“CD-Dependable 14.5% Yield” — It’s a Bond … No, a Stock … No, it’s an EIS!

Everybody loves a good dividend, no? In that case, the promise of this teaser ad from the folks at High Yield Investing might get the blood boiling a little bit …

“High-Yield Superstar … Unique Stock/Bond Hybrid Offers a CD-Dependable 14.5% Yield”

First of all, to make sure that there is no mistake, if you really believe that this yield is “CD-Dependable” then I’ve got some shares of Citigroup that you might like to buy … only $50 a share. CDs are insured by the FDIC and will never lose money (unless you consider inflation, or some kind of apocalypse that leads the US to abandon FDIC insurance or worse). This investment could easily lose money.

But that doesn’t mean it’s not enticing … we hear some more:

“What if you could enjoy the best of both worlds? Higher than average stock dividends combined with the regularity of bond interest payments rolled into one investment. Well now you can.

“This investment hybrid combines shares of an issuer’s common stocks with its bonds. They’re called Enhanced Income Securities (EIS) and you can easily buy and sell them on the U.S. stock exchanges. You get current income now… along with a built-in inflation protector in the stock’s capital gains.

“The beauty of this yield hog is that you can depend on its income stream, which is as reliable as a CD. That’s because EIS issuers are required to distribute a stated percentage of their cash flow to shareholders. You can count on its income stream and still enjoy the upside growth potential of a stock. It’s perfect for long-term income investors.”

So that’s more or less what an “EIS” is — they’re also sometimes called income participating securities (IPS) or income deposit securities (IDS), and probably other names as well.

These investments have only been around for a few years, they rose in popularity for a very brief while back when US investors were looking with lust at Canadian Income Trusts and wishing for more high-yield investments here at home. I know of only four of these securities, one of which is the one being teased today.

According to the ad, “we have the perfect one in mind — offering stable double-digit yields in one of the safest industries NOT affected by economic downturns…”

“A Full Plate of Delicious Double-Digit Yields and Capital Gains!

“The company issuing this EIS is a food manufacturer. Brand image is the name of the game in the food industry, and this company has a few of the biggest brands around. I bet you have had one of their most famous brands for breakfast… or enjoyed their wide variety of snacks… or dined on their line of Mexican foods. A famous chef manufactures his seasonings through them. Wal-Mart is their biggest customer.

“Quarterly dividend payments come in at close to $0.39 a quarter. About half is designated as bond interest, the other half as stock dividends. That gives this unique security a 14.5% dividend yield at current prices.

“Combine that robust cash flow with strong capital appreciation and it’s a flavorful one-two punch of profits wrapped in the safest industry on earth. Returns like these are especially sweet in these recent economic upheavals.”

So what is it? Thinkolator sez …

B&G Foods (EIS ticker is BGF, common stock ticker is BGS)

This is a manufacturer of shelf-stable food products, primarily for grocery stores — their biggest two brands that might be recognizable are probably the ones teased in the ad, Cream of Wheat and Ortega, but they have a dozen or two other lines of products, largely stuff that’s never really advertised like beans, sauces and such, though they do also make a line of Emeril products (not sure if that’s good or bad, he seems to have used up more than his 15 minutes of fame already).

An Enhanced Income Security is essentially the combination of a high yield stock with a high yield subordinated bond — so each share of BGF represents one share of the common stock, which itself has a high yield and a policy of distributing essentially all of their free cash flow as dividends, and $7.15 of principal on a bond that yields 12%. When these units were sold to the public they had a $15 asking price, and they’ve fallen to about $10 now.

Currently the stock half of the security has a dividend of .68 a year and a share price of about $5, meaning that the yield just on that common stock is 13.5%. The company recently cut the dividend to this level, and they’ve said that they hope investors consider the dividend to be sustainable. I’d hope so, too, but of course the market is telling you that it has some qualms on that front — you don’t get a 13% yield if the market is confident in your ability to keep paying that dividend ad infinitum.

At a current share price of $10.67 for the enhanced income security of B&G Foods we can just do the subtraction and determine that the bond half of this unit is valued at about $5.50. The yield was 12% on the original principal of $7.15, but at the reduced-by-the-market principal of $5.50 the yield is, of course, much higher. The interest payments on this bond, which unlike the dividends are not adjustable and cannot be ceased (unless they go bankrupt or something, of course) total about .86 per share, which would give a yield on this bond of close to 16%.

