Howmet Preferred: Investment Opportunity To Capitalize On Lower Interest Rates (HWM.PR)

In May 2024, I covered Howmet Aerospace (NYSE:HWM), and while I believe the stock is overvalued against its company median valuation, it gained 21% which compares favorably to the 9.8% return for the S&P 500. In this report, I want to take a closer look at the company’s Class A Preferred stock.

Details About Howmet Aerospace Inc. 3.75% Cumulative Redeemable Preferred Stock Series A

When Howmet Aerospace was spun-off from Arconic, Howmet Aerospace assumed the Arconic Preferred 3.75% Preferred Stock Series A. The stock (NYSE:HWM.PR) has a par value of $100 million, which coincides with the liquidation preference. The dividend of the preferred stock is cumulative in nature, meaning that in case a dividend payment is skipped it cumulates and unpaid dividends are still due. Currently, the preferred shares trade at $63 per share, giving it an effective dividend rate of 5.95%. This yield is significantly higher than the 0.33% yield of the common stock. There are certain things that the preferred stock lacks compared to common stock, and that are the benefit of share repurchases and dividend growth.

Why Howmet Aerospace Preferred Stock Trades Below Par Value

Howmet preferred stock currently trades at a 37% discount to its par value. If there was reasonable suspicion to assume that Howmet Aerospace would redeem the preferred stock, it would make for a very compelling investment opportunity. However, I don’t believe there currently is any reason or indication that Howmet Aerospace would redeem the preferred stock. It is stock they assume from Arconic when Howmet Aerospace was spun off. The preferred stock never traded closely to par value. The reason is not quite known to me. It could be related to the spin-off itself. The common stock distribution was such that for every four shares of Arconic Inc. (later Howmet Aerospace) one common share of Arconic Corp. was obtained. So, one original share of Arconic Inc. became 5 shares, of which 80% of the shares were for Howmet Aerospace. While the preferred stock was not split, we see that it traded pretty much as if 80% of the par value would be attributable to Howmet Aerospace. However, Howmet Aerospace assumed the preferred stock obligations fully.

The graph does show us that during the pandemic, the preferred stock tanked. If there are concerns that a company can maintain its dividend payments, we can see the stock trade at steep discounts to par value. To understand why the preferred stock has started tanking since the late 2021 and more prominently. We have to look at the preferred stock from an income investor perspective and keep the interest rates in mind. The first interest rate hikes started in 2022 and the Fed fund rate is now 5.33%. Effectively, this means that the income from the preferred stock would be less attractive. At a price of $80, it would imply an effective dividend yield of 4.7% which is way below current interest rates. In response, the preferred stock started dropping towards a price level at which the preferred stock would create an attractive dividend income opportunity.

The Opportunity In Howmet Aerospace Preferred Stock

Currently, the effective yield is 5.95%. Currently, the expectation is that the Fed will cut interest rates by 25 bps in September and by year-end there is a 44.3% probability that the target rate will be 425-450 bps and 300-325 bps (probability 26.5%) by December 2025. What this means is that effectively, it will become more and more compelling to own Howmet Aerospace preferred stock and I believe the share price of the preferred stock will also trend higher. This opens up an opportunity to buy the stock at a 5.95% yield on cost and eventually sell the preferred stock at a gain. If the stock would return to the price levels of $80, that would mean there is 27% upside to the preferred stock price on top of the income that is being collected. If that takes a year, it would provide a 32% total return and if it takes two years it would provide a total return of 39%. What investors should keep in mind is that the preferred stock price will likely move with interest rate changes, and any delay in interest rate cuts will also mean that upside will be limited.

Conclusion: Howmet Aerospace Provides An Interesting Opportunity

I believe that Howmet Aerospace preferred stock provides an interesting opportunity. Not so much for the income, although at a current yield of nearly 6% that looks interesting, but as interest rates come down, I believe the preferred stock price will start climbing again, which could result in significant total returns. As a result, I am rating Howmet Aerospace Preferred Stock Series A a buy.