Co-produced with Preferred Stock Trader
Introduction – Argo Group International Holdings, Ltd.
This article is similar to the recent Enstar Group (ESGRO) article that we wrote which was very successful in identifying a very undervalued situation. While the ESGR article focused on BB+ rated preferreds, this one examines preferreds rated “BB” by Standard & Poor’s (or S&P). Like ESGR, Argo Group (ARGO) is a Property/Casualty Insurance company with investment-grade rated bonds (BBB- rather than BBB for ESGR).
We are only focused here on the preferred shares and will provide just a brief company profile of ARGO from Yahoo Finance.
Argo Group International Holdings, Ltd. underwrites specialty insurance and reinsurance products in the property and casualty markets. The company operates in two segments, U.S. Operations and International Operations. The U.S. Operations segment underwrites primary and excess specialty casualty, and commercial multi-peril, as well as contract, product, environmental, and auto liability products; and general, auto, management, errors and omissions, and public entity liability, as well as workers compensation, and surety and inland marine risks. This segment distributes its products through a network of wholesale agents and brokers. Its International Operations segment offers coverage for long-tail casualty and general liability; property catastrophe reinsurance, and direct and facultative excess insurance; professional indemnity, directors and officer’s liability, and medical malpractice; and North American and international binders, and residential collateral protection for lending institutions. This segment also underwrites risks of general liability, international casualty, and motor treaties; and personal accident, aviation, cargo, yachts, and onshore and offshore marine insurance. This segment distributes its products through brokers and third-party intermediaries. Argo Group International Holdings, Ltd. is headquartered in Pembroke, Bermuda.
Argo Group International Holdings, Ltd. – Redeemable 7.0% Non-Cumulative Resettable Fixed Rate Preferred Shares (ARGO.PA)
ARGO-A was issued just last month with a “qualified” non-cumulative dividend of $1.75 or 7.0%. In five years, if not called, ARGO-A will change to a floating rate of 6.71% plus the five-year Treasury-note. And every five years after that, if ARGO-A remains uncalled, the rate will adjust to the then current five-year T-note rate plus 6.71%. Importantly, ARGO-A goes ex-dividend on Aug. 28. The initial dividend will be smaller – about 32 cents per share, calculated from the July 9 IPO date.
ARGO-A Is The Best S&P Rated “BB” Preferred Stock In The Market
As the chart shows, ARGO-A has the best current yield, and combination of current yield and YTC by a wide margin. But even this chart greatly understates the superiority of ARGO-A because it doesn’t include its much superior floating-rate formula.
AEL-A only looks competitive because it trades below par, giving it a high YTC that it likely won’t achieve. It will float at the five-year Treasury note rate plus 4.32%, while ARGO-A will float at the five-year Treasury-note plus 6.71%, a floor that is a huge 50% better than that of AEL-A. Only the American Equity Life Holding (AEL) preferred B shares (AEL.PB) or AEL-B comes near the yield metrics of ARGO-A, although its current yield is lower at 6.6% and the reset is also lower at 6.3% plus the five-year T-note. But AEL carries extreme leverage that we are not comfortable with. It has about $25 of liabilities for each $1.00 of market capitalization. Therefore, we consider ARGO-A much superior to AEL-B.
The best of the LIBOR fixed-to-floater peers, Valley National Bank’s (VLY) preferred B shares (VLYPP), has an even worse floating-rate than AEL-A at LIBOR plus 3.85% and a Yield-to-Call of only 5.3% vs. 7% for ARGO-A – and yet VLYPP sells for $1.00 more than ARGO-A. ARGO-A is extremely undervalued relative to its “BB” rated peers.
Note: Yield values are as of original publication on Aug. 15.
Why is ARGO-A Trading at Such A High Yield?
ARGO-A is most likely trading at such a high and attractive yield because it’s a brand new preferred. It’s probably still under the radar. Seeking Alpha and Yahoo Finance (ARGO-PA) just added it (Aug. 15/16), and other financial websites that we are aware of still do not have it listed. Additionally, it appears that underwriters are still selling their shares of ARGO-A as their goal is to lock in underwriting profits on their ARGO-A holdings and not to hold these shares for investment.
We believe that once smart investors find out about it, and underwriters finish their selling (which will probably be very soon), the price will trade much higher very quickly. Note that you will be able to find this new preferred stock listed with your broker, and if you can’t you may need to call them. They might have it listed under a ticker that is difficult to find.
ARGO-A Fair Value
We have a fair value of $28.00 for ARGO-A. At that price it still has a higher yield than almost all its peers while having a far superior floating-rate formula. We believe that once underwriter selling finishes, ARGO-A will quickly move much higher. HTLFP, an almost identical but unrated “reset preferred,” has already moved up to $26.85 since underwriter selling ended in July.
Why High Fixed-To-Floating Preferred Stocks are the Best Place to Be
Today, we are in a very low interest rate environment. Many investors are preferring to buy into a fixed-term preferred stock to lock in the high yields for the very long term. For reference, here’s a history of the rates on five-year T-bills and their trend:
As we can note, interest rates have been going down significantly.
However, many investors are missing the point that there’s a strong possibility that long-term interest rates will go up significantly due to high inflation expectation. All the central bankers across the globe are flooding the markets with liquidity and printing tons of money as a response to the pandemic economic crisis. There may be a big price to pay in the future. This will most likely come in the form of high inflation that will eat up some of your asset value and your future income. Floating rate assets are a great way to protect against inflation and the high interest rates that usually follow. Investors need to prepare for this eventuality. High inflation and higher interest rates may come sooner than most expect, and investing in ARGO-A is a great way to prepare.
ARGO-A not only offers a very high “qualified” yield in today’s market, but its “reset rate” feature also provides protection against inflation and higher interest rates which we may well see over the next few years. This is a great way to boost your income regardless of where interest rates go in the future.
ARGO-A is a “BB” rated preferred stock with QDI dividends, and a very high floor on its resettable rate. It’s suitable as a buy-and-hold preferred stock for those income investors wishing to invest in high-yield stocks for the very long run.
We have a $28.00 price target on ARGO-A based on how other “BB” preferred stocks are trading. We believe that once underwriters finish their selling, and investors become aware of ARGO-A, it will quickly move higher in price.
Disclosure: Preferred Stock Trader is long ARGO-A.
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Disclosure: I am/we are long ARGO.PA, ESGRO. 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.
Additional disclosure: Treading Softly, Beyond Saving, Trapping Value, PendragonY, Preferred Stock Trader, and Long Player all are supporting contributors for High Dividend Opportunities.