Overall, the combined security gets a yield of almost exactly 15%. Much of the dividend from the stock half of the security gets treated as return of capital, since it’s a payout based on free cash flow but is significantly higher than their recent reported earnings, so that might be tax advantageous for some people. The bond half (more than half now) would be treated as regular income. You could, of course, also buy the stock itself, but you get somewhat less security since the debt is senior to the equity in any bankruptcy filing, and since the debt interest should continue to be paid regardless of the level or consistency of the common stock dividend, which might provide some backstop to the shares even if the company doesn’t end up getting into significant financial difficulty (if the dividend stopped, the interest income on BGF would still get you something like an 8% effective yield).

The company carries a lot of debt, some of which is represented by these enhanced shares, so there may well be extra risks for them, but they’ve also claimed that they believe they sell “comfort food” and good, inexpensive eat at home options (like taco kits) that should see improving sales in a weak economy. Don’t know if it will be a good match for you, but it is at least interesting to consider. The original prospectus for the shares is here if you’d like to learn more about the way these shares are structured.

If you’re interested in the other securities of this type, the only one I know of that you might be willing to consider today is Otelco (OTT), a wireline phone company that carries a similar effective yield in the mid-teens — the other two don’t appear to be viable options anymore, one was a coin-operated laundry operator (Coinmach, ticker DRY) and the other was the stadium concession company Centerplate (CVP), which is in the process, probably, of being bought out by KKR, though financing has been an issue (article here if you’re interested). All of these launched in 2003 or 2004, and there has apparently not been much interest in building more of these Frankenstein’s Monsters in the years since, unless there are more of these little fellas hiding in the woodwork who I’ve not yet met — perhaps these oddly structured securities will come back someday, but in the meantime the folks at High Yield Investing thinks BGF, at least, is worth your time.

What do you think?

The author will always disclose any direct long or short equity, debt or option position in any stocks written about as of the day of publication, and will not trade in any stocks mentioned for three days (72 hours) after publication. Full disclaimer is at the bottom of the page.

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1. No comments on my board yet. I really hate to be first, but. . .

   This kind of stock and bond unit is apparently quite common in the Canadian Trusts. Neil George (what did happen there? Very sudden.)at KCI loved them. It may have some tax advantages and other things. The bond part may make it a little more secure than a common stock. In Canada, the combined units apparently help protect the unit value and the issuing companies from the “October Massacre” tax changes.

   Depending on how well B&G Foods is doing in the marketplace, this might be as good a place as any to park some money. Aren’t foods supposed to be relatively recession proof because food is one thing that is really essential?

   Neil George liked OTT also; the new flag bearer at KCI dropped it like a hot potato. What was that about?

   I may continue to watch both B&G and OTT. Businesses that have good potential to endure and good dividend returns?

   ———-Dusty.

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   eldenfrente Reply:
   January 14th, 2009 at 6:36 pm

   Beware of these “EISs.” Unflappable Neil George touted them nonstop on Personal Finance and sister sheets from KCI. BG Foods, Otelco, Centerplate, Arctic Glacier, Coinmach… they were alll his professed darlings… until they precipitously headed south without warning Mr. George. For all his chest-thumping, NG and KCI have proven to be a huge disappointment. Not to mention Thorburg Mtge., Korea Equity…. and the list goes on.
   BTW: Has George “left” the KCI marketing machine???

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   Posted by Dusty | January 14, 2009, 11:08 am

2. These half-fish, half-fowl hybrids are a bad idea for most investors.

   If you think the bonds are a good buy – buy the bonds. If you think the stock is a good buy – buy the stock. If you think that BOTH are a good buy, then you might want to buy some of both but you probably don’t want to buy them in the exact same ratio as in BGF. And you might want to have different stops on the stock and the bonds.

   All that these hybrids accomplish is to confuse investors.

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   EYOUNG Reply:
   January 14th, 2009 at 11:43 am

   I would have to assume, Nostromo, that it depends on where a person is in their earnings life,,, Someone like me, for example who is a disabled retiree, this does hold interest for me, for the simple fact of its seemingly relative safety factor,,, This is the first I have heard of this type investment vehicle, so I can’t really say whether it is good or bad,, or indifferent,,, I DO think, however, it is worth investigating, to make an informed decision.
   EYoung

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   Posted by Nostromo | January 14, 2009, 11:15 am

3. Tax treatment of OTT ‘dividends’ is unusual: according the the Otelco website “A portion of any dividends declared during first quarter 2009 is expected to also be considered as ordinary and qualified dividends. Any dividends paid for the remainder of 2009 are anticipated to be a non-taxable return of capital.”

