In “This 6% Yielding Security is Worth a Look,” I introduced readers to Duke Energy’s junior subordinated exchange-traded debt, ticker DUKH. This security has the look and feel of a preferred stock but also has a few notable differences. Exchange-traded debt is certainly not as popular an investment choice as preferred stocks or more traditional bonds. And preferred stocks and traditional bonds are certainly nowhere near as popular as common stocks or investing in bond funds, which helps put into perspective just how unknown exchange-traded debt may be. Additionally, the number of exchange-traded debt products available for trading is relatively small, which also likely contributes to their being an unknown product.
Income-focused investors who were intrigued by DUKH may also be interested in the junior subordinated debt of another member of the utilities sector. PPL Corp., through its financing subsidiary, PPL Capital Funding, issued $400 million of junior subordinated exchange-traded debt earlier this year. It trades under the ticker PPX and is “fully and unconditionally guaranteed as to payment of principal, interest and any premium under the subordinated guarantees” by PPL Corporation.
Before sharing the terms of PPL’s junior subordinated debt, let me first provide a basic background of the company. PPL Corporation is a utilities holding company that provides electricity and natural gas to roughly 10.5 million customers in the U.S. and the United Kingdom. Approximately 85% of the company’s projected 2013 earnings comes from its rate-regulated businesses, and PPL projects 8% compound annual growth in its rate base through 2017. Rate base refers to the value assigned by regulators to a utility on which that utility is allowed to earn a particular rate of return. Moreover, PPL projects operating segment capital expenditures to decline from $4.4 billion in 2013 to $3.3 billion in 2017.
PPL Corp., the holding company, is headquartered in Allentown, Pennsylvania. Its operations are primarily run through the following five subsidiaries:
1. PPL Global, LLC: Serves 7.8 million customers in the U.K through is distribution businesses
2. PPL Electric Utilities Corporation: Serves 1.4 million customers in Pennsylvania
3. Louisville Gas and Electric Kentucky Utilities (LG&E and KU Energy, LLC): Serves 1.3 million customers in Kentucky, Virginia, and Tennessee
4. PPL EnergyPlus, LLC: Sells wholesale and retail electricity
5. PPL Generation: Controls or owns 12 power plants in Pennsylvania and Montana
For a breakdown of PPL’s generation output through the second quarter of 2013, please see below:
Turning to PPX, PPL’s 5.90% junior subordinated exchange-traded debt, there are several points of interest worth noting:
1. PPX matures at $25 per share on April 30, 2073. As I mentioned in the DUKH article, some investors may see a maturity date of 2073 and immediately turn their attention elsewhere. But let me remind readers that this security is a type of preferred-stock/bond hybrid. Many of the preferred stocks you will come across nowadays are perpetual preferreds, meaning they have no maturity date. By adding a maturity date, albeit one that is likely to occur after many of us have passed away, PPX has a structural advantage over perpetual preferreds. After all, the price of this subordinated bond will one day, absent a default by PPL Corp., mature at $25. Perpetual preferreds have no such certainty regarding share price. If you are looking for an income-producing security that provides an attractive yield and relatively attractive credit risk, and you aren’t concerned about price fluctuations (you are just looking to collect an income stream), the extremely long-dated maturity shouldn’t be of concern. Additionally, another structural advantage PPX has over preferreds is that it is higher up the capital structure.
2. Two structural disadvantages to that of many (but not all) preferreds include PPX’s distributions not qualifying for lower dividend tax rates and PPX’s not having a redemption feature in the event of a takeover. In the event of a takeover, many preferred stocks (including non-convertible preferreds) allow for the conversion of the preferred into common stock. Bonds typically rectify this concern with “Change of Control” provisions, but PPX does not include a put option for a change of control.
3. Interest is paid quarterly (similar to preferreds), as opposed to the semiannual interest payments that are so common among bonds.
4. There is a multifaceted call feature including a make whole call until April 30, 2018, a conditional call until April 30, 2018 for a tax event, a conditional call until April 30, 2018 for a rating agency event, and a continuous call at $25 per share on or after April 30, 2018.
5. Similar to many preferred stocks and unlike traditional bonds, PPX can defer distributions. Deferred distributions can occur for up to 10 years, and, similar to how preferred stock distribution deferrals usually work, in the event PPX defers distributions, PPL Corp. would not be allowed to pay cash dividends on its common stock or any preferred stock outstanding during the deferral period. Furthermore, during a deferral period, PPL Corp. would not be allowed to buy back stock or make any principal or interest payments on any debt securities equal or junior in right of payment to PPX. Additionally, a deferral period may not extend beyond the maturity date.
6. One major difference between a deferral period for PPX versus that of a preferred stock (whether a cumulative preferred or not) is that should PPL Corp. defer interest payments, interest on the debentures will not only continue to accrue at 5.90%, but interest on the deferred interest will also accrue at 5.90%, compounded quarterly. Essentially, in the event of a distribution deferral, PPX turns into a zero-coupon bond. Depending on what other income-paying securities are yielding at the time, investors might actually prefer to have deferred interest compound at a rate of 5.90% rather than being paid out. It should be noted that there are tax consequences associated with an interest deferral, and you should read the prospectus for further details.
7. On a final note, the 5.90% interest rate is 5.90% of $25 per share ($1.475 per share per year). As of Friday’s close, PPX was trading at $21.45 and yielding 6.88%.
If you are looking to build a diversified income stream that includes exposure to the utilities sector, PPX is worth considering. If PPX specifically does not pique your interest, but you like to learn about other unique income-producing ideas from across the capital structure (not just stocks), I think “Income Investing Insider” will be of particular interest. If, however, PPX is something you might end up purchasing, you should keep the following in mind: If you think there is a chance you might experience a liquidity event in the future, and you don’t have sufficient other securities to sell first in order to meet your liquidity needs, then PPX’s longer-dated maturity could become an issue. This is especially true if benchmark Treasury yields continue much higher from here. In that case, I would only consider owning PPX as part of a broadly diversified income portfolio that consists of other securities with shorter maturities or other securities that aren’t as sensitive to changes in interest rates.
Please keep in mind that this article is for informational purposes only and not a recommendation to buy or sell any securities. Only you can decide if taking the counterparty risk of investing in individual securities is right for you.
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