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PS Business Parks: Another Below-5% Preferred Stock IPO

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Introduction

Our goal is to present to you our IPO analysis for every new fixed-income security that enters the market and to find out if there is any trading potential. In this article, we want to shed light on the newest Preferred Stock issued by PS Business Parks Inc. (PSB). Even though the product may not be of interest to us and our financial objectives, it definitely is worth taking a look at.

The New Issue

Before we submerge into our brief analysis, here is a link to the 424B5 Filing By PS Business Parks Inc. – the prospectus. (Source: SEC.gov)

For a total of 12 million shares issued, the total gross proceeds to the company are $300 million. You can find some relevant information about the new preferred stock in the table below:



Source: Author’s spreadsheet

PS Business Parks, Inc. 4.875% Cumulative Preferred Stock, Series Z (NYSE: PSB-Z) pays a fixed dividend at a rate of 4.875%. The new preferred stock has a “BBB” Standard & Poor’s rating and is callable as of 11/04/2024. Currently, the new issue trades a little below its PAR at a price of $24.79 and has a 4.92% Current Yield and YTC of 5.20%. The dividends paid by this preferred stock are not eligible for the preferential 15-20% tax rate on dividends. They are also not eligible for the dividend received deduction for corporate holders. This means that the “qualified equivalent” current yield and YTC would be 4.10% and 4.34%, respectively.

Here is what the stock’s YTC curve looks like right now:



Source: Author’s spreadsheet

The Company

PS Business Parks, Inc., a member of the S&P MidCap 400, is a real estate investment trust (“REIT”) that acquires, develops, owns and operates commercial properties, primarily multi-tenant industrial, flex and office space. The Company wholly owns over 27 million rentable square feet concentrated in six states and holds a 95% interest in a 395-unit apartment complex.

PS Business Parks features “Office/Warehouse” properties that can be easily configured to suit a variety of uses and tenants. Our commercial real estate properties include traditional office, warehouse, and flexible space combining the benefits of warehouse and office to best cater to your business needs.

One key feature of PS Business Parks’ website is the ability to view images of the properties you are searching for in specific markets. We also provide you with all the information and resources necessary to make the most informed decision in selecting a location with PS Business Parks. This will cut down on the time you spend looking for the right property for your business. In addition, a highly skilled professional team is assigned to each park to provide our customers a high level of service and help make decisions quickly. PS Business Parks saves you time when searching for a property and offers premier service after you move in.

Source: Company website | About

Below, you can see a price chart of the common stock, PSB:



Source: TradingView

Quite a performance from PSB, as it has risen from $30 during the Great Recession to $180 in the present, which becomes the impressive 500% gain for a period of 10 years. The dividend of the common stock is constantly increasing, from $1.76 in 2013 to $4.00 in 2018. Also for 2019, PSB is expected to have paid a $4.20 yearly dividend. With a market price of $181.42, the current yield of PSB is at 2.31%. As an absolute value, this means it pays $115 million in dividends yearly. For comparison, the yearly dividend expenses for all outstanding preferred stocks (with the newly issued Series Z preferred stock) of the company is around $63 million.

In addition, with a market capitalization of around $4.92 billion, PSB is one of the relatively large “Diversified” REITs in the US (according to Finviz).

Capital Structure

Below you can see a snapshot of PS Business Parks’ capital structure as of the time of its last quarterly filing in June 2019. You also can see how the capital structure has evolved historically.



Source: MarketWatch | Company’s Balance Sheet

As of Q2, PSB had a total debt of $33 million ranking senior to the newly issued preferred stock. The new Series Z preferred shares rank is junior to all outstanding debt and equal to the other preferred shares of the company, which total $1.98 billion.

The Ratios Which We Should Care About

Our purpose today is not to make an investment decision regarding the common stock of PSB but to find out if its new preferred stock has the need quality to be part of our portfolio. Here is the moment where I want to remind you of two important aspects of the preferred stocks compared to the common stocks.

  • Preferred shareholders have priority over a company’s income, meaning they are paid dividends before common shareholders.
  • Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders.

Based on our research and experience, these are the most important metrics we use when comparing preferred stocks:

  • Market Cap/(Long-Term Debt + Preferreds). This is our main criteria when determining credit risk. The bigger the ratio, the safer the preferred. Based on the latest annual report and taking into consideration the latest preferred issue we have a ratio of 4,920/(33 + 1,259) = 3.80, which is a superior number for all creditors of the company, indicating the company is very low leveraged. Moreover, there is almost no debt, and in practice, the preferred shareholders are the first to be paid in the event of a liquidation.
  • Earnings/(Debt and Preferred Payments). This is also quite an easy-to-understand approach. One can use EBITDA instead of earnings, but we prefer to have our buffer in what is left to the common stockholder. The higher this ratio, the better. The ratio with the TTM financial results from the Income Statement data is 111/(0.59 + 63) = 1.74 repeating the ratio above, showing significant buffer for the preferred stockholders to be calm about the payments.

