- Internal management and greater diversity in BDC land.
- Another telecom added to the portfolio.
- Holding at 45--Nothing new currently on the shopping list.
This is Part 2 of a three-part article to describe Q1 changes in my Retirement Income Portfolio. My goal to diversify the portfolio is essentially complete, with the number of holdings increased from 40 to 45. One-third of the portfolio is made up of Dividend Champions.
Part 1 was published on April 16: Retirement Income Portfolio: A Stronger Focus On Dividend Champions. It described the purchase of Procter & Gamble (NYSE:PG), PepsiCo (NYSE:PEP), WGL Holdings (NYSE:WGL) and HCP Inc (NYSE:HCP).
Sold One and Bought Two Business Development Companies
In a March 16 article, The BDC Portion of My Portfolio, I described my decision to close a position in Prospect Capital (NASDAQ:PSEC), a popular, high-yielding BDC. Here's the short version of my reason to sell PSEC:
In my opinion, PSEC is one of the more aggressive BDCs. BDC Buzz, who is long PSEC, cited the potential big payoff (in yield) that comes with risk, and said "PSEC is about as renegade as I can handle."
I have come to view all BDCs with more skepticism. Nicholas Marshi, co-founder of BDC Reporter, said, "We doubt that the BDCs or the borrowers themselves have any certainty about who will prosper and who will fail in the next recession. I know this view frustrates many investors, but it's better to know what you don't know than have the illusion that you do, and act accordingly." This, for me, is a reason to limit one's BDC sector exposure to a fairly small percentage of the portfolio and to diversify, if possible, within the BDC sector.
I prefer internally managed, rather than externally managed BDCs, because sometimes the fee structure rewards externally managed BDCs to expand the numbers through debt. Debt has its place, but that seems to be a potentially dangerous incentive.
So, I sold PSEC and made an investment in two other BDCs.
Triangle Capital Corporation
TCAP is headquartered in Raleigh, North Carolina. The company website (www.tcap.com) describes their primary focus as "mezzanine financing with equity components for lower middle market companies." TCAP typically invests $5 to $35 million for acquisition financings, leveraged buyouts, management buyouts, recapitalizations, growth financings and employee stock ownership plans (ESOPs).
Triangle is an internally-managed BDC, founded in 2007, which offers subordinated debt with warrants, first and second lien loans, one-stop and uni-tranche structures, and equity co-investments. TCAP describes the "lower middle market" target portfolio companies as typically having revenues of $10 million to $200 million, and EBITDA of $5.0 million to $35.0 million.
As a business development company, Triangle generally does not pay federal income taxes on any net ordinary income or capital gains that it distributes to its stockholders as dividends.
TCAP's portfolio contains investments in a variety of business sectors including manufacturing, distribution, transportation, energy, communications, health services, and restaurants.
Triangle co-founder and CEO Garland Tucker also co-founded TCAP's predecessor companies, Triangle Capital Partners, LLC (2002) and Triangle Mezzanine Fund LLLP (2003). In 1991 he co-founded First Travelcorp, a corporate travel services company. Earlier positions included Group Vice President (for southeastern corporate finance) at Chemical Bank, New York and President and CEO of Carolina Securities Corporation. Tucker has been in the securities business since 1975.
Alan Brochstein concluded a November 2011 SA article about TCAP with this paragraph: While many factors ultimately influence the level of future dividends, it is very likely that the ownership of Tucker and his team and outside directors creates an incentive for its management team to steer it in a direction that sustains or even grows the payment without taking excessive risk. The fact that the company hasn't cut its dividend since the IPO reinforces this apparent alignment of the interests of management with investors.
Dividends paid since inception include:
2009 $1.62 (plus a 5 cent special dividend)
2014 $2.16 (indicated rate excluding special 15 cent dividend)
A special 15 cent dividend was declared early in 2014, in addition to the regular quarterly dividend of $.54. The March 26 dividend of $.54 was the fifth quarter paid in that amount.
I completed a Stock Selection Guide on TCAP. This tool was developed by the National Association of Investment Clubs in the 1950s. The SSG looks at ten years of history to determine a potential price range during the next five years. Data is from Morningstar via the NAIC website (www.BetterInvesting.org).
