The previous article, It's That Time Of Year - Reallocation (here), provided my outlook for the markets in 2013 and developed a re-allocation scenario that in my opinion, best addresses how we Mid-Rangers can continue to protect our portfolio principal while using dividends and distributions to offset living expenses.
Our re-allocation of asset classes resulted in an increased percentage weighting of MLPs, slight reductions in the weighting of royalty trusts, REITs and BDCs, while retaining our 2012 weightings for foreign stocks and cash.
As I cautioned in the previous article, I personally have no intention of buying or selling portfolio stocks until I see where the government is headed relative to the fiscal cliff issues. I keep secretly hoping that our elected officials in D.C. will one day soon collectively mimic a pack of lemmings - but that is another story altogether.
In the meanwhile, I have completed a review of present portfolio holdings and have identified a listing of potential candidates for inclusion/addition to the portfolio for early 2013.
Master Limited Partnerships
At a 55 percent weighting, this asset class occupies the preeminent position in our portfolio. I favor the midstream assets, (predominantly pipeline MLPs) believing they are the least sensitive to fluctuations in the underlying commodity prices.
Our primary evaluative criteria for this asset class were as follows:
- Consistent increases in distributable cash flow [DCF]
- A minimum DCF coverage ratio of 1.0 (1.2 or higher is even better)
- Distribution yield of plus/minus eight percent
- A compound annual growth rate (CAGR) greater than five percent
VNR - Vanguard has demonstrated a good record of increased DCF increases; the latest quarterly coverage ratio is 1.16X; the current yield is 9.1 percent; the CAGR is 6.3 percent; and it has recently increased the quarterly distribution from $.20 to $.203.
MEMP - Memorial is a newer MLP which I wrote about in late October (here). It is primarily a producer of natural gas (79 percent) and should do especially well if we have a cold winter. The price has fallen of late due to a secondary stock offering.
Memorial's DCF is increasing, the coverage ratio for the last quarter was 1.44X. It presently yields 11.8 percent and has a CAGR of 5.6 percent. In addition, the distribution was increased from $.48 to $.495 last quarter.
Thirty-five percent of our portfolio will be devoted to midstream MLPs in 2013. This will include present, as well as potential new holdings. Three midstream companies gained my attention during my research effort: Crestwood Midstream Partners (CMLP), Targa Resources Partners (NGLS), and Crosstex Energy (XTEX). There are a few others; however, I think these three could be undervalued at today's prices.
CMLP - Crestwood has increased its DCF, and while the latest coverage ratio is right at 1.0X, it should increase in the coming quarters. The present yield is 8.9 percent and the CAGR is 16.6 percent. In addition, the quarterly distribution was increased from $.50 to $.51 last quarter.
NGLS - Targa's DCF continues to increase and the latest coverage ratio was 1.1X. The present yield of 7.5 percent is a little lower than I like to see (but close enough) and the CAGR is a respectable 8.8 percent. The recent distribution increase from $.643 to $.663 was also a plus.
XTEX - Crosstex is a little more speculative, but the stock has been getting more positive attention the past few days. The company's DCF has been increasing and the coverage ratio stands at 1.13X as of last quarter. Crosstex yields about 9.5 percent and has a CAGR of 14.9 percent.
The downstream and specialty sector offers two solid prospects, both of which presently occupy positions in the Protected Principal Retirement portfolio: Calumet Specialty Products Partners (CLMT) and Global Partners (GLP).
CLMT - Calumet, in my opinion could be a portfolio cornerstone. It has continued to perform well, increasing its distribution and shows continued promise.
The DCF has increased, the coverage ratio is 2.3X, yield is 8.2 percent and the CAGR is 11.3 percent. The distribution was recently increased to $.62 from $.59.
GLP - Global Partners DCF has also increased and the coverage ratio is a healthy 2.3X. Present yield is 9.2 percent and the CAGR stands at 42.7 percent. The distribution was increased from $.525 to $.533 last quarter.
Performance of U.S. royalty trusts over the past six months has been miserable at best. Some of the Canadian trusts (corporations) have done a bit better. My short list for potential portfolio additions has gotten very short.
The primary evaluative criteria for royalty selection were:
- Distribution payments on U.S. trusts at, or greater than subordination thresholds (meeting the target distributions even better)
- Longevity of the trust
- Number of years until subordination threshold distribution levels expire
- Consistent or increasing distributions from Canadian trusts/corporations
The result of our research effort yielded two U.S., and two Canadian trusts: Chesapeake Granite Wash Trust (CHKR), Sandridge Permian Trust (PER), Freehold Royalties Ltd. (FRHLF.PK), and Eagle Energy Trust (ENYTF.PK).
