This is an update of activity in my Retirement Income Portfolio for the past two weeks.
Increased utility exposure - Duke Energy added to portfolio
I decided it was time to boost the portfolio's exposure to utilities. On April 20, I added some initial shares of Duke Energy (NYSE:DUK) at $78.30. It now represents 2.3% of the portfolio.
Why Duke? I like DUK's size and the scale of operations that this allows. Geographically, DUK complements my other utility holdings, which are Southern Company (NYSE:SO), WEC Energy (NYSE:WEC), and CenterPoint Energy (NYSE:CNP). I like their recent acquisition of Piedmont Natural Gas (NYSE:PNY), a company whose shares I once owned and never found a re-entry point because the market consistently gave it a premium valuation.
I believe Duke Energy has taken significant steps to be a better keeper of the environment after a $102 million fine was imposed on the utility in 2015 after the infamous Dan River coal ash debacle.
For several years I've been looking for some of the large utilities to begin to assert themselves in the alternative energy/distributed energy business. I believe eventually the big utilities and the big oil companies will see opportunities in these areas - at least the survivors will. The publicity around the Dan River spill kept Duke off my radar for a time, but recently I took another look and decided to include DUK in the portfolio.
Duke through the lens of my checklist
In a January 24 article, I used a 20-point checklist to study Archer Daniels Midland (NYSE:ADM). Some readers saw the checklist as too long, so instead of seeing it as a 20-point checklist, I've modified it a bit and I now see it as a study that includes seven stops, or visits to seven resources. This gives one the flexibility to modify the checklist as one sees fit. It could have seven or ten points, or 20 or more.
1st Stop: FAST Graphs
At FAST Graphs, I learn that DUK has an A- credit rating from S&P, a 45% Debt/Cap percentage, and a current dividend of 4.2%. The graph shows the price slightly above the undervalued range, so it is in the fair value range. The 2015 price range is essentially the same as the 1997 price range. In the intervening years, the market price has been volatile. Duke's current management seems to be leading the company to a place where the market price is making a new base after a relatively flat overall performance.
2nd Stop: David Fish
Each month, SA Contributor David Fish provides a mammoth spread sheet with an extraordinary amount of data about companies that annual increase their dividends. His "CCC List" includes those that have raised the dividend at least 5 consecutive years (Challengers), at least 10 consecutive years (Contenders) and at least 25 consecutive years (Champions).
Duke Energy has raised the dividend 11 consecutive years. The 5-year growth has averaged 2.2% and the 10-year growth has averaged 4.7%. The current yield of 4.2% plus the 5-year growth rate of 2.2% gives DUK a "Chowder Rule" number of 6.4, which is lower than SA Contributor Chowder prefers for an initial purchase of a utility stock.
3rd Stop: FinViz
FinViz tells me that DUK's book value is $57.74, the trailing 12 months earnings per share is $4.03, the projected earnings for next year is $4.78, and that earnings are expected to increase 4.6% over the next five years. FinViz gives me these ratios:
- 19.6 Price/Earnings
- 16.5 Forward P/E
- 4.2 PEG Ratio (defined below)
- 2.3 Price/Sales
- 1.4 Price/Book Value
(The PEG ratio is the Price Earnings ratio divided by the growth rate.)
4th Stop: Morningstar
Morningstar gives DUK three stars. It shows me that revenues and earnings for the past three years have been relatively flat. A quick balance sheet review of assets and liabilities looks ok. Shareholder equity has been relatively flat for the past three years. It shows $6.676 billion in cash flow and 694 million diluted average shares, for a $9.62 cash flow per share in 2015. It also shows hefty capital expenditures for the past three years, including $6.766 billion, for a negative free cash flow of $90 million.
5th Stop: BetterInvesting.org
The business of alternative, renewable energy
Better Investing provides subscribers with a one-page Company Research sheet using data from Morningstar. The current yield of 4.2% is low relative to the high yields of the past five years. The current PE ratio of 19.5 is close to the 19.6 average PE ratio for the past five years. The current price of $78.78 is in line with the average price for the past five years.
6th Stop: Duke Energy's website
Duke Energy's website has a helpful Investors section. Generally, corporations have improved the quality of their websites to make them more interactive and user-friendly. Duke is no exception. Financial information, SEC filings, corporate governance documents, and much more is available at our fingertips.
7th Stop: Quarterly Conference Calls
I find it helpful to listen to webcasts of quarterly earnings calls. I look for clarity of information, transparency in presentation, and a willingness to engage analysts. In the 2015 Q4 conference call of February 18, 2016, CEO Lynn Good reported on the company's decision to exit their Latin America generation business as well as their proposed merger with Piedmont Natural Gas. Seeking Alpha is now putting transcripts and webcasts (where available) on one link.
