If managing a retirement portfolio was easy, there would be no need for mutual funds, index funds, or ETFs. We would all just pick really good stocks and sit back and let the dividends roll in. Unfortunately, by investing in individual stocks, there are higher degrees of risk.
The way the Team Alpha portfolio manages some of that risk is to allocate funds judiciously, and to monitor the companies of the stocks we own. When an issue with a stock and a company becomes clear, then we have a decision to make; do we sit tight and wait, or do we sell the stock and look for greener pastures?
That is what the Team Alpha portfolio faces now with Linn Co, LLC (NASDAQ:LNCO).
Let's Review Team Alpha's Allocations
Our Team Alpha portfolio now consists of Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NYSE:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Linn Co, LLC (LNCO), Annaly Capital (NYSE:NLY), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Healthcare Select Sector SPDR (NYSEARCA:XLV), General Dynamics (NYSE:GD), and iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF).
|Starting Lineup||Allocation% Goal|
We recently sold Wal-Mart and some shares of Johnson & Johnson, to raise cash and repurchase shares of Annaly Capital. By so doing, we increased the overall dividend yield from 4.63% to 4.70% and increased our cash reserves to roughly 5%.
The Issue And Our Decision
Linn doesn't deduct the cost of its financial derivatives from its hedging gains in calculating a key cash-flow measure. That suggests cash flow is overstated.That yield has attracted investors, but they could be overpaying. Linn's units trade for 10 times 2012 pretax cash flow, roughly double the valuation of energy exploration and production companies such as Apache (NYSE:APA), Devon Energy (NYSE:DVN), and Canada's Suncor Energy (NYSE:SU), and in excess of valuations accorded smaller energy producers structured as MLPs.Moreover, Linn may be overstating the cash flow available for distribution, by not deducting the cost of financial derivatives-mainly put options-from its realized gains on hedging activities in its quarterly results.
If questions are being raised about LINE, it could directly impact the shares of LNCO, which does nothing more than hold shares of LINE to avoid the K-1 MLP tax issue, while paying investors regular dividends. The obvious intent was to enable more investors to hold LNCO in their IRAs, and also would not need to deal with another tax form (the K-1) outside of their IRAs.
When questions of this sort are raised, prudent shareholders must take note. While I had watched the share price of LNCO drop in recent weeks, I waited for confirmation from public sources to actually decide to take action.
While I have decided to sell LNCO from the Team Alpha portfolio on the next trading day, I should note that Linn Energy has stated that everything is fine with their accounting:
In a statement provided to Barron's last week, Linn said, "Nobody disputes that 'depreciation' of oil and gas assets should be deducted from Ebitda [earnings before interest, taxes, depreciation, and amortization] or distributable cash flow because it is a 'capital' expense, and we view puts the same way."
In the same statement, Linn expressed confidence "in the validity and accuracy" of its financial reporting.
Notwithstanding, most analysts have not paid much attention either, until recently:
David Amoss, an analyst at Howard Weil, broke ranks on Friday and downgraded Linn to Sector Perform from Outperform, citing the company's treatment of its hedging costs. Amoss cut his estimate of 2013 distributable cash flow to $2.45 per unit from $3.03, "to better reflect the underlying cost of the hedges" that he estimates at $120 million annually, he wrote in a client note. Linn might have to make accretive acquisitions this year to cover its $2.90 distribution, he added. Alternately, it is possible the distribution could be cut. Linn shares fell 3.8% on Friday, but still trade for two times book value.
I feel the prudent action for retirement investors to take would be to sell all shares of LNCO and place the cash in reserves to find another place for it to work.
By taking this action, we will be adding roughly $7,400 to our cash reserves for a total of about $15.5k. While we will be taking a small capital loss, the important effect will be in our dividend yield.
Since LNCO has a dividend yield of roughly 7.50% the portfolio will reflect this sale with a dip in the overall yield to 4.65%. That being said, we will now have a rather comfortable level of cash reserves at about 11% of the total portfolio value. Given that, I believe we can see some market dips in March or April, the cash could be redeployed into stocks that could come down in price that are already in the portfolio, or used to buy shares in different stocks, that offer us a sound dividend opportunity.
My next course of action will be to find one or two new little gems that will offer us some sweet dividends and maybe even some decent capital appreciation.
Additional disclosure: LNCO will be sold on the next day of trading.