In a recent article I had a closer look at American Finance Trust (AFIN) and although the generous 13% dividend yield wasn’t covered in the second quarter, the REIT was making good progress to bring the coverage ratio back to 100% (and higher). However, after doing my deeper dive in AFIN, it looks like the REIT can offer the best of both worlds: investors can speculate on increasing share prices with the common share but income-focused investors should have a closer look at the preferred shares issued by AFIN. The 7.5% preferred share is trading with AFINP as its ticker symbol and is currently trading approximately 3% below par.

Source: Yahoo Finance

A quick recap of the financial performance of American Finance Trust

First of all, to fully understand the preferred shares and the sustainability of the payout, it’s useful to briefly recap my conclusions from the AFIN article. You can re-read the entire article here.

The main takeaways of the American Finance Trust discussion were the relatively high rent collection percentages. Whereas the REIT collected less than 90% of the rent due in Q2, it announced the collection rates improved throughout the summer and are now exceeding 90%. During the second quarter, AFIN has granted its tenants approximately $8M in deferred rent, but this deferral doesn’t have any impact on the FFO and AFFO generated by the REIT. Deferred rents are still just recorded as a revenue and subsequently added as a receivable to the balance sheet. If rent would be forgiven by American Finance Trust, the FFO and AFFO would obviously be hit.

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I was a bit disappointed to see the recent dividend cut to $0.85 per year (payable in 12 monthly tranches) still wasn’t fully covered by the FFO and AFFO in the second quarter. However, I also explained the recent debt refinancings will reduce the interest expenses and boost the FFO and AFFO again. Including the contribution from deferred rent, I do expect AFIN’s FFO to cover the dividend on the common shares from Q4 on. That being said, the coverage ratio will just be around 100% and there obviously always remains the risk the deferred rents won’t be paid further down the road in case a tenant which successfully negotiated a rent deferral agreement goes belly up anyway.

The implications for the preferred shares

So, although the FFO will start covering the 13% dividend yield on the common shares, I wanted to focus on the preferred shares as these shares provide an additional layer of safety. Its preferred dividends are senior to the common share dividends and considering AFINP is a cumulative preferred share, it also means that even if the REIT skips some of the preferred dividends, it needs to pay all outstanding preferred dividends before it can start paying a dividend on the common shares.

Just to be clear, I don’t expect AFIN to suspend neither its common share dividend nor its preferred dividend, but it helps to explain how bad AFIN’s performance will have to be before suspending the preferred dividend.

In the second quarter, the AFFO attributable to the common shareholders was $21.2M. However, this also already includes the preferred dividend of $3.62M per quarter. This means the AFFO before making the preferred dividend payments in Q2 was almost $25M. And given the debt refinancings, the AFFO before deducting preferred dividend payments will almost certainly exceed $25M in the next few quarters.

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This means that in order to pay the preferred dividend, American Finance has to pay less than 15% of its Adjusted Funds From Operations. Or in other words: even if the AFFO on a pre-preferred dividend basis drops by 80%, the preferred dividend will still be more than fully covered with a coverage ratio of approximately 130%.

The preferred share of American Finance Trust pays an annual preferred dividend of 7.5% of the $25 par value in four equal quarterly tranches of $0.46875. Given the current share price of around $24.13, the current yield on cost is approximately 7.77% and has a current coverage ratio of approximately 690%, making it a safe income security.

Investment thesis

While more speculative investors would probably be better off buying the 13% yielding common shares as the dividend yield is higher while the common shares are trading at a discount to the book value, the preferred shares offer a lower but safer income. With a current preferred dividend yield of approximately 7.77%, which ranks senior to the common shares, the preferred shares appear to be a good income-oriented idea for dividend investors.

I currently have no position in the common shares nor the preferred shares but I will likely start building a position in the preferred shares.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AFINP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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