rate to reset on TRP-E, at the current 5 year treasury yield you are getting a 1% higher yield on TRP-E then TRP-D when the rate resets. Since I have no idea what will happen with rates between April and October of 2024, this looks to be a large difference. In addition the current yield on TRP-E is higher at 6.87% versus 6.51% for TRP-D. On the other hand, TRP-D does start collecting the higher yield 6 months sooner than TRP-E which is an advantage, especially with rates high currently.

But perpetual preferred stocks should be valued into perpetuity and in this case we have 2 preferred stocks with very similar reset rates; that being the Canadian 5 year yield plus 2.35% and 2.38%. Given that the reset formula for each preferred stock is so close, the fact that TRP-E sells for a lower price, $13.77 versus $15.08 makes it currently a better value long term. But personally, I do own both as I do like the idea of getting the high yield 6 months sooner and eliminating some reset rate risk by getting the high rate locked in sooner in case rates drop between April and October of next year. But of course rates could rise between April and October.

Note

For U.S. residents with taxable accounts, there will be withholding of 15% of your dividends on TRP preferred stocks but you can recover all of that by filing a Foreign Tax Credit form at tax time.

Summary/Conclusion

At our Conservative Income Portfolio service, we cover all of the Canadian reset-rate preferred stocks and there are many to like. Currently, Canadian preferred stocks are very undervalued and look to be much better investments than U.S. preferred stocks.

TRP-E ( TRP.PR .E) and TRP-D ( TRP.PR .D) are both reset-rate preferred stocks that reset next year with the strong likelihood of huge jumps in yield making them enormously undervalued relative to other preferred stocks of the same credit quality.

TRP-E ( TRP.PR .E) is a BBB- (S&P) rated Canadian denominated reset-rate preferred stock whose dividend will reset in October 2024 for the next 5 years. Based on its current price and the current yield of the Canadian 5 year note, TRP-E is set to see its current yield take a massive jump from 6.87% to 12.06%. When you consider that similar BBB- rated preferred stocks yield around 6.5% on average, you can see just how undervalued this preferred stock is. Investors seem to focus only on current yield when that is no way to value a reset-rate preferred stock.

TRP-D ( TRP.PR .D) resets sooner, in April of 2024. Based on its current price and the current yield of the Canadian 5 year note, TRP-D is set to see its yield jump from 6.51% to 11.06%.

I expect the prices of these preferred stocks to move much higher as we move toward their reset dates. And this is regardless of where interest rates are when the reset occurs. If we take TRP-E, for example, the yield spread of more than 7.75% over treasuries is enormous for an investment grade security (12.06% versus 4.25%). Thus, if rates drop between now and the reset date, the yield on TRP-E will still be extremely high relative to the treasury yield and will still be grossly undervalued. As we move closer to the reset dates, investors won’t be able to ignore the huge jump in relative yield that will occur with these 2 preferred stocks and will likely be falling all over themselves chasing these preferred stocks higher.

If you are concerned by the sharply rising interest rates we are currently seeing, these preferred stocks provide great protection as if rates move higher their reset rates will be even higher than the 12.06% and 11.06% I used in this article.

If you own EBGEF ( ENB.PF .V), we strongly suggest you sell and move to one of these preferred stocks. At Friday’s closing price EBGEF is set to reset next year at 9.18% versus 11.06% and 12.06% for TRP preferred stocks. At our Conservative Income Portfolio service, we believe that the best way to generate high returns is to recycle your capital. In other words, sell when you have a nice profit and move that money into something with more upside potential and a higher yield. Rinse and repeat.

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