At a 4/16/14 price of $25.99, the Price/Earnings ratio was 8.8, below the 5-year average PE of 10.7. The current yield is 8.3%, below the high yields seen in each of the past five years, which ranged from 31.1% in the recession year 2009, 14.4% in 2010, 13.0% in 2011, 10.7% in 2012, and 8.5% in 2013.
David Fish includes TCAP among his Dividend Challengers and he calculates TCAP's five-year dividend growth rate as 8.4%, giving it a "Chowder Rule" number of 16.8.
TCAP trades at a premium to its net asset value (book value), which it reported as $16.10 on 12/31/13.
I projected a possible high price during the next five years of $45.10, and a possible low price of $22.60. This study determined a "buy" zone from $22.60 to $28.20 and a "sell" zone from $39.50 to $45.10.
I purchased TCAP at $26.82. During the past month the price has retreated. Since the time of purchase the stock has drifted down slightly, fluctuating between $25.67 and $26.98. The current price of $25.99 (which is in the "buy" range) reflects a potential compound annual return of 15% including dividends over the next five years, if the high price of $45.10 is achieved (and if the average yield for the next five years is 7.8%).
Main Street Capital Corporation
MAIN is a business development company headquartered in Houston, Texas. The company website (www.mainstcapital.com) states that MAIN "provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies." Typical Main Street investments support management buyouts, recapitalizations, growth financings, refinancings and acquisitions of companies that operate in diverse industry sectors. MAIN's strategy is to partner with entrepreneurs, business owners and management teams. Main Street offers "one-stop" financing alternatives for lower middle market companies that generally have annual revenues between $10 million and $150 million. Main Street's middle market debt investments are made in businesses that are generally larger in size than its lower middle market portfolio companies.
MAIN was formed in 2007 from predecessor funds that were founded in 1997. MAIN operates as an internally managed BDC. MAIN does not pay any external investment advisory fees, but instead incurs the operating costs associated with employing investment and portfolio management professionals.
Through a subsidiary, MAIN provides investment management advisory and other services to other parties and receives fee income for such services. As a business development company, MAIN generally does not pay federal income taxes on any net ordinary income or capital gains that it distributes to its stockholders as dividends.
Main Street has originated, purchased or financed lower middle market investments in over 164 companies in numerous industries. In addition to these lower middle market investments, Main Street has also completed debt investments in a variety of middle market businesses that are generally larger in size than its lower middle market portfolio companies.
Vincent Foster has served as Chair of the Board of Directors and CEO since 2007 and as President since October 2012. Foster also serves as a founding director of Quanta Services, Inc. (NYSE:PWR), which provides specialty contracting services to the power, natural gas and telecommunications industries, and as a director of Team, Inc. (NYSE:TISI), which provides specialty contracting services to the petrochemical, refining, electric power and other heavy industries. He also served as a director of U.S. Concrete (NASDAQ:USCR) from 1999 until 2010, Carriage Services (NYSE:CSV) from 1999 to 2011 and HMS Income Fund from 2012 until February 2013. Foster, a C.P.A., had a 19 year career with Arthur Andersen, where he was a partner from 1988-1997. From 1997, Foster co-founded and served as co-managing partner or chief executive of several Main Street predecessor funds and entities.
Dividends paid since inception include:
2007 $.33 (initial dividend after company organization)
2008 $1.425 (after paying three quarterly dividends of $.34, $.35, and $.36, MAIN began paying monthly dividends of $.125 in Q4 2008)
2009 $1.50 (twelve monthly dividends of $.125)
2010 $1.50 (twelve monthly dividends of $.125)
2011 $1.56 (three monthly dividends of $.125 in Q1, six monthly dividends of $.13 and three monthly dividends of $.135
2012 $1.71 (three monthly dividends of $.135, three monthly dividends of $.14, three monthly dividends of $.145, and three monthly dividends of $.15)
2013 $2.66 (three monthly dividends of $.15, six monthly dividends of $.155, three monthly dividends of $.16, for a total of $1.86 in regular dividends, plus special dividends of $.35, $.20, and $.25)
2014 $.99 (six monthly payments of $.165, for a current indicated rate of $1.98 in regular dividends)
At a 4/16/14 price of $31.64, the PE ratio was 11.9, above its five-year average PE of 8.5. The current yield is 6.1%, considerably below the high yields reached in each of the past five years, which were 12.5% in 2009, to 14.4% in 2010, 9.9% in 2011, 8.4% in 2012, and 8.0% in 2013. The market has given a premium valuation to MAIN. Some of the reasons for this are spelled out in Adam Glass' recent SA article about MAIN, which claims that MAIN is the "best dividend stock" in America. Adam reports MAIN's compound dividend growth rate 8.5% since inception in 2007.
