High Yield for Uncertain Times

06/30/2006 12:00 am EST

Focus:

Carla Pasternak

Editor, The Income Investor

"It only takes one hurricane to bruise you financially, and the same can be said of the market's recent turbulence," says Carla Pasternak. "Will things return to normal? Over the long run, the answer is probably yes, but it sure doesn't hurt to batten down the hatches while you ride out the market's volatility."

"In today's uncertain market environment, securities that preserve your capital and also provide growth potential look especially attractive. I’ve found two convertible preferred shares with double-digit yields. These preferreds allow you to convert your shares into common stock at any time.

"This feature is especially attractive when the security's underlying common stock is in an uptrend. You can also choose to retain the preferred shares and keep receiving interest payments until maturity, at which time you will be repaid your principal.

"SuperTel Hospitality 8% Series A (SPPRP NASDAQ) is a convertible preferred stock from a real estate investment trust that owns 78 hotels and motels across the mid-western and eastern US. It's the company behind such popular names as Super 8, Comfort Inn, Hampton Inn, Holiday Inn Express, Best Western, Days Inn, and Ramada, among others. The hospitality industry has been hot, and investors have been bidding up SuperTel's common stock. In the past 52 weeks, the shares have gained over 46%.

"SuperTel's common stock yields about 6.6% and provides capital gains potential, but the preferred shares are especially attractive to conservative investors looking for guaranteed principal. The preferred shares now yield 7.6% based on an 80-cent annual distribution, paid monthly. Moreover, the shares are convertible at any time into 1.77 common shares of SPPR. At a recent price of $10.52, investors in this firm's preferred shares are paying just $5.94 for common shares that are selling for $6.02 on the open market.

"Although the preferred shares are convertible at the holder's option, a provision allows the company to force the conversion if the common stock sells for $7.36 or higher over 20 consecutive days starting in 2009. The shares aren't redeemable for three years. The preferred share dividend doesn't qualify for the reduced 15% tax rate. As such, the shares are best held in a tax-deferred account. I like SuperTel's preferred shares for conservative investors who want to guarantee their principal.

"I also recommend Ford Motor Capital Trust II convertible 6.5% (F-S NYSE). With an annual payout of $3.25 distributed in quarterly installments, this automaker's preferred stock now yields 11.8%. The convertible feature gives shareholders the option to convert at any time until 2032 each preferred share into 2.8 shares of Ford's common stock.

"Based on the current price of the preferred shares, investors would have an incentive to convert into common stock if Ford's common shares rose to around $10 per common share. Given that Ford's common stock has traded above $10 as recently as last year, the shares could certainly return to those levels. The preferred shares can't be called until January 15, 2007, and (barring bankruptcy or liquidation) will be redeemed for $50 per share well below what you can buy them for today.

"As you might expect, Ford's preferred shares are rated below investment grade. That said, the company has paid its 81-cent quarterly payments like clockwork since December 2003. Meanwhile, Ford is in turnaround mode and company earnings are expected to improve +35% next year. Looking beyond that, analysts are calling for Ford to deliver long-term earnings growth of about +5% over the next five years.

"This beaten down blue chip is in the early stages of a turnaround. By investing in the firm's preferred shares now, investors will be able to reap the rewards if Ford's restructuring efforts start to pay off over the next couple of years. As such, the shares are suitable for aggressive investors who can tolerate the risk that comes with this potentially high-reward turnaround play."

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