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   Posted by stockcrazy10 | January 14, 2009, 11:40 am

4. We need to remember that return of capital is just that. Return of capital… and of course it is non taxable because you are getting your money back.
   The consequence is that the basis of the stock is reduced by the amount of capital returned and when the stock is sold either the loss is reduced or the gain is increased.

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   Posted by Pelican71 | January 14, 2009, 12:04 pm

5. As I recall, the folks at High Yield Investing were recommending this stock over a year ago (and even before that), when it was in the $18-20 dollar range and had just about the same 14% ish dividend.
   I used to subscribe to that newsletter, and bought BGF at around $20 and sold it at $12 or so after several months.
   What did this dividend lover learn?
   When a stock goes down 40-50 percent, it doesn’t really matter how much they are paying in dividends…it takes a long time to recouperate. And the fact that they’ve cut that dividend throws up a red flag in my opinion…
   I like to think that when a stock goes down like they all have, but they continue to pay dividends, well, if you reinvest, you simply get MORE shares of the stock…so when it recovers you end up with lots more shares! Perhaps it’s just putting a balm on the wound, but as long as the company remains strong, it would seem to make sense to hold on for the ride and accumulate.

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   Simon Reply:
   January 15th, 2009 at 2:39 am

   I agree totally. It’s a good idea in a market recovery, but I believe we are far from that. Also, if your stock drops 40%, even if they don’t cut the dividend and leave it at 14%, you’ve now held that stock for 3 years and just broken even. May has well be paid 3.5% in a money market fund for that time.

   [Reply]

   

   charles Reply:
   January 15th, 2009 at 2:11 pm

   Boy oh boy! I know what you mean.
   I really thought we’d have a big Obama surge at the end of 08 and going into 09…but the figures that have been coming out seem to be crushing morale.
   Maybe next week.

   [Reply]

   

   David Reply:
   January 16th, 2009 at 2:05 pm

   Where do I get 3.5% in a money market fund? Lucky to get .05%!! Does anyone know of any secure, safe investment -pre refunded munis?

   [Reply]

   

   ted in conway sc Reply:
   April 22nd, 2009 at 7:24 pm

   when u learn please email me and let me in srs in sc

   Posted by Charles | January 14, 2009, 12:16 pm

6. What Happened to Niel George?? And, is an Elliot wave similar to a finger wave???

   [Reply]

   Posted by Steve | January 14, 2009, 4:11 pm

7. I own an EIS that is doing pretty well. It’s a Canadian Utility: Atlantic Power Corporation: ATPWF While the price has been fluctuating recently like everything else, they have just raised their dividend….again. They own numerous utilities in the US: just bought another in Florida. They also hedged currencies; website says: the Company’s cash on hand and projected future cash flows from existing projects are sufficient to meet the current level of cash distributions to IPS holders through 2015. They pay monthly dividends. I’m satisfied with the stock.

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   Posted by Mary Ann | January 17, 2009, 11:40 am

8. Good article, and a very worthwhile site to which I hope to return. Two points should be mentioned regarding the risks here, which neither you nor HYI mentioned:

   HYI states:

   “The beauty of this yield hog is that you can depend on its income stream, which is as reliable as a CD. That’s because EIS issuers are required to distribute a stated percentage of their cash flow [me: but that could vary] to shareholders. You can count on its income stream and still enjoy the upside growth potential of a stock. It’s perfect for long-term income investors.”

   Even if EIS issuers are required to distribute a fixed percentage of cash flow, that flow can and will vary with the fortunes of the business, as with any stock. If it drops, both dividend and probably share price (since it’s bought for income) will decline.

   Also, I’d be curious about their payout ratio, cash flow and profit margins. While food suppliers as an industry may be recession resistant, I believe there is plenty of competition and generally low margins. Would need more info to assess how steady their revenues really are.
   Also, like all stock/bond hybrids I’ve seen, this one is thinly traded. Low liquidity means extra volatility, since you just need one big seller to pressure the stock, and in case of bad news or other sudden need to sell out, there are no buyers but the market maker, who can and will gap the price way down to protect himself, making fast exits potentially far more expensive than with more liquid shares. Indeed, many investors in principle will avoid shares trading under2-500,000 shares a day for this reason alone.

   For more on stock/bond hybrids and their risks, see http://www.highdividendstocksguide.blogspot.com

   [Reply]

   Posted by Cliff Wachtel | February 12, 2009, 11:12 am