Andrii Yalanskyi
In a prior article, I discussed evaluating Energy Transfer Preferred Stock offerings traded on the NYSE. Due to tax issues, I had to sell my Energy Transfer common stock in my IRA, IRA-Roth, and HSA accounts. Given my bullishness on the energy sector, and natural gas in particular, I want to use MLP preferred shares in my tax-deferred accounts. This article is a discussion of what I found through my research and my conclusion that the market seems to mis-value offerings in this sector.
Goal
My wife and I have been retired for over a dozen years. We fund our retirement expenses from our portfolio’s income and Social Security. Our goal is that we spend half of what our portfolio earns and that we reinvest the other half. We intend to do this for as long as possible, preserving our investment capital until we are forced to draw from it. Our investment capital has grown 23% from when we retired. Some years have been better than others.
These preferred stocks fit into our goals well. They return a good income stream due to their competitive yield. While not totally safe, they are safe enough for us. You really can’t get any sort of decent return without some degree of risk. The risk I’m currently accepting is that several of these instruments are perpetual. There is no call date. The risk that I see is that these enterprises whither over time and the investment eventually becomes worthless. I don’t worry too much about that since I believe natural gas will be here and a viable enterprise, long after I’ve ceased to be one.
Criteria
The preferred stocks that I’m interested in are ones that currently offer a +6% rate of return, are in the energy sector, and which will reset their rates in the near future. The adjustable rate offerings are of interest to me given the current inflationary environment that we find ourselves in. I believe some of these offerings may have rates that will reset higher than their current rate of return.
As I stated above, a key criteria is that the companies offering the security are primarily in the natural gas business. While I believe energy is currently a secure area to invest, I believe natural gas has more longer-term potential and security. Factors that I considered critical in my research were: current return, return after rate reset, S&P Global’s credit rating, and two-year return.
Selections
An initial screen for these criteria resulted in thirty offerings. When you considered S&P Global’s rating, that group was reduced to nine offerings. The majority of the stocks returned were unrated. Having a rating was important to me to be able to see what the experts thought of these offerings. It provides a risk assessment by which to compare the securities.
The nine offerings were from DCP Midstream (DCP), Enbridge Inc (ENB), Energy Transfer (ET), and NuStar Energy (NU).
| Symbol | Name | S&P rating |
| DCP.PB | DCP MIDSTREAM LP 7.875 CUM RED B | BBB- |
| DCP.PC | DCP MIDSTREAM LP 7.95 SR C PFD UT | BBB- |
| ENBA | ENBRIDGE INC 6.375 SNT18 B 78 | BBB- |
| ET.PC | ENERGY TRANSFER L P 7.375% PFD SR C | BB |
| ET.PD | ENERGY TRANSFER L P 7.625 PFD UNIT D | BB |
| ET.PC | ENERGY TRANSFER L P 7.60% CUM PFD E | BB |
| NS.PA | NUSTAR ENERGY LP PFD UNIT SER A | B- |
| NS.PB | NUSTAR ENERGY LP RED PFD SER B | B- |
| NS.PC | NUSTAR ENERGY LP 9.00% CUM PFD | B- |
Further assessment led to the removal of NuStar Energy. While the other companies (DCP, ENB, ET) have some exposure to petroleum, they are mainly in the natural gas business. NuStar was not. It’s heavily exposed to oil. The other strike against NuStar was its securities ratings. I would prefer to put my money in investment grade instruments. In the case of ET, I stretch that a bit. I’m hopeful that as ET improves its debt ratio, the agencies will improve ET’s ratings. For completeness, here are the meanings of the S&P Global ratings per my broker:
| Rating | Meaning |
| BBB- | Considered lowest investment grade by market participants |
| BB | Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions. |
| B- | More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments |
The key information for the remaining securities, as of 9/14/2022, are below.
| Symbol | Price |
Current Yield |
Dividend |
Reset Date |
Reset Rate + 90-day LIBOR |
Prospectus |
| DCP.PB | $24.96 | 7.89% | $1.97 | 5/15/23 | 4.882% | DCP.PB |
| DCP.PC | $25.10 | 7.92% | $1.99 | 10/15/23 | 4.882% | DCP.PC |
| ENBA | $24.41 | 6.53% | $1.59 | 4/15/23* | 3.593%* | ENBA |
| ET.PC | $22.34 | 8.25% | $1.84 | 5/15/23 | 4.53% | ET.PC |
| ET.PD | $22.69 | 8.40% | $1.91 | 8/15/23 | 4.74% | ET.PD |
| ET.PE | $23.80 | 7.98% | $1.90 | 5/15/24 | 5.16% | ET.PE |
The Numbers
All of these securities are based on a $25 par value. On, or any time after, the reset date these securities can all be recalled for $25 by the company. All of these securities use a 90-day LIBOR rate. The reset rate is applied to the $25 par value to calculate the reset rate of return. It’s worth noting that LIBOR has been obsoleted. Each of the prospectus uses a calculation agent (i.e. an independent financial institution), to be named, that will determine the 90-day LIBOR replacement rate.