CHKR - Currently receiving royalties from 20 percent natural gas, 30 percent natural gas liquids and 50 percent oil, CHKR will terminate in 2031. Its drilling obligation ends in June 2015, and consequently, the minimum distribution payments per the subordination threshold will end in June 2016. Subsequent to June 2016 quarterly distributions will fluctuate based upon the underlying commodity prices.
To date CHKR's quarterly distributions have been at (past two quarters), or greater than (initial three quarters) the subordination threshold. The subordination threshold for the fourth quarter 2012 is $.68. Distributions will peak around the third quarter 2013.
PER - Sandridge Permian Trust receives approximately 98 percent oil and two percent natural gas royalties and will terminate in 2031. Drilling obligations end in March 2015 and subordination thresholds will cease in March 2016, fluctuating thereafter.
PER's quarterly distributions have outperformed many of the other U.S. trusts since inception. All quarterly distributions to date have exceeded the target distributions. The anticipated fourth quarter 2012 target distribution level is $.62.
FRHLF - Freehold Royalties Ltd. is a Canadian perpetual trust that receives royalties from production of 60 percent oil, 37 percent natural gas and approximately three percent natural gas liquids. It pays a monthly distribution of $.14.
ENYTF - Eagle Energy has been an enigma, to say the very least. It is headquartered in Canada; however, all royalty interests are located in the U.S. It pays a monthly distribution of $.0875.
The ENYTF stock price has recently declined significantly from recent highs just above $10 to a low just below $7 yesterday. The initial decline was attributable to an institutional seller (see news release here), and the latest decline had to do with unpublished 2013 guidance. On December 7, ENYTF released its 2013 guidance (here) that seemingly addressed shareholder concerns. The stock has rebounded twenty-three cents since the release of 2013 guidance, and presently yields just under 15 percent.
Real Estate Investment Trusts
Our proposed reduction in the [REIT] asset class stems from the removal of mortgage REITs from the portfolio. The mortgage REITs appear to be mirroring their performance leading up to the 2008 debacle, and with spreads decreasing, dividend reductions and earnings not providing adequate dividend coverage I no longer believe that these are suitable investments for the Protected Principal Retirement portfolio.
That leaves us with equity REITs to consider. I very much enjoy reading Brad Thomas' articles here on SA. I believe that Brad is one of the sharpest when it comes to equity REITs.
Due to appreciation of most equity REITs over the past few years, yields have dropped to the point where very few are paying eight percent or more. For that reason, our portfolio's REIT allocation has been met by closed-end funds such as Alpine Global Premier Properties (AWP) and, up until about a month ago by Cohen & Steers Quality Income Realty Fund (RQI). We had substantial profits in and felt it was best to sell the position until year end fiscal cliff issues were addressed.
AWP - Alpine affords the opportunity for exposure to foreign real estate with U.S. holdings presently at 34 percent. It is presently selling at a 7.5 percent discount to net asset value [NAV], and is paying 8.3 percent. Year-to-date its stock price is up 49 percent and its NAV is up 33 percent.
RQI - RQI is 100 percent invested in U.S. large cap REITs. It presently sells at a two percent discount to [NAV] and has a yield of 6.8 percent.
It remains a solid candidate for our portfolio on a dip. An eight percent yield would be achieved at a price of nine dollars per share, or less.
Three equity REITs have caught my attention: Omega Healthcare Investors (OHI), Medical Properties Trust (MPW) and Whitestone REIT (WSR). I do not include a long list of evaluative criteria since the fundamental analysis conducted on any stock is similar to that used for [REIT] evaluation, except that we look at Funds From Operations [FFO] and Adjusted Funds From Operations [AFFO] instead of earnings per share.
OHI - Omega is a long-term care healthcare REIT, and could be impacted by Obamacare - we will have to wait and see. OHI presently yields 7.7 percent and its quarterly FFO consistently has beaten analyst estimates. Its quarterly dividend also has continued to increase, most recently to $.44 from $.42 a share. Revenues have increased 19.6 percent year-over-year, and earnings increased by 40.5 percent year-over-year.
OHI is one of, if not the highest yielding healthcare equity REIT on the market today.
MPW - MPW owns a considerable number of hospitals, rehab facilities and medical office buildings. I believe that MPW is less sensitive to Obamacare than OHI will be (correct me if I am wrong here).
In September 2008, MPW reduced its dividend from $.27 to $.20 quarterly, where the company has maintained it ever since. There is talk of portending dividend increases, as FFO (most recently $.25/share) more than covers the present dividend.
WSR - Whitestone is fairly unique, in that it invests in redeveloped properties in large metropolitan areas in the southwestern U.S. It is probably the more speculative of the three portfolio candidates discussed herein.
Its FFO continues to increase each quarter; however, it has missed analyst estimates each of the past three quarters. The company is a monthly dividend payer, and the current rate is $.095/month, for an annual yield of 8.4 percent.
One word of caution - WSR's FFO does not cover its dividend as yet.
