Co-produced with Treading Softly.
Life presents us with plenty of unique opportunities.
You have your recurring income, which is more or less the same each month. Your monthly expenses and lifestyle will adapt to whatever that budget is. Then one day, you get a lump sum of money. There are various ways you might come into an unusually large lump sum of cash. Maybe a lawsuit settlement, an inheritance, a lottery win, or maybe you sell your house.
So if you suddenly had $10,000, $50,000, or even $100,000 become available, what would you do with it? Hopefully, you would consider investing a large portion of it for your future. One of the best uses of a lump sum of cash is to put it to work, creating an income for you.
Fixed-income investments would be my first recommendation. Fixed income like preferred securities, traditional bonds, and baby bonds all offer a steady stream of income and benefit from being higher in the capital stack.
I especially like preferred securities from healthy dividend-paying companies, as the common dividend would have to be eliminated before the preferred dividend could be suspended or not paid. This provides an easy way to see if there is potential trouble ahead for the preferred income stream.
Furthermore, as the Federal Reserve has been hiking interest rates, many preferred securities have fallen into discount to PAR territory. This means you can lock in a higher yield than at PAR and enjoy capital gains when the price climbs again.
When will that happen? When the Federal Reserve starts cutting rates again.
Why does this happen? The only way to adjust the available yield of a fixed interest-paying investment is to change the amount it trades hands for. So as rates rise, investors demand a higher yield and are unwilling to pay full price for a lower yield. This effect happens in reverse when rates fall. The demanded yield falls, allowing prices to rise from the ashes.
Today we will look at multiple excellent fixed-income investments for long-term income.
Let’s dive in!
Pick #1: CODI Preferred Stock – Yield +7%
Compass Diversified (CODI) is a mini-conglomerate that invests in middle-market businesses with goals towards long-term prospects. CODI differs from private equity – the capital allocation is more permanent with a long-term value enhancement focus. This allows the company to invest across the layers of people, processes, org culture, and growth opportunities to drive transformational change.
Today, CODI’s market cap stands at $1.3 billion. Since its IPO in 2006, the company has paid $1.2 billion in distributions. This company has been an excellent dividend steward and stellar performer in price preservation and total returns.
Since its IPO, CODI has been active with M&A. Their business approach is three-fold. They strategically acquire companies, provide financial and management support, hand-hold them to unlock value, and then opportunistically divest to capture significant gains.
CODI’s current portfolio comprises the following names, acquired at various periods and economic conditions.
Most of these companies may be unfamiliar to the average individual, but these are vital players in niche markets. Source: CODI November 2022 Investor Presentation.
If you have been to a catered event, you may remember seeing those portable burners underneath the food containers. The Sterno Group (acquired by CODI in 2016) is a leader in that space. This company is a 100-year-old brand and a manufacturer and marketer of portable food warming systems, creative indoor and outdoor lighting, and home fragrance solutions for the food service industry and consumer markets.
Note: Compass Diversified Holdings was previously treated as a partnership for U.S. federal income tax purposes but elected, effective September 1, 2021, to be taxed as an association taxable as a corporation.
Investors will no longer receive a Schedule K-1 for tax purposes.
During Q3, CODI reported a 22% increase in revenues and a 16% higher operating income. The company’s adjusted earnings for Q3 increased 28% YoY to $46.0 million, and adjusted EBITDA was up 27% to $98.3 million.
Despite higher inflation and supply chain disruptions, the company reported record YoY performance due to the competitive positioning of its subsidiary companies. Due to its diverse markets, business, investment, and inventory cycles, CODI is well-positioned to outperform in good and bad times.
At the end of Q3, CODI reported $61.3 million in cash and cash equivalents. 70% of its total outstanding debt carries a blended fixed rate of 5.2% with maturities at 2029 and beyond. The company has no significant debt maturities until 2027.
YTD, CODI paid $18 million towards preferred dividends, $58 million on interest expenses, and $53 million on common dividends. With solid execution and growing EBITDA, the preferred dividends are adequately covered.
With CODI, you have a dividend-paying mini-Berkshire Hathaway (BRK.A, BRK.B), and we like its preferreds for higher yields and better income safety. Up to 7.9% steady yield is up for grabs for the patient investor.
Pick #2: GNL Preferred Securities
Global Net Lease, 7.25% Series A Cumulative Redeemable Perpetual Preferred (GNL.PA) – Yield 7.6%
Global Net Lease, 6.875% Series B Cumulative Redeemable Perpetual Preferred (GNL.PB) – Yield 7.4%
GNL is a triple-net-lease REIT (real estate investment trust) where tenants take care of maintenance, taxes, and insurance expenses in addition to paying rent. As of September 30, 2022, GNL reported a 98.6% portfolio occupancy, and 61% of the REIT’s portfolio annualized straight-line rent (“SLR”) was derived from Investment-Grade tenants.
At the Q3 earnings call, GNL reported that over 94% of its leases featured annual rental increases, providing a hedge against the long-term effects of inflation. Notably, since the beginning of the COVID-19 pandemic, over 82% of the REIT’s acquisitions have been industrial or distribution properties, increasing the overall exposure to a highly dependable asset class that is immune from the disruption of e-commerce or remote work.
Being income investors, our attention is on GNL’s discounted preferred securities:
7.25% Series A Cumulative Redeemable Perpetual Preferred (GNL.PA)
6.875% Series B Cumulative Redeemable Perpetual Preferred (GNL.PB).
GNL’s balance sheet has a weighted-average interest rate of 3.5%, and the company maintains 3.3x interest coverage. Moreover, 75% of GNL’s debt is fixed-rate, protecting the company against the higher expenses of rising rates. GNL spends $20.4 million on preferred dividends, a sum well-covered by the company’s net cash from operating activities of $160 million for the 9 months of FY 2022. The REIT spent $72 million on interest expenses up to Q3. GNL’s debt interest and preferred dividends are adequately covered by GNL’s cash position ($128 million as of September 30, 2022) and its operating income.
Triple net REITs are the strongest as a sector, and these structures of leases have proven to be the most recession-resistant in recent decades due to the structure and the long-term nature of the lease agreements. GNL preferreds trade at an attractive discount, and current price levels set investors up for a +5% capital upside and steady ~7% yields for the foreseeable future. We see an attractive combination of safety and high yields for the patient income investor.
With fixed-income investments, you have a clear picture of what income will be coming and when it will arrive. How much is that annual income worth to you?
By holding preferred securities from GNL and CODI, we lock in recurring and reliable income streams. This way, we can check the box of securing your financial future and allow ourselves to move forward to planning the exciting adventures you will embark on in retirement.
The benefit of the Federal Reserve’s aggressive rate hiking has been that fixed-interest investments became rapidly more attractive. Right now, we’re nearing the maximum level of attractiveness as we approach a long-expected recession and eventual rate cuts. When the cuts come, investors will again look to preferred securities for stable sources of recurring income. The best time to invest is before the crowd comes storming in.
We provide weekly fixed-income insights, dialogue, and opportunities to the members of High Dividend Opportunities as an exclusive part of their membership. Due to the low trading volume on most of our ideas, we only share them with the public after a delay, allowing our members to have the first chance to act.
I’m happy that we can provide these opportunities to the public today and help build more safety into your retirement income!