Ashford Hospitality Preferreds Warrant Caution
By: Tim McPartland,
As income investors search for high yield in a world where low yields are the norm, they must use an abundance of caution to ensure that the high yields they locate are sustainable dividends. Ashford Hospitality (NYSE:AHT), which is a large lodging real estate investment trust (REIT), recently slashed the dividend of its common shares by 50%, setting off alarm bells for income investors as the company also has five outstanding issues of perpetual preferred stock. Income investors often use the dividend payment to common share owners as an indication of the safety of the preferred dividend.
While this is a simplified method to determine safety, it is likely true that a common dividend that is rising indicates strong financial health of the company. The logic of these investors is that the common share dividend will be eliminated prior to any potential suspension of preferred stock dividends. The reason is a company is not allowed to suspend preferred stock dividends if it is paying a common stock dividend.
The five preferred stock issues outstanding from AHT have coupons ranging from 7.375% to 8.45%. The 8.45% issue has been outstanding since 2007 and the company partially redeemed the issue in 2017. The inability (or desire) to fully redeem this very high coupon sets off alarm bells about the risk in the company. Considering the solid economy during the last number of years, any fiscally strong company would have redeemed these shares, but Ashford chose not to, or could not redeem them.
We have written before about AHT and the one item that always caught our attention is the weakness of the balance sheet. The company has operated with a very high debt/equity ratio. Ashford Hospitality has debt which is nearly eight times its equity — yikes! This is an extreme debt/equity ratio that in our opinion is unacceptable for almost any company except for a bank.
The preferreds from Ashford Hospitality have traded weakly for several years, but with the slashing of the common share dividend, the $25/share preferreds fell about another 4% each. The share prices now range from $22.10 for the 7.375% (NYSE:AHT-G) issue to $25.33 for the 8.45% (NYSE:AHT-D) issue. Current yields are all in the 8.4% range.
The question an income investor should ask is whether the company can weather an economic downturn? If the company is marginally cash flow positive during the best of times, what will happen when the next soft economy, or recession, arrives?
It is my opinion that there is a 50/50 chance that if the next recession arrives in the next 12 months, Ashford Hospitality eventually would be forced to suspend preferred stock dividends. This would mean we likely would see shares of the preferred issues immediately trade in the $10-$12 area. This price is warranted only because the shares are cumulative, meaning the company eventually would have to pay suspended dividends before they could ever pay a common share dividend.
So, what does a current holder of the AHT preferreds do? There is never a clear answer to a question like this one. The situation is all about risk/reward and each and every investor has different needs and goals. Obviously, a conservative investor like myself would not be in these shares, but we envision many others that may believe that it “will work out” and they are more than happy to hold the shares and earn a current yield of 8%. They may be right.
With the dicey financials of this lodging REIT, investors need to scrutinize each and every press release from this company. Each quarterly earnings announcement will become hyper critical to investors as one tries to gauge the company’s performance.
Of course, the wild card in this situation is that if the company announces surprisingly low earnings, the share price of the common shares, which are already trading down at $3.30/share, will fall further. Additionally, it would be likely that the preferred shares will trade lower as well.
For the very conservative investor who holds these preferred shares, consideration should be given to selling the shares if you are going to lay awake at night and worry. Many times, a sale and redeployment of funds from a holding “gone wrong” will put one’s mind at ease and allow the investor to move forward in hopes of a more solid income investor.
Tim McPartland is a private investor with over 45 years of investment experience. His analysis, research and writing is devoted to the hunt for income producing securities of all types, but in particular specializing in preferred stocks, exchange traded debt and Master Limited Partnerships.