A brief discussion of this is in order since the replacement rate is key to estimating these securities going forward. After reading the Federal Reserves proposed rules Implementing the Adjustable Interest Rate (LIBOR) Act, I concluded that 90-day LIBOR will be replaced, per the Fed, with 90-day SOFR (Secured Overnight Financing Rate) + 26.161 bps (0.26161 percent). The reason I feel confident in this assumption is that the promulgated rules offer legal protection for the calculation agent that determines the LIBOR replacement rate, as long as the agent picks the Board-selected benchmark replacement. In our litigious society, I find it hard to imagine a calculation agent that wouldn’t use that protection. I’m not a lawyer or a banker, but this makes sense to me.
The issue then jumps to, how do you estimate SOFR? SOFR is loosely tied to the Fed Funds Rate. As inflation is projected to rise, so too are these rates. Forecasting these rates is a challenge. I’ve chosen to use the estimates from EconForecasting. Using their estimates, I come to the following guess as to 90-day LIBOR replacement rate in the next two years.
| Estimated 90-day LIBOR replacement rate | |||||||||
| 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 | |
| SOFR est. | 3.810% | 3.730% | 3.500% | 3.320% | 3.170% | 3.060% | 3.050% | ||
| Constant | 0.262% | 0.262% | 0.262% | 0.262% | 0.262% | 0.262% | 0.262% | ||
| LIBOR replacement | 4.072% | 3.992% | 3.762% | 3.582% | 3.432% | 3.322% | 3.312% | ||
The reset rates by quarter for each of the securities is below. There is one exception. All of the securities have one reset rate, except for ENBA. In the case of ENBA, it has 3 rate resets (3.593% on 4/15/2023, 3.843% on 4/15/2028, and 4.593% on 4/15/2043). In the interest of an apples-to-apples comparison, I’m only considering the first reset.
| Reset Rate by Quarter | |||||||||
| Symbol | 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 |
| DCP.PB | 4.882% | 4.882% | 4.882% | 4.882% | 4.882% | 4.882% | 4.882% | ||
| DCP.PC | 4.882% | 4.882% | 4.882% | 4.882% | 4.882% | ||||
| ENBA | 3.593% | 3.593% | 3.593% | 3.593% | 3.593% | 3.593% | 3.593% | ||
| ET.PC | 4.530% | 4.530% | 4.530% | 4.530% | 4.530% | 4.530% | 4.530% | ||
| ET.PD | 4.740% | 4.740% | 4.740% | 4.740% | 4.740% | 4.740% | |||
| ET.PE | 5.160% | 5.160% | 5.160% | ||||||
These rates then added to the estimated 90-day LIBOR replacement rate result in the rate that will be applied to each security’s $25 par value. As you see, the yield on these securities is higher after the rates reset than the current yield. The rates are attempting to keep up with inflation.
| Rate on $25 Par Value | |||||||||
| Symbol | 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 |
| DCP.PB | 7.875% | 7.875% | 8.954% | 8.874% | 8.644% | 8.464% | 8.314% | 8.204% | 8.194% |
| DCP.PC | 7.950% | 7.950% | 7.950% | 7.950% | 8.644% | 8.464% | 8.314% | 8.204% | 8.194% |
| ENBA | 6.375% | 6.375% | 7.665% | 7.585% | 7.355% | 7.175% | 7.025% | 6.915% | 6.905% |
| ET.PC | 7.375% | 7.375% | 8.602% | 8.522% | 8.292% | 8.112% | 7.962% | 7.852% | 7.842% |
| ET.PD | 7.625% | 7.625% | 7.625% | 8.732% | 8.502% | 8.322% | 8.172% | 8.062% | 8.052% |
| ET.PE | 7.600% | 7.600% | 7.600% | 7.600% | 7.600% | 7.600% | 8.592% | 8.482% | 8.472% |
Applying these rates to the $25 par value results in the estimated dividend that will be paid each quarter.
