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Cliff Wachtel
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Cliff Wachtel, CPA, is currently the Director of Market Research, New Media and Training for Caesartrade.com, a fast growing forex and CFD broker. He covers a variety of topics including global market drivers, forex, currency hedged and diversified income investing, and is currently working on a... More
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  • THE MUST-AVOID SEVEN DEADLY SINS FOR INCOME INVESTORS: PART 11A OF A SERIES

     

     

    PART 11A OF A SERIES OF ARTICLES: THE HIGH-DIVIDEND INVESTOR’S COLLAPSING DOLLAR SURVIVAL GUIDE- A MID-SERIES REVIEW

    Introduction

     

    For my regular readers the below may seem a bit repetitive. However, the fundamentals of good teaching include constant repetition, summary, and drill. 

     

    Thus it's critical to occasionally review the key points of income stock investing.

    So, dear readers, here's a review of the Must-Avoid 7 Deadly Sins for Income Investors.

     

    Part 11B will briefly review the best of the specific recommendations covered thus far in this series.

     

    1. Ignoring the Overall Market Trend

    While you don't have to attempt to time market tops and bottoms, one should always be aware of the markets' overall trend.  In particular:

     

    A. If the market is in an established downtrend

    Invest only funds you can let sit, and be very selective about what you do buy. Also, because down trending stock prices usually move in a downward channel, set your buy prices near the lower range of that declining channel if you want to try to get the lowest near term price.

     

     

     

    Don't confuse this with picking an overall bottom. In an established downtrend, assume prices will ultimately head lower until there are clear signs of a reversal.

     

    B.  If the market is in an established uptrend

    You can be more aggressive, accepting lesser yields for stocks that are appreciating with the idea that you'll take some profits when the trend fades. Again, however, stocks don't trend straight up or down. Usually up-trending they fluctuate within a rising channel, so try to set your buy prices near the lower end of the rising channel.

     

     

    C. If the market is in a trading range

    Set your buy orders at the low end of the range (support) and consider taking at least some profits at the upper end (resistance).

     

     

     

     

     

     

    2. Ignoring Likely Support and Resistance Points – The Keys to Knowing When to Buy and Sell

     

    Those familiar with technical analysis can skip this section.

     

    While income investors are justifiably more inclined to be long term buy and hold investors, they should still be well versed in enough technical analysis and chart reading to identify support/resistance price levels for choosing buy prices (or selling puts for extra income) and resistance levels for selecting points to consider taking some profits (or selling some covered calls for extra income).

     

    A. Definitions

     

    What are these? In their simplest forms:

     

    A support level is simply the lowest price that a stock has reached over a given period before stopping its decline and then reversing direction and rising. It’s like getting the stock on sale. The more times that level has been reached but not breached, the more tested and reliable it is.

     

    A resistance level is the highest price a stock has reached over a given period before halting its rise and then declining. The more times this peak price has been reached but not penetrated, the more tested and reliable it is.

     

    In short, support and resistance define the likely lower and upper range in which a stock price fluctuates over a given time.

     

    Note: Once breached, support becomes resistance, and resistance becomes support. In other words, if a stock had never declined over the past 5 years below $10 and then falls below it and stays below for more than a brief period, the prior $10 support level is now consider a resistance level. That is, as the stock price approaches $10 it will be expected to retreat and thus this might make a good selling point. If, however, the stock rises above $10 and stays above it, that price again becomes a support level.

     

    There is plenty of good, free information online about the different kinds of support and resistance price levels. Some, like trend lines and price support levels, will make intuitive sense. Others, like Fibonacci retracements and extensions, may not.

     

    However the following list of types of support and resistance are widely followed and used, making their influence a self fulfilling prophecy by virtue of their sheer popularity.

     

    So if you want a clearer idea of when to buy (or sell puts) or sell (or sell covered calls), study the following concepts.

