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WESCO (WCC) is a major distributor of primarily electrical components and products to a wide range of end users including construction and manufacturing firms. The company’s preferred shares, which are the focus of this update, are a carryover from the company’s acquisition of Anixter in early 2020. In our previous article on the Wesco International Series A Cumulative Preferred (NYSE:WCC.PA) we recommended selling the shares given the significant market price premium to redemption value and the exceptionally high probability that the preferred shares will be called for redemption in June 2025. The preferred shares’ performance in the interim has borne out that perspective declining approximately 15.5% from $31.51 at the time of publication to the most recent quotation of $26.63. Shareholders would have received $5.3125 in the interim resulting in a total value (barring any reinvestment of dividends) $31.9425, resulting in essentially no return. In essence, shareholders have received a conversion of market value to cash on a nearly one-to-one basis with current taxes exchanged for a deferred capital loss.
The decline in the preferred shares, however, has shifted our view slightly with regard to the attractiveness of the preferred shares which we will detail after a brief review of the terms of the preferred stock.
Preferred Shares
The Wesco International Series A Cumulative preferred stock (WCC.PA) as the name implies is a series of cumulative preferred stock with a liquidation/redemption price of $25.00 per share. The preferred stock yields a fixed 10.625%, payable quarterly, until June 22, 2025, at which time the dividend rate is reset every five years at a premium of 10.325% over the applicable rate on the five year U.S. Treasury bond.
The preferred shares are redeemable at the company’s option at the redemption price on June 22, 2025, and on June 22 every five years after the initial potential redemption date. In addition, based on certain change of control or rating agency events, the details for which we would refer readers to the associated prospectus, the company has the right to call the preferred shares for redemption at redemption prices between $25.00 and $25.50 depending on the specific circumstances.
Investment Viewpoint
The preferred shares carried a yield of 8.45% at the time of our prior article but due to the significant premium over redemption value the effective yield to redemption was much lower at approximately 4%. The yield at the time was insufficient to warrant investment given the plethora of alternate income-oriented opportunities available in the market.
The 15.5% decline in share price still results in a market quotation above the redemption value of the shares but at this stage represents a more compelling yield to redemption. The high dividend rate results in a yield on quotation today of 10.0% – quite high by any objective standard – while the yield to redemption is somewhat lower at approximately 7.5%. A yield to redemption of 7.5% is quite reasonable for preferred shares of a company with the financial strength of Wesco. Moreover, given recent market turmoil and the potential for lower average annual market returns in the near future due to the significant appreciation prior to and after the initial shock of the pandemic a secure 7.5% yield for the next two years should be quite attractive to more conservative income-oriented investors. Moreover, it should be noted that as qualified dividends eligible taxpayers should receive preferential tax treatment of the dividends versus interest income oriented securities.
The potential for the shares not to be redeemed at the first maturity date, remote as we believe this outcome to be, only adds to the appealing risk profile as this would result in a yield over the subsequent five years, at current rates, approaching an unconscionable 15%. Obviously, we consider it very unlikely that the company would decide to lock in a cost of capital that high for five years barring some extraordinary circumstances in the next two years.
Conclusion
The current market quotation of the company’s preferred shares represents what we believe is a reasonable opportunity to secure a decent yield until the likely redemption of the preferred shares. The yield to call – as the preferred shares will almost certainly be called on June 22, 2025 – of approximately 7.5% is reasonable based on the company’s risk profile, the current interest rate environment, and comparable optional available in the market. Investors with an income-oriented focus should be particularly interested in the preferred shares while realizing that current income will be partially offset on redemption by a smaller capital loss.
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