| Dividend on | $25 | par value | |||||||
| Symbol | 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 |
| DCP.PB | $0.4922 | $0.4922 | $0.5596 | $0.5546 | $0.5402 | $0.5290 | $0.5196 | $0.5127 | $0.5121 |
| DCP.PC | $0.4969 | $0.4969 | $0.4969 | $0.4969 | $0.5402 | $0.5290 | $0.5196 | $0.5127 | $0.5121 |
| ENBA | $0.3984 | $0.3984 | $0.4790 | $0.4740 | $0.4597 | $0.4484 | $0.4390 | $0.4322 | $0.4315 |
| ET.PC | $0.4609 | $0.4609 | $0.5376 | $0.5326 | $0.5182 | $0.5070 | $0.4976 | $0.4907 | $0.4901 |
| ET.PD | $0.4766 | $0.4766 | $0.4766 | $0.5457 | $0.5314 | $0.5201 | $0.5107 | $0.5039 | $0.5032 |
| ET.PE | $0.4750 | $0.4750 | $0.4750 | $0.4750 | $0.4750 | $0.4750 | $0.5370 | $0.5301 | $0.5295 |
The estimated yield with that dividend for the current stock price results in:
| Annual Yield at current Price | ||||||||||
| Price | Symbol | 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 |
| $24.96 | DCP.PB | 7.888% | 7.888% | 8.968% | 8.888% | 8.657% | 8.477% | 8.327% | 8.217% | 8.207% |
| $25.10 | DCP.PC | 7.963% | 7.963% | 7.963% | 7.963% | 8.657% | 8.477% | 8.327% | 8.217% | 8.207% |
| $24.41 | ENBA | 6.385% | 6.385% | 7.677% | 7.597% | 7.366% | 7.186% | 7.036% | 6.926% | 6.916% |
| $22.34 | ET.PC | 7.387% | 7.387% | 8.615% | 8.535% | 8.305% | 8.125% | 7.974% | 7.864% | 7.854% |
| $22.69 | ET.PD | 7.637% | 7.637% | 7.637% | 8.746% | 8.515% | 8.335% | 8.185% | 8.075% | 8.065% |
| $23.80 | ET.PE | 7.612% | 7.612% | 7.612% | 7.612% | 7.612% | 7.612% | 8.605% | 8.495% | 8.485% |
Using that estimated yield on a hypothetical $1000 investment would result in the following income over the next two years. With the exception of ENBA, as explained above, each security has reached its final reset rate in 4Q24.
| Return on | $1,000 | |||||||||
| Symbol | 4Q22 | 1Q23 | 2Q23 | 3Q23 | 4Q23 | 1Q24 | 2Q24 | 3Q24 | 4Q24 | Total |
| DCP.PB | $19.72 | $19.72 | $22.42 | $22.22 | $21.64 | $21.19 | $20.82 | $20.54 | $20.52 | $188.79 |
| DCP.PC | $19.91 | $19.91 | $19.91 | $19.91 | $21.64 | $21.19 | $20.82 | $20.54 | $20.52 | $184.34 |
| ENBA | $15.96 | $15.96 | $19.19 | $18.99 | $18.42 | $17.97 | $17.59 | $17.31 | $17.29 | $158.68 |
| ET.PC | $18.47 | $18.47 | $21.54 | $21.34 | $20.76 | $20.31 | $19.94 | $19.66 | $19.64 | $180.12 |
| ET.PD | $19.09 | $19.09 | $19.09 | $21.86 | $21.29 | $20.84 | $20.46 | $20.19 | $20.16 | $182.08 |
| ET.PE | $19.03 | $19.03 | $19.03 | $19.03 | $19.03 | $19.03 | $21.51 | $21.24 | $21.21 | $178.15 |
Analysis
Given that both of DCP’s offerings have high reset rates, both starting in 2023, they have the best payout on a $1000 investment over the next two years. I can understand why they command the higher price today. They offer more inflation protection and return over the coming years.
The ET offerings come in second in return over the next two years. However, the ET.PE security offers the best ongoing yield beyond 2024. It has the best terminal rate of any of the securities considered. What I find interesting is that the market doesn’t seem to be taking this into account. Since DCP.PC is trading above par value, that indicates to me that it is the security most valued in the market. It does possess a better S&P Global rating than any of the ET offerings. Perhaps that accounts for its higher price.
In the case of ENBA, based on its price I have a hard time seeing why the market is valuing it so highly. It has the lowest current yield. It has the lowest yield after the rates reset. At a final reset rate of 4.593% in 2043, it just edges ET.PC’s reset rate of 4.53% by 6bps. Considering you’d have collected a higher yield for 20 years with ET.PC, I don’t understand the market’s valuing it higher. It also does have a better S&P Global rating than the ET offerings.
It’s worth considering the businesses that support these securities. A simple screen shows:
| Symbol | Market Cap | Enterprise Value | Wall St Analyst Rating |
| DCP | 8.0B | 13.95B | Buy |
| ENB | 86.4B | 151.38B | Buy |
| ET | 37.07B | 100.39B | Strong Buy |
ENB dwarfs DCP in size and value. As a smaller player, DCP may be considered more speculative. ET fits in the middle. It also is rated as an improving prospect by Wall Street analysts. One note on all of the preferred securities, they are lightly traded when compared to their common stocks. It would seem unwise to try to trade these securities without that in mind (e.g. using limits in your trades).
With this assessment in hand, I concluded that I’m happy with my current ET preferred holdings. They aren’t the absolute highest yield over the next two years, but they are close enough. To me, ET.PE is the best offering in the group going beyond two years. I can collect a reasonable rate of return that is somewhat inflation protected over the coming years. I also have faith in ET that its prospects will continue to improve. My hope is that as ET gets its financial house in order, paying down debt, that S&P Global will increase its rating. If the better market value for DCP and ENBA are due to the agency’s rating, that should help drive up ET shares’ price. Over time, I do intend to migrate some of my ENBA position into the DCP holdings.
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