I projected a possible high price during the next five years of $43.90, and a possible low price of $25.50. This study determined a "buy" zone from $25.50 to $30.10 and a "sell" zone from $39.30 to $43.90.
I made an initial purchase of MAIN at $34.48. The stock promptly retreated and I made a second purchase at $31.44. The current price of $31.64 (which is in the "hold" range) reflects a potential compound annual return of 8.0% including dividends over the next five years, if the high price of $43.90 is achieved (and if the average yield for the next five years is 6.9%).
If my judgment in compiling these two BDC Stock Selection Guides is accurate (which is always a big "if"), then TCAP appears to present a more compelling buy than MAIN at present. Those who follow MAIN closely are aware that its price has escalated more than most BDCs and it trades at a hefty premium to net asset value, or book value, which it reported as $19.89 on 12/31/13. My computations via the Stock Selection Guide tend to be conservative, and the SSG indicates that over the next five years the projected return from an investment in MAIN essentially will be the dividend payout.
Until recently, I had never seriously studied BCE, a Canadian telecommunications company, because of things like currency exchange and foreign taxes on dividends. When my wife began her venture into stock studies in January, she became very focused on a company's five-year dividend growth rate and the "Chowder Rule" number. Sometimes she would ask my opinion about a stock and I might offer some insight gleaned from Seeking Alpha or Sports Illustrated. When she asked me what I knew about BCE, I said, "It's a Canadian phone company and I think it was formerly known as Bell Canada Enterprises." She said, "Is that all you know about it?" I said, "That's about it."
Rather than being disappointed by my lack of knowledge, her competitive instinct kicked into action because she sensed that she had found one that I had missed. She ranked her potential stock purchases according to their five-year dividend growth rate and their "Chowder Rule" number. She announced that BCE's five-year DGR is 25.6% and BCE's Chowder Rule number is 30.9. I said, "That's pretty good." She gave me a sideway look that usually comes when I utter something that is inanely obvious.
I am pleased that she has found some good stocks that I had missed. Pride has no place in investment decisions and I am willing to pursue a good stock idea regardless of its source! So, I made an initial purchase of BCE at $42.77. BCE has raised the dividend each year since 2009 and it is on David Fish's list of Dividend Challengers.
BCE is Canada's largest communications company, which (according to their website: www.bce.ca) provides "a comprehensive and innovative suite of broadband communication services to residential and business customers in Canada."
The company sees itself as having made "industry-leading investments in media content and broadband networks," including "high-speed Fibe Internet, Fibe TV, Satellite TV, Bell Mobility and Virgin Mobile, Home Phone local and long distance services as well as IP-broadband services and information and communications technology (ICT) services."
Bell Media is BCE's newest division, described by the company as "Canada's premier multimedia company with leading assets in television, radio and digital media. They include CTV, Canada's #1 television network, and the country's most-watched specialty channels." BCE shares are listed in Canada and the United States.
US companies tend to be circumspect about possible future dividend decisions. BCE, on the other hand, provides a schedule of upcoming dividend dates and amounts, "subject to approval by the Board of Directors." The company anticipates paying a $.6175 quarterly dividend in July 2014, October 2014, and January 2015.
I completed a Stock Selection Guide on BCE. At a 4/16/14 price of $44.23, the Price/Earnings ratio was 17.4, well above the 5-year average PE of 12.9. The current yield is 5.0%, below the high yields seen in each of the past five years, which ranged from 8.6% in the recession year 2009, 7.0% in 2010, 6.0% in 2011, 5.7% in 2012, and 6.0% in 2013. BCE's declining yield over the past five years reflects our current bull market. Investors need to be aware that many stocks are not cheap at present, when compared with the stock's recent history.
