WASHINGTON, May 10, 2017 – Our second level head tells the big story for our portfolios today. While respected Canadian banking and investment banking firm RBC issued a “Buy” recommendation on Ireland-based pharmaceutical giant Allergan (symbol: AGN), highly influential Goldman Sachs (GS) downgraded the stock from “Buy” to “Neutral.”
Goldman’s call, of course, carried greater weight than RBC, and AGN common promptly tanked, dropping from yesterday’s close of $238.51 per share to as low as $228.44 per share during active trading Wednesday morning. AGN has attempted to recover from time to time since then, but currently stands at $229.44/share, of a substantial 3.6 percent as of 2:30 p.m. ET.
As regular readers already know, the price of Allergan common shares is really a secondary concern for us. That’s because the largest position in our portfolios is currently a big chunk Allergan’s convertible preferred “A” shares, symbol AGN/PRA at our brokerage house. (Symbol may vary at other brokerages.)
Of course, AGN and AGN/PRA are two different classes of stock. We’ve invested in the latter rather than the former since AGN/PRA shares pay a substantial dividend $55.00 per share annually, or $13.75 per quarter. That’s approximately 7 percent per annum, given our average purchase price for these shares.
So why, with this kind of dividend protection, are shares of AGN/PRA currently off a horrendous $24.17 per share, a percentage basis of -2.83 percent as we write this at 2:30 p.m. ET? Preferred stocks trade based solely on their dividend, right? Because in most cases the dividend of a preferred stock is paid out at a constant dollar rate and because preferred stocks are senior to common stocks should a company be doing badly, forcing it to cut the common stock dividend first, right?
Well, yes, that’s right. But AGN/PRA is a convertible preferred, meaning its shares can be converted by the investor into a roughly equal dollar amount of common shares pretty much at will. What this means to traders is that this kind of preferred stock, regardless of current yield, trades at least in part, as if it is a hostage to the common, which it pretty much is if you want to convert your shares.
AGN/PRA has been trading recently in a range from the low-$800s to the mid-$800s per share range, while AGN common has been wandering about in the low- $200 per share range. Last time we looked, the conversion ratio was something like 3+ shares of common per redeemed single share of the preferred.
One more fact, however. Once issued, preferred stocks trade pretty much like bonds, rising and falling in price depending on the (usually) flat but generally dependable dividend they pay. But most preferreds, under various scenarios, will tend to get “retired,” i.e., “called” at some point, with the issuing firm redeeming existing shares of existing investors at “par value.” In the case of most preferreds, that’s $25 per share.
For this reason, savvy investors who like the steady yields of preferred stocks, usually wait patiently to buy those shares at a discount, i.e., at a price below $25 per share. Investors can generally do this when interest rates are on the rise, as is currently the case.
But they can also buy new-issue preferreds before they open for trading to the general public, by hunting them down on the so-called “gray market” where new preferreds generally hang around until they can get their regular exchange listing. (We’ve discussed this before and will bring it up again in a future column.)
With regard to all the above, however, AGN/PRA, is a somewhat unusual case. That’s because par value for these shares is not $25 per share. It’s $1,000 per share, which is more often the case for some bank preferreds. But even then, it’s fairly rare.
That’s why moves in AGN/PRA are quite huge in dollar amounts. For that reason, quite frankly, this is why we generally never venture into territory where a preferred stock is priced essentially for rich people.
However, again, as our regular readers know, the real reason we accumulated a large position in these shares – over time and only on price dips – is that AGN/PRA is also a term preferred stock. In other words, these shares have a specific redemption date, which just happens to be soon, namely, March 1, 2018.
This means that the shares we currently own, acquired at an average price of around $804 per share, will be redeemed by Allergan next March 1 for $1,000 per share. While we wait, of course, we still get to collect that $13.75 quarterly dividend, too. What’s not to love?
Of course, as always, Allergan could suddenly go bankrupt and we could lose all our money in the process. No transaction is risk-free, though investors sometimes forget that simple fact. But with a huge firm like this one, we think odds are against it, so we took the risk of accumulating a larger-than-advisable position in these shares in terms of holding a “balanced” portfolio of stocks. We’ll find out how this one works out next March.
But, the way we figure it, getting a current 7 percent yield while copping a 2018 capital gain of close to 25 percent (based on original purchase price) was a chance worth taking.
The only time we worry a bit is on days like today. That’s because, as we’ve just seen, AGN/PRA, being convertible shares, can get whacked when someone decides he hates the common shares. Hence, today’s swan dive in AGN/PRA, which would make no sense at all if these shares weren’t convertible. But they are, so our larger portfolio is looking pretty lousy today. We are, however, encouraged that it will look a whole lot better on March 1, 2018, so we grit our teeth and hold.
UPDATE: Allergan reported a 1st Quarter 2017 diluted losses (ex-items) of $7.85 per share. This missed last year’s same period results by $7.4419. However, the loss was “intentional” to some extent, based on write-downs, in particularly, Allergan’s write-down in its position in shares of Teva Pharmaceuticals (TEVA), something expected by most analysts we’ve checked.
Any other stock, having exceeded our sell-threshold point (which we recently moved up to -8 percent from -5 percent), we’d dump right away. But we’re waiting for the March 1, 2018 redemption date on this one. If the stock continues to tank and drop below our average price, we might squeeze in a few more shares, although we should probably not add to the position at this point.
The one mystifying thing about today’s AGN/PRA action: the stock goes ex-dividend tomorrow, May 11. That means that everyone blindly dumping these shares today misses out on locking in the latest dividend. Doesn’t make any sense to us. Either the investors dumping shares today are extraordinarily dumb, at least in our opinion. Or these were computer generated sales or automatic stop-loss sales that kicked in without human intervention. Otherwise, who’d want to miss such a swell dividend?
On other fronts, after yet another clobbering yesterday, shares of Cliffs Natural Resources (CLF) another of our major holdings that’s currently under duress, were up sharply earlier in the day, but are still currently ahead by 20 cents per share, a jump of some 3.25 percent. We have a long way to go on this stock, which is clearly a lot cheaper per share than AGN/PRA. But it’s been grossly oversold at this point, we think, so perhaps earlier this week, it finally found its floor and will now begin to rise.
Complicated stuff, but it gets this way some time for large and small investors alike.