     

    B.  Basic Types

     

    Most Basic

    Definition of price support and resistance

    Trend lines

    Channels

    Moving Averages

    Bollinger Bands

     

    More Advanced

    Fibonacci retracements and extensions

    Parabolic SAR

    Classic chart price patterns

    Classic candlestick patterns

     

    There are many more I could give here, but this section is obviously for those new to technical analysis.

     

    C. Sources of Free Study Materials

     

    1.   Your own internet search

     

    To search out free sources on basic technical analysis, use search terms like:

     

    “Technical analysis” AND Introduction

    “Technical analysis” AND (support OR resistance)

     

    2.   A few specific recommended sites include:

     

    General Investing Education Sites

    www.investopedia.com/u...

     

    Foreign Exchange Trading Sites

    Because technical analysis is so heavily used in forex trading, these sites often have good education resources on various aspects of technical analysis. Once you learn about it and want to test your ability to use it, they also provide free practice accounts for 30 days where you can try to paper trade and test yourself. There are many, but here are a couple I liked.

     

    www.avafx.com It’s concise and clear, a good place to start for a quick overview. I also found their email and live chat support very responsive and helpful when questions arose. If you want to practice technical analysis with a free practice account, their trading platform was easy to use and had good yet easy charting tools. I’m involved with forex trading, and my experience with them thus far has been good.

     

    To access their free technical analysis materials:

    Click on the RESOURCES tab on the upper horizontal navigation bar, then

    Click on Education Center at the top of the left margin

     

    www.babypips.com/school A wide selection of often good but brief technical analysis topics. Choose from a variety of levels and subjects in the left margin

     

     

    3. Assuming Lower Yield Is Necessarily Safer

    Many intuitively equate lower yield with greater stock price or dividend stability.  Yes, in theory, perfectly functioning markets should automatically and instantly assign safer companies lower yields and vice versa in relation to their perceived risk levels. In fact, perceived risk and reward usually are inversely related, especially in periods of relative market calm.

     

    However, markets are often neither rational (especially during historically extreme bull or bear markets) nor fully informed, nor up to date with reality. In strong bear markets such as this one, even solid stocks sell off with the general market as investors indiscriminately sell stocks to raise cash and reduce risk of further loss. Thus their yields rise proportionally.

     

    For example, if a stock cost $10, and pays $1 of annual dividends, it yields 10%. If that price drops to $7, yet net income or funds from operations (in the case of MLPs and certain income funds) remain stable, the dividend holds steady, and the stock now yields 14%. In this case, the yield does not reflect increased business risk. Of course, it may, if the stock is cyclical and performs along with the overall economy, as is the case with many non-essential consumer and luxury goods stocks, heavy manufacturers, real estate, etc).

     

    Thus the high yield can simply reflect the overall market's weakness or misperception, not necessarily a problem with the company. This is especially true for dominant companies in recession resistant niches like utilities or other power generators, firms with largely fixed revenues via long term contracts with stable customers, dominant or near monopoly suppliers of critical services or products like energy infrastructure MLPs or income funds, certain communications service providers, etc.

     

    Again, virtually all stock prices follow the market. Thus even the largest, theoretically more stable firms' stock prices drop in approximate proportion to the overall market along with medium and small cap stocks in more recession proof niches that may offer better yields and performance.

     

    A. Defining Acceptably High Yields

    While what constitutes an acceptably high yield for income is debatable, it's clear that the typical sub-5% yields seen in blue chips or "dividend aristocrats" companies will leave you with virtually nothing after real inflation and taxes.

     

    Yes, over time they do grow their dividends, but rarely is that annual growth dramatic enough to make a significant difference. For example, if the annual yield is 3%, and the company raises the dividend 10% (an unusually high rate of dividend growth) you're still only getting 3.3% per year. Real inflation (i.e. the actual cost of living for those of us who eat, use energy, education, medical services etc) is usually well above that level.  You need a large principal invested at that rate to have anything left after real inflation and taxes.

