In Praise of Preference Shares

Preference shares are today a relatively neglected instrument of corporate finance. The current conventional wisdom of the City is that they offer none of the upside of ordinary shares and none of the tax advantages of loan notes.

I have an alternative perspective. True, preference share dividends are not tax deductible, unlike loan interest payments. But this is less of a disadvantage today, with corporation tax now 20% and due to fall to 18%, than when the rate of corporation tax stood at 30% back in 2007. And preference shares offer two major advantages over senior bonds or loans from the viewpoint of the companies that offer them:
• they do not need to be repaid – they are a form of permanent capital; and
• if the issuing company runs into temporary financial difficulties, it can pass the dividend payment on its preference share without risking insolvency.

For the investor, preference shares offer a steady and predictable source of income, with a higher yield than corporate bonds – more than 3% higher today, in fact, with prefshares generating an average yield of 6¼% at their Offer prices, compared to an average yield of barely 3% on bonds quoted on ORB. In addition, preference share dividends are more secure than those on ordinary shares. Overall, they occupy a useful position on the risk–return spectrum, which is why it is somewhat disappointing that my research identified just 22 preference shares which are suffiicently liquid to be easily purchased by a retail investor. For the record, the 22 prefshares, with their offer price and yield at August 10th 2015, were as follows:

[1] Aviva 8.75% Cumulative Irredemable Preference Shares [EPIC: AV.A]. Offer Price 139.5. Yield 6.27%.
[2] Aviva 8.375% Cum Irr Pref [AV.B]. Offer Price 136.5. Yield 6.12%.
[3] Balfour Beatty Cumulative Irredemable Preference Shares [BBYB]. Offer Price 119. Running Yield 8.03%. Yield to Maturity: 4.91%. (Note that the Balfour Beatty convertible issue is repayable on July 1st 2020 at 100, implying a loss of 19% on the current offer price, and for this reason their yield to maturity is significantly lower than their running yield).
[4] BP 8% Cum Irr Prf [BP.A]. Offer Price 152.75. Yield 5.24%.
[5] BP 9% 2nd Cum Irr Prf [BP.B]. Offer Price 169. Yield 5.33%.
[6] Bristol & West 8.125% Pref [BWSA]. Offer Price 127.5. Yield 6.37%.
[7] Bristol Water 8.75% Cum Irr Prf [BWRA]. Offer Price 152.5. Yield 5.74%.
[8] Ecclesiastical Insurance 8.625% Non-Cum Irr Prf [ELLA]. Offer Price 133.5. Yield 6.46%.
[9] General Accident 8.875% Cum Irr Prf [GACA]. Offer Price 139.5. Yield 6.36%.
[10] General Accident 7.875% Cum Irr Prf [GACB]. Offer Price 131.0. Yield 6.01%.
[11] Lloyds Bank 9.25% Non Cum Irr Prf [LLPC]. Offer Price 142.75. Yield 6.48%.
[12] Lloyds Bank 9.75% Non Cum Irr Prf [LLPD]. Offer Price 151.0. Yield 6.46%.
[13] Lloyds Bank 6.475% Non Cum Irr Prf [LLPE]. Offer Price 109.0. Yield 5.94%.
[14] National Westminster Bank 9% Non Cum Prf [NWBD]. Offer Price 142.0. Yield 6.34%.
[15] Northern Electricity 8.061% Cm Irr Prf [NTEA]. Offer Price 146.5. Yield 5.50%.
[16] Raven Russia 12% Cum Red Prf [RUSP]. Offer Price 135.0 Yield 8.89%.
[17] Rea Holdings 9% Cum Red Prf [RE.B]. Offer Price 118.5. Yield 7.59%.
[18] RSA Insurance Group 7.375% Cum Irr Prf [RSAB]. Offer Price 125.5. Yield 5.58%.
[19] Santander 10.375% Non-cum Prf [SAN]. Offer Price 156.5. Yield 6.63%.
[20] Santander 8.625% Non-cum Prf [SANB]. Offer Price 130.5. Yield 6.61%.
[21] Standard Chartered 7.375% Non-cum Irr Prf [STAB]. Offer Price 121. Yield 6.10%.
[22] Standard Chartered 8.25% Non-cum Irr Prf [STAC]. Offer Price 130. Yield 6.35%.

Easily the highest yielding preference share on this list is the Raven Russia issue, which is already included in the high yield bond portfolio. The next highest yield is offered by the 9% preference shares issued by Rea Holdings, an Indonesian plantation owner and palm oil producer. For the most recent financial year ended December 31st 2014, the company generated revenues of just under £81 million, with pre-tax profits of £15 million. The dividend on the ordinary shares was covered 3.5 times, providing very solid protection for the preference share dividend. So the 9% preference shares become the sixth investment of the high yield bond portfolio.

Issuer Rea Holdings Plc
Coupon 9%
Maturity Date Undated
Payment Dates 6-monthly on June 30th and December 31st
Offer Price 118.35
Yield at Offer Price 7.6%
Nominal Amount £1,000
Cost £1,183.50 + £5.75 commission = £1,189.25

August 10th 2015

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