The first quarter 2016 earnings will be released at 7 am ET on Tuesday, May 3. On the Investors opening page under "Upcoming Events" you can click the "First Quarter 2016 Earnings" button for a link to the webcast.
Duke's website has a section about Renewable Energy, with portals to wind, solar, biopower and landfill gas projects.
Added to my position in Southern Company
On April 21, I doubled my stake in Southern at $49.37. SO now comprises 2.9% of the portfolio. The utilities now makes up 8.8% of the portfolio's market value and 10.6% of the portfolio's income.
I believe Duke and Southern will become increasingly involved in alternative energy and distributed energy.
Southern's website has a similar section about Renewable Resources, with portals to solar, wind, biomass, green energy/landfill gas, and hydro.
As I explored these developments, I decided to limit my exposure to "yieldco" type investments to the three enterprises I have held for many months: the REIT Hannon Armstrong Sustainable Infrastructure (NYSE:HASI), the wind power company Pattern Energy (NASDAQ:PEGI), and the wood pellet/wood chip MLP Enviva Partners (NYSE:EVA).
I briefly held units of two partnerships, 8point3 Energy Partners (NASDAQ:CAFD) and NextEra Energy Partners (NYSEMKT:NEP). I purchased these as long term investments, but as I did further research, I decided to limit my alternative exposure to HASI, PEGI and EVA, and to increase exposure to DUK and SO, now that I am convinced they will follow through on some of their statements about embracing alternatives.
I bought units of NEP on March 4 at $24.71 and sold them on April 21 at $26.26. I bought units of CAFD on March 10 and March 23 for $15.11 and $13.83 (for a cost basis of $14.90). I sold them on April 21 at $15.21. Additionally, I "accidentally" received one quarter's income from the CAFD units.
So, "no harm, no foul." I believe three "yieldco" type investments will be enough for me to look after.
Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO)
I introduced this ETF in March 20 article and on April 22, I made an initial purchase of shares of VWO at $35.00. This ETF represents 1.0% of the market value of the portfolio and .9% of the portfolio's income.
The VWO purchase was the result of a limit order placed on April 18th. At the same time, I placed a limit order to buy shares of the WisdomTree Emerging Markets ETF (NYSEARCA:DEM) at $35.00. That order has not filled.
Federal Agricultural Mortgage Corporation (NYSE:AGM.C)
Here's one you don't read about every day. Known by the nickname "Farmer Mac," it was created by the Agricultural Credit Act of 1987 as a federally chartered, private corporation responsible for guaranteeing the timely repayment of principal and interest to investors in an agricultural secondary market.
This secondary market allows a lending institution to sell a qualified farm real estate loan to an agricultural mortgage marketing facility, or pooler, which packages these loans, and sells to investors securities that are backed by, or represent interests in, the pooled loans. Farmer Mac guarantees repayment and can also serve as a loan pooler.
The company was founded during a $4 billion bailout of the Farm Credit System, hoping to provide an alternative source of credit to farmers following the models of Fannie Mae and Ginnie Mae.
Farmer Mac's common stock symbol is AGM. The shares closed on April 29 at $40.68, up $1.21. The common stock pays a quarterly dividend of $.26 ($1.04 annually), for a current yield of 2.55%.
However, I do not own shares of the common stock. On April 28, I bought shares of AGM.C, a preferred stock that pays a quarterly dividend of $.375 ($1.50 annually). The purchase price was $26.35, which equates to a yield of 5.69%. The AGM.C shares now comprise 1.5% of the portfolio.
Why a preferred stock?
On April 27th, my portfolio reached a new high. It was up 15.2% for the year. For several days I had been looking for ways to "lock in" some of these gains. (I realize nothing is a "lock" with the market, but my goal was to increase the relative safety of the portfolio - particularly the safety of the income.)
I had already purchased shares of PSA.B, a preferred stock issued by Public Storage. As I looked at the portfolio, I was aware that I had no exposure to the financial sector (other than REITs, which will become a separate S&P sector this year). Many of the preferred stock issues in the U.S. are from banks and other financial institutions. So, I decided to look for four preferred stocks from the financial sector to go with the preferred REIT stock already in the portfolio. My goal was to find four preferred stocks that could each represent about 1.5% of the portfolio, for a total exposure of 6.0% in financial preferreds.
Laddering preferreds to prepare for RMD
There was one other element to my plan. I am scheduled to reach 70.5 in mid-2021. So, by April 1, 2022, I will need to begin making withdrawals from my IRA at least equal to the IRS required minimum distribution. I began looking for preferred stocks that are not callable until the required minimum distribution kicks in.