     

    One of the few upsides of strongly bearish markets such as this one is that it’s possible to find very solid companies with reliable yields above 8%, because:

    Even prosperous companies see their stock price pummeled and thus their dividend yields rise in proportion to the price declines as panicky institutions (who hold most of the shares) and individuals sell indiscriminately

     

    Even when panic selling subsides, the residual heightened fear in bear market raises risk premiums as investors wait buy only the most tempting (i.e. lowest price, highest yielding) bargains.

     

    Thus under these conditions, I try to find quality companies yielding at least 8%. Yes, high inflation and taxes could wipe this out too, as could selling at a loss greater than your income. That's true for every stock.

     

     

    B.  Low Yield Dividend Stock Investing Is not the Same Thing as Income Investing

     

    However, your odds of profiting are obviously better with steady high yields than with steady low yields.

     

    With low dividends, your only chance to really profit is with price appreciation, which will be hard to get until the market enters a sustained uptrend, which is currently not expected.  The most optimistic speculation is for a flattening market remaining in a trading range for the coming years. That means short lived rallies. Try to catch them early if you can, but that's attempting to time the market. Few are consistently successful at that.

     

    Remember, stock prices follow the overall market, and the shares of larger, more established firms have been hit just as badly as those of smaller firms.

     

    4. Neglecting to Check If the Yield Is Sustainable

     

    On the other hand, the underlying business must be able to sustain and ideally grow the dividend. Whether you do the research yourself or use a newsletter like mine, it's critical to check the sustainability of the dividend. As mentioned in prior articles, you need to focus on overall business health, and especially on payout ratios and how income, funds from operations, and cash levels compare to current and future debt obligations.

     

    5. Failing to Calculate Minimum Needed Yield

    If you need $80,000/ year, and you have $500,000 to invest, what overall yield do you aim for? Divide income be principal: 80,000/500,000 = 16%.

     

    Ok, 16% is not realistic under current conditions unless one accepts higher risk levels or we get further periods of panic and new lows that produce opportunities for such yields. That may yet happen, though it will take courage to take substantial positions at that point.

     

    But this illustration does show that the investor needs to be pushing for the highest reliable yields possible.  Those with larger portfolios can be afford to diversify more into lower yielding stocks, those with smaller ones will need to choose between a narrower focus on higher yielding albeit quality stocks, and a somewhat lower yield with a more diversified mix and theoretically lower risk.

     

    6. Failure to Diversify Currency

     

    In the not so distant past this was almost irrelevant for US investors, who for generations had held the world’s safest currency backed by the world’s most stable economy. No longer.

     

    Now currency diversification has become critical, and failure to do so will probably be the biggest single mistake most U.S. income investors will make in the coming years.   

     

    With the US government committed (thus far) to printing about $13 Trillion in new dollars, (about a year’s worth of US Gross National Product) a steep devaluation in the USD's purchasing power seems inevitable at some point, and major overseas buyers of US dollars are very unhappy about that. Understandably, the major buyers of US Treasury bonds like China and Japan would like to further diversify out of the US dollar. Admittedly, though, it’s unclear how they’ll do this without hurting their own reserves or exports. Assuming they ultimately do reduce their demand for US Treasury bonds, this means declining overseas demand for dollars and thus further pressure on the USD likely at some point in the coming years.  

     

    This is a massive problem for income investors based in US dollars.

     

    Why? Because income investors are by definition usually in liquid currency denominated assets, their fate is tied to the currency in which that security is denominated.

     

    The solution is to own stocks and bonds denominated in different currencies (some more based on exports (Yen, CAD, AUD) some more on capital flows (GBP).  

     

    Caution: All other currency groups are also expanding money supply, and few are successful at predicting foreign exchange trends. Thus some diversification into high dividend investments that are based in other currencies is essential.