I projected a possible high price during the next five years of $60.70, and a possible low price of $38.70. This study identified a "buy" zone from $38.70 to $44.20 and a "sell" zone from $55.20 to $60.70. Thus the present price of $44.23 is in the "hold" range, barely above the top of the "buy" range.
From the BCE website: Dividends paid or credited to non-residents of Canada are subject to a 25% withholding tax unless reduced by treaty. Under current tax treaties, U.S. and U.K. residents are subject to a 15% withholding tax.
On my spreadsheet, I post everything in Canadian dollars, except in the dividend column. I use this formula for the quarterly dividend:
.6175 x .91 (the dividend in Canadian dollars x the current exchange rate, which is 1C$ = .91$US). Thus the dividend is $.561925 US.
I multiply this number by .85 to deduct the 15% Canadian withholding tax:
.561925 x .85 = .4776362 (which give me the after-tax dividend in US dollars).
Thus, my spreadsheet indicates BCE dividend income as currently $.4776 per quarter per share in US dollars. For US holders of BCE, it is my understanding that a tax credit is available to offset the Canadian withholding tax, but this is not available for BCE shares held in IRAs. Perhaps SA readers who hold BCE shares can provide more information.
Retirement Income Portfolio as of April 17, 2014
Holdings added since 12/31/13 are italicized. The "Yr" column indicates that the dividend has been raised every year since the year stated. The closing price on April 17 is provided, along with the current annual dividend or distribution, the current yield, the actual percentage of the portfolio for each holding and the target percentage goal for each holding.
|American St Water||AWR||55||31.00||.81||2.6%||1.1%||1.0%|
|Northwest Nat Gas||NWN||56||44.53||1.84||4.1%||1.5%||1.5%|
|Procter & Gamble||PG||57||81.76||2.57||3.1%||2.8%||3.0%|
|Johnson & Johnson||JNJ||63||98.96||2.64||2.7%||3.4%||3.0%|
|Leggett & Platt||LEG||72||32.95||1.20||3.6%||1.1%||2.0%|
|Universal Hlth Rlty||UHT||87||42.68||2.50||5.9%||1.5%||1.5%|
|National Retail Prop||NNN||90||34.15||1.62||4.7%||1.2%||2.5%|
|Kinder Morgan Prt||KMP||97||77.49||5.52||7.1%||5.4%||3.5%|
|Enterprise Prod Prt||EPD||97||72.95||2.84||3.9%||2.5%||3.5%|
|Deere & Co||DE||04||93.40||2.04||2.2%||1.6%||2.5%|
|Digital Realty Trust||DLR||05||53.47||3.32||6.2%||1.9%||2.5%|
|Starwood Prop Trust||STWD||09||23.20||1.92||8.3%||5.6%||3.0%|
|Main Street Capital||MAIN||10||31.56||1.98||6.3%||2.2%||1.0%|
|Merck & Co||MRK||11||56.47||1.76||3.1%||2.0%||2.0%|
|Medical Prop Trust||MPW||13||13.34||.84||6.3%||1.4%||1.0%|
|American Rlty Cap||ARCP||13||13.29||1.00||7.5%||1.8%||2.0%|
|Monmouth Real Est||MNR||9.43||.60||6.4%||2.5%||2.5%|
The goal for cash is 7.5% and the current cash level is 1.1%. The current yield of the portfolio is 5.1%.
In Part 3 of this article, I will give the rationale for purchasing Deere, Tupperware, Mattel and American Realty Capital. At present, I have no additional stocks on my "shopping list."
I offer this as a journal of how I am approaching my retirement income portfolio. It is not a recommendation to buy or sell any security. Everyone's situation is different. It is crucial that you perform your own due diligence. These "long" positions are presented to give you some ideas for stocks to study. Just because a position has been closed does not mean I have a negative view of these investments. Sometimes a sale was made to take a profit or to rebalance the sector allocation of the portfolio.
Disclosure: I am long AWR, NWN, PG, EMR, GPC, KO, JNJ, SYY, LEG, PEP, ED, WGL, T, HCP, UHT, NNN, O, KMP, EPD, WPC, SO, AVA, GIS, WEC, DE, DLR, WR, TCAP, STWD, BCE, TUP, MAT, ETN, LNCO, EPR, LTC, VTR, RYN, MAIN, MRK, PPL, CSG, MPW, ARCP, MNR. 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.