Security price: $71.00
Industry: Diversified
Forecast distribution: $4.886 per share
In 2010, Seven and Westrac merged to form Seven Group Holdings (SVW.AX), a good old-fashioned conglomerate with exposure to industrial services, media and energy. The group rolled over its preference shares to a new structure: ‘Transferable Extendable Listed Yield Shares’ (TELYS4). These securities are redeemable, convertible preference shares entitling holders to a preferred, non-cumulative, floating rate dividend.
SVWPA’s ‘floating’ dividend yield is calculated based on a gross margin of 4.75% per annum above the 180 day Bank Bill Swap Rate (BBSW), which currently sits at 2.2%. The effective gross dividend rate for SVWPA is therefore 6.95% on a face value of $100, but calculated on the current market price of $71.00, is approaching double figures at 9.8%. The steep discount to face value currently offered by SVWPA reflects the underlying volatility of SVW’s earnings but we believe the market has undervalued one particular aspect of the security. SVWPA carries a dividend stopper, a contractual term that precludes payment of all ordinary dividends for 12 months if a preference share dividend is not paid.
We think of it this way. In FY15, SVW generated an underlying profit of $204m and operating cash flow of $287m, and was able to comfortably pay dividends to ordinary shareholders. In FY16, despite guidance to a 10% drop in earnings, the likelihood of a dividend is equally high and thanks to the dividend stopper, SVWPA’s near-10% gross yield is protected.
Of course, the payment of dividends is at the board’s discretion and is subject to there being sufficient funds legally available. However, in our view SVW presents as a solid, sufficiently capitalised business with a more moderate level of gearing. As a consequence and coupled with the dividend stopper in place, the perceived risk of non-payment is relatively low. Better still, as SVWPA’s yield is not tied to SVW’s ordinary distribution rate, forecast flatness will not affect the yield for preference shareholders.
Although an investment in SVWPA brings with it more risk on a relative basis, the grossed up yield of almost 10% compares favourably to returns being offered by term deposits. In our view, it would take a significant decline in SVW’s outlook for Kerry Stokes and the rest of the board to consider forsaking the preference dividend. This is particularly true given SVW’s ongoing share buyback, which has totalled more than $46m to date, and demonstrates the board’s capital management flexibility.
We believe SVWPA should be on the radar of all income focused investors, and may also offer capital upside if supported by positive performance in the underlying company.