The PS Business Parks Family

The group is composed of 5 more preferred stocks with fixed rates. Their dividends are not qualified, but after PSA recently issued the 4.875% PSA-I, this is the second REIT to issue such a preferred stock that broke the 5% nominal yield mark. (This is actually not really unexpected, since PS Business Parks was initially formed as a division of Public Storage.) I just want to mark that it is also now the 7th exchange-traded issue (all preferred stocks) priced below the 5% threshold for the past 2 months, as this is already becoming the norm – something that had only happened once for the last 3 years (GDL-C in March 2018). The previous fixed-rate preferred stock with less than 5% nominal yield is also owned by Public Storage, 4.90% PSA-E, issued on October 6, 2016.



Source: Author’s database

PSB uses the proceeds from the newly issued PSB-Z to redeem all of the outstanding PS Business Parks 5.75% Cumulative Preferred Stock, Series U (PSB.PU) and PS Business Parks 5.70% Cumulative Preferred Stock, Series V (PSB.PV) on December 30, 2019. With this refinancing, the company saves itself a yearly rate of 0.875% for $200 million liability of PSB-U and 0.825% for $100 liability of PSB-V. In other words, the absolute value of this savings is expressed in $2.58 million yearly dividend expenses less.

I’ll compare the newly issued Series Z Preferred Stock with the rest of its “brothers” by their Yield-to-Call and Current Yield.



Source: Author’s database

PSB-Z obviously has the lowest Current Yield, thanks to the fact that it has also the lowest Nominal Yield, in the group. However, the older issues are trading above their par value, and their Yield-to-Call is also their Yield-to-Worst. In terms of lowering interest rates, the higher the YTC, the better the security. In this case, PSB-Z rewards almost 0.30% more YTW than the maximum you could realize if you choose the second-highest in the group, PSB-Y.

In addition, you can see a comparison between PSB’s preferred stocks and the fixed-income securities benchmark, the iShares Preferred and Income Securities ETF (PFF). On the following chart, a close behavior to the ETF during the recession in the late of the last year is observed that gradually goes into a categorical superiority of all PSB’s securities over the fixed-income benchmark. In PSB-V and PSB-U, this is less pronounced, mainly because even then they were already callable.



Source: TradingView

Sector Comparison

The section below contains all preferred stocks in the “REIT – Diversified” sector (according to Finviz) that pay a fixed dividend, have a positive YTC and a par value of $25. It is important to take note that none of these preferred stocks are eligible for the 15% federal tax rate. The first chart is presented by their Yield-to-Call and Current Yield.



Source: Author’s database

To get a better idea of the yield curve, I’ll compare the group by their Yield-to-Worst (equal to their Yield-to-Call). For the purpose, two more filters will be added, the security must not be callable and must trade above par value.



Source: Author’s database

Now, let’s see only the preferred stocks that are rated by Standard & Poor’s:



Source: Author’s database

All REIT Preferred Stocks

In this section, I’ll compare all REIT preferred stocks with a par value of $25 that pay a fixed dividend rate. For a clearer view, I’ve excluded the preferred stocks issued by CBL & Associates (CBL) and Washington Prime Group (WPG) from the bubble charts.



Source: Author’s database

The next chart presents only the preferred stocks with a positive yield-to-call:



Source: Author’s database

I will add one more condition – the preferred stocks to be rated by Standard & Poor’s:



Source: Author’s database

The next bubble chart will examine how the yield curve in the sector looks. It presents only these preferred stocks that are not callable, have a positive YTC and are rated by S&P, by their years-to-call and YTC:



Source: Author’s database

All “BBB” Preferred Stocks

The last chart contains all preferred stocks, with a PAR of $25, that pay a fixed dividend rate, have a “BBB” Standard & Poor’s rating and positive yield-to-call.



Source: Author’s database

Special Considerations

Nothing out of the ordinary.

Addition to the iShares Preferred and Income Securities ETF

With the current market capitalization of the new issue of around $300 million, PSB-Z is a possible addition to the S&P US Preferred Stock iShares Index during some of the next rebalancings. If so, it will also be included in the holdings of the main benchmark, PFF, which is the ETF that seeks to track the investment results of this index, and which is important to us due to its influence on the behavior of all fixed-income securities. I’ll just remind you about last year’s rally in fixed-income borne from the redemption of the two “giants” HSEA and HSEB and the released cash of over $600 million used from PFF to buy more of the rest of its holdings.

Conclusion

As fixed-income traders, we follow every preferred stock or baby bond which is listed on the stock exchange. As such, PSB-Z is no exception, and the homework we always do we share it with the public. It is not necessary for the IPO to be an arbitrage and a bargain, but in many cases, the new security happens to be better than the ones already trading on the market.

The company had a history of great common stock rally and also has very good financials in terms of fixed-income investors, having 3.8x times more equity than liabilities and paying 2x times more dividends on its common stock than all of its outstanding preferred stocks that are standing above in the capital structure. So, here the credit risk is absolutely out of the table. Despite its lower nominal yield, PSB-Z has a slightly higher YTW than the rest of PSB’s outstanding preferred stocks. The same is also observed in the comparison with all other REIT preferred stocks and those that have the same rating of “BBB” as the new IPO. However, its current yield is one of the lowest both in the sector and with the “BBB” rated ones. This is not necessarily a bad thing when we are talking about an environment of lowering interest rates. Apparently, this is the new normal.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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