Business Development Companies
I recently published an article on business development companies [BDCs] (here). It provided an overview of the 30 or so that I try to follow, a few of the evaluative criteria that I use, and potential candidates for our portfolio.
This asset class seems to be ever-changing and typically is very sensitive to interest rates, inflation and the economy in general. The most promising candidate that resulted from that article was Full Circle Capital Corporation (FULL). Since writing this article, current year earnings estimates have been reduced to the point that dividend to earnings per share ratio has risen to 114 percent.
Our primary criteria for evaluating BDC portfolio candidates are:
- Dividend yield of plus/minus 10 percent
- A dividend to 2012 earnings per share [EPS] ratio of less than 1.0
- A dividend to 2013 earnings per share ratio of less than 1.0
- A price to NAV of less than 1.0
PSEC - PSEC's investment portfolio crosses several asset classes, but is weighted towards energy and industrials. It has recently revamped its monthly dividend policy, increasing the dividend level by 8.2 percent. This puts the present yield at approximately 12.4 percent.
The company's dividend to 2012 EPS ratio is .82 and for 2013 the ratio is .99. The price to NAV ratio is .97.
TICC - TICC gives investors exposure to the technology sector. It pays a quarterly dividend, which was recently raised to $.29 from $.27. The present yield is 11.6 percent.
TICC's dividend to 2012 EPS ratio is .98 and for 2013 the ratio is .96. The price to NAV ratio is 1.02 (close enough).
In the November article on foreign stocks (here), I looked at five possible additions to our portfolio. The criteria used to identify these includes:
- Countries with strong economies
- Reasonable foreign tax rates on dividends
- Sustainable dividends
- Favorable industry sectors
Aside from Canadian royalty trusts, the foreign component of the portfolio consists of three energy-related companies, each of which is influenced by Mr. John Fredriksen of Norway. These three are Seadrill (SDRL), North Atlantic Drilling Ltd. (NATDF.PK), and Ship Finance International (SFL).
Before moving on to other candidates, let me first say that I would not hesitate to add to any of these three companies on price dips.
There is no need to reprint the analyses of the foreign stocks appearing in the November article cited above (boring enough to plow through a long article). Of the five reviewed in that article, my top choice as a potential portfolio addition is Cemig (CIG). The stock has moved up about two dollars a share recently, possibly based upon their reduction of long-term debt.
Of the other stocks covered in the November article, I continue to follow AES Tiete (AESAY) closely.
Closed-end funds [CEFs] offer the opportunity to diversify our portfolio across almost any asset class at prices normally at a discount to NAV. I continue to research a broad spectrum of CEFs on a weekly basis.
CEF sectors of interest to our portfolio include U.S. and foreign REITs, foreign equity/income funds, emerging market funds, natural resources funds, and funds using options strategies as a means to generate income.
Our primary criteria for CEFs includes:
- Fund price at a discount to NAV
- A discount to annual fee ratio of about 10 to 1
- A yield on NAV less than 12 percent
- Annual fees/expenses below 1.5 percent
In my previous articles on CEFs I took a close look at seven in particular: Cohen & Steers Global Income Builder (INB); Calamos Global Dynamic Income Fund (CHW); Blackrock Resources and Commodity Fund (BCX); EV Tax-Managed Global Fund (EXG); H&Q Healthcare Investors (HQH); Nuveen Multi-Currency Fund (JGT); and Nuveen Real Estate Income Fund (JRS).
I am not eliminating any of these seven funds from the portfolio watchlist since discounts and premiums can change very quickly, expenses also change and I believe that if the criteria are met, any, or all of these would be of benefit to us Mid-Rangers.
When I applied our evaluative criteria to each of the seven CEFs, only three passed all four criteria - BCX, EXG and JGT. INB, HQH and CHW have relatively high annual expenses/fees, and JRS presently trades at a premium to NAV.
I have attempted to cover a lot of ground without making the length of this article unbearable, and I hope that I have succeeded without boring anyone.
As I mentioned in the preface above, I have absolutely no intention of purchasing any of these stocks until I see how our fiscal cliff issues are resolved (if at all). I think if the country is allowed to go over the cliff, we will see a relatively sharp drop in stock prices. I am almost looking forward to this as far as the MLPs are concerned, as I think it will afford a buying opportunity that we haven't seen since 2008-2009.
I do not believe that any of us have a real idea how the markets will perform in 2013 (although lots of so-called experts are trying to make us believe that they know), so I think we all just sit back and wait.
In the meanwhile, those of us whom desire will have the opportunity to celebrate the birth of our Lord.
Barring any significant changes in the world, I probably will not be composing any additional articles until after Christmas, so I hope that you all have a very Merry Christmas with families and friends.
And, for those of you believing the world will end on December 21st, it was nice having you as readers for a while.
Additional disclosure: The information contained in this article does not constitute a recommendation to buy or sell any of the stocks mentioned.