     

    7. Failure to Invest in Inflation Resistant Stocks

     

    Unfortunately, protecting your purchasing power will be more complicated than merely buying income stocks tied to other currencies. All currency blocks are expanding their money supplies, and that will at some point lead to erosion in their purchasing power, aka inflation.

     

    What makes a stock inflation resistant? The ability to pass on rising costs to its customers, aka pricing power.  This comes from businesses based in some kind of vital tangible asset or vital commodity, the price of which rises in proportion to the dollar’s decline. Energy, precious metal, agricultural and other key commodity businesses fit this category. Pricing power can also come from being a dominant or monopolistic provider of a critical service that allows the firm to pass along increased costs to customers. For all the bad press about them, certain large and rural telecommunications companies are good examples of this, as are certain energy infrastructure MLPs in the US and Canadian clean energy and energy infrastructure firms.

     

     

    8. High Dividend Stocks To Consider

     

    Our newsletter discusses these in more detail, but see Part 11B for a brief review of the best stocks covered thus far and of stocks to be examined in future articles in this series on The High Dividend Investor’s Collapsing Dollar Survival Guide.  

     

     

     

     

     

     

     

     

    9. Conclusion, Disclosure & More Info

     

    Here in Part 11A of this series on the High Dividend Investor’s Collapsing Dollar Survival Guide, we reviewed key mistakes that income investors must avoid in order for their portfolios to survive and prosper.

     

    In Part 11B we’ll briefly review the best of stocks covered thus far and still to be covered.

     

    Disclosure: I have positions in most of the above mentioned investments.

     

    Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendsto... Also, watch for coming notice of our quarterly newsletter, the High Dividend Stocks Guide Newsletter.

     

     

     

     

     

    Apr 28 6:03 AM | Link | Comment!
  • SKF Ultrashort Financials: Critical Immunization Against the Spreading Madness

     

     

    Is the banking sector rapidly disintegrating into some real-life version of The Mad Hatter’s tea party from Alice in Wonderland?

     

    Forget the volumes of technical debate on the current moves to save the banks. Let’s just step back and use common sense. Consider just a few recent events.

     

    Suspension of Mark to Market Accounting

     

    Using this method, mortgaged backed securities were valued just like any other asset for which there is an active market -  as of the latest sale prices for similar assets on the open market, just like you would determine a fair price for a house, car, business, or toaster. Prices of various kinds of debt have been reasonably discounted severely because there is now increased risk of default, just like used car prices drop with age and mileage because of the increased risk of loss from repair costs.

     

    With the suspension of “M2M”, the banks and government are attempting to inflate the value of banking assets based solely on current cash flow. By this logic, because GM bonds are current on interest payments, they should be valued at 100% of par rather than the 10% or less that reflects the risk of future default.

     

    It’s like saying that critically ill patients on life support are as healthy as anyone else as long as they continue to breath.

     

    The Fed Accepting Lower Quality Collateral

     

    Instead of just top-rated sovereign debt (admittedly no longer risk free), the Fed now accepts in certain cases investment grade corporate bonds and commercial paper, residential and even commercial real estate loans.

     

    • Residential Real Estate loans: Increasing joblessness (even at a declining rate of growth) means more mortgage defaults. Also, remember that employment is a lagging indicator, and thus will not improve until later in still unseen recovery.

     

    • Commercial real estate loans: As I’ve noted earlier, the bankruptcy of GGP, the largest mall REIT, casts genuine doubt about the stability of retail property valuations for the foreseeable future.

     

    • I haven’t even begun to discuss the manipulations needed to achieve the illusion of earnings improvements. Too technical for now.

     

    What Investors Can Do

     

    Because I believe critique without a practical remedy is of limited value for my readers, I leave you all with one simple strategy to protect your portfolios for the day when the façade falls away.

     

    Short the Financial Sector

    In short, by one means or another, short the financials.

     

    One simple idea: The Ultrashort Financials (SKF). As the below chart shows, these are at multiyear lows that are not