Why I’m Putting Cash on Ramco-Gershenson Convertible Preferred

Ramco-Gershenson Properties Trust (NYSE: RPT  ) is not a name that rings bells with many people. But this small-cap REIT (market cap: $625 million) has something interesting in its capital structure: a convertible preferred stock. This convertible offers an above-average dividend, some upside, and limited downside -- all of which I'll explain below. So I'm adding the stock to my Special Situations portfolio on the next market day.

The business
Ramco-Gershenson is a real estate investment trust that owns and manages shopping centers in metro markets on the East Coast and in the Midwest, including Detroit, Fort Lauderdale, Jacksonville, Tampa, Atlanta, Chicago, and St. Louis. The company owns interests in 83 shopping centers and one office building, and its portfolio comprises some 15.2 million square feet of gross leasable area.

The company invests mainly in large, multi-anchor properties that feature nationally recognized chains and dominant supermarkets that sell products to meet everyday needs. Tenants include Home Depot, Wal-Mart, Lowe's, Best Buy (NYSE: BBY  ) , Target, Publix, Kroger, and Whole Foods.

The company is working on getting its business growing again after getting hit by the financial crisis and cutting its dividend. It looks like it may have turned the corner. In the year to date, the company saw same same-center net operating income grow by 3.1%. And in the recent quarter, management raised guidance on funds from operations (FFO) -- the second time this year -- to $1.01-$1.03 per share, up $0.02 cents from before. And the company expects more growth next year. That translates into a P/FFO ratio of less than 13, not too aggressive for a REIT.

The special opportunity
The interesting part about Ramco-Gershenson isn't the common, though at current prices it offers a 5% yield. The company's Series D Convertible Preferred Stock (NYSE: RPT-PD  ) could provide a better dividend with similar upside and less downside. At the current price, the preferred offers a yield of 6.9%.

The preferred stock is a bit of an odd bird, even in the backwater that is the preferred stock world. It offers a 7.25% coupon at par, but par is $50, twice the usual price for preferred issues. The stock has no fixed maturity date and no traditional call date, though. And then there's that convertibility feature.

While there is no call date, the day of April 20, 1918 is an important. Until then, the preferred stock is convertible at any point at the investor's discretion into 3.4699 shares of Ramco common stock, reflecting an initial conversion price of $14.41 per common share. For reference, Ramco common trades around $13.40 now. After that 2018 date, if the price of the common stock exceeds 130% of the conversion price ($18.73) for 20 of 30 consecutive days, then the company can unilaterally convert all preferred shares into common shares.

Moreover, the preferred stock is cumulative, meaning if the company defers payment on the dividend, it will continue to accrue. And because of the preferred's higher rank in the capital structure (and this is a company that must pay out dividends in order to maintain its REIT status), we have some protection in the preferred as long as common dividends are paid.

By buying the preferred shares, we get some "guaranteed" dividend income, but we also get upside if the common appreciates. In addition, because of the sizable dividend, we're not as heavily exposed to the downside as the common. Take a look at what the performance of the common and the preferred would be in the following scenario, assuming two years for the common stock to appreciate to the given levels, and dividends for each. As you can see in the last column, the more the common appreciates, the greater percentage of the total common-stock gain that the preferred captures.

Common Stock Price

Total Common Stock Gain

Total Preferred Gain

Percentage Earned of Common Stock Gain

$16

29.4%

18.8%

63.8%

$17

36.9%

25.3%

68.6%

$20

59.3%

44.9%

75.8%

Risks
Unlike the common, the preferreds don't offer the same risk of dilution. Dilution is a typical concern at REITs because of the necessity of accessing capital and the debt-heavy structure that can "force" them to access equity capital at the wrong time. With the preferreds, we don't have the same risk (we're looking for survival rather than thrive-al), though we would also lose potential upside beyond the dividend yield.

The debt-heavy structure also means there's a recurring need to refinance that debt. That could be problematic if markets seize up again. Plus, the low-rate environment has been great for REITs now, but at some point in the future, rates will go up. The company, through an equity offering last year, has reduced its debt multiple to 6.7 times EBITDA and is working on getting an investment-grade rating. That doesn't eliminate the debt-heavy structure, but reduced financing costs could allow the company to generate more cash.

The company is working to reduce exposure to the three national office supply chains and other retail chains that might be undergoing secular declines due to web retailing, such as Best Buy. Still, this is an ongoing risk.

Foolish bottom line
The purchase of Ramco's preferred stock is also a portfolio management decision, here. I have a ton of cash, and I need to get it working. The preferreds get more cash into the portfolio with that huge dividend while also offering upside if the common moves up. So my Special Situations portfolio will buy 100 shares on the next market day.

Interested in Ramco's Series D Preferred Stock or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).


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