Just because a preferred stock has a date at which it can be called, it doesn't mean that the company will automatically call the stock at or soon after that date. But, I wanted to have the security that the stock will not be called until 2022.
I view a preferred stock almost like a bond and I began thinking about "laddering" some preferreds according to their call date. The PSA.B shares are callable beginning in 2021, so I'm looking for preferreds with call dates after that. AGM.C is callable beginning in July, 2024.
One advantage of common stock over preferred is that common stock dividends tend to increase and preferred dividends are fixed. So, there is no dividend growth.
What if today's market price is above the call price?
AMG.C is callable at $25, which means Farmer Mac could send me the $25 principal back at any time after July, 2024. You'll notice that I paid $26.35, so if the stock is called, I will get a $1.35 per share "haircut" from my purchase price. For each of the preferred stocks I've studied, I have calculated this "haircut" into the total return. I set a target price that would provide for a 5% annual dividend (with the "haircut" figured in). So, if Farmer Mac performs as promised, I will receive a 5.69% annual dividend on my purchase price. But, if the stock is called in 2024, the return will be "lowered" by the difference between the price I paid and the call price.
At the risk of being a bit "wonky," here's how it works:
For example, let's take PNC Bank's 6.125% preferred. It is callable at $25 in May, 2022. The recent price was $29.02. The yield at that price is 5.3%, but in order to get a 5.0% "guaranteed" return (should it be called at $25 in May, 2022), one would need to buy the stock at $26.25, or 9.5% less than the present price.
When I calculated the return on the Farmer Mac preferred, the price was $26.43, and this came to a 5.1% return (if called at the earliest possible date). I was able to purchase it at $26.35.
Other risks with preferred stocks
There are at least two other factors to consider with preferred stocks. One is the credit rating. AGM is not rated by S&P. It's a fairly small operation in the big scheme of things. Another factor is whether the preferred stock is cumulative or non-cumulative. This means that if for some reason the company suspends the dividend, their obligation to pay will be cumulative - which means they are on the hook for back dividends. AGM.C is not cumulative. So, these are two risk factors that must be considered.
I decided to take the risk. I have some awareness of their work through my farmer daughter. Her farm was too small to qualify for a loan through Farmer Mac, but her experience introduced me to the world of farm finance. AGM.C is a small part of the portfolio and the operation appears to me to be financially sound. From this Farmer Mac webpage, you can download annual reports and other financial information for the past three years.
Small purchase of Microsoft
On April 22, I made a small purchase of additional shares of Microsoft (NASDAQ:MSFT) at $52.04. (If my crystal ball had been working properly, I would have waited until it moved to the $49 range on April 29th!) MSFT now represents 4.4% of the portfolio.
Here is the portfolio with prices as of the close on Friday, April 29. Div is the annual dividend or distribution. Yld is the yield as of April 29. %Port is the percentage of the portfolio represented by each holding (and sector). %Inc is the percentage of portfolio income represented by each holding (and sector). Basis is the cost basis for each holding. Credit is the S&P credit rating for the company. CCC is the number of consecutive years of dividend increases, as maintained by David Fish's list of Champions, Contenders and Challengers. GPC is not rated by S&P, so the Value Line rating is listed. PSA's company rating is A and all of PSA's preferred issues are rated BBB+ by S&P.
|Int Bus M||IBM||145.94||5.20||3.6||4.3||4.3||140.78||AA-||20|
|Pub St Pfd||PSA.B||26.09||1.35||5.2||3.1||4.4||25.38||A/BBB+|
There are now 33 holdings in the portfolio:
- 27 common stocks
- 2 preferred stocks (PSA.B, AGM.C)
- 2 master limited partnerships (EPD, EVA)
- 2 ETFs (VNQ, VWO).
The portfolio yield as of April 29, 2016 was 3.6%. The gain for 2016 through April 29 has been 10.9%.
I welcome your questions and suggestions and I always enjoy our conversations in the comment thread. I encourage you to participate.
It is not my intent to advocate buying or selling any security. I offer this update to share ideas for stocks to study and as part of the journal of my ongoing effort to build a retirement income portfolio that puts a priority on relative safety, a history of dividend growth and solid future prospects.
Everyone's situation is different. Please do your own due diligence.
Disclosure: I am/we are long MMM, GE, CMI, EMR, UNP, DOV, MSFT, IBM, CSCO, QCOM, TXN, JNJ, PFE, MRK, PG, WMT, ADM, PEP, EPD,PEGI,EVA, PSA.B, VNQ, WPC, HASI, CNP,WEC, SO, DUK, GPC,AGM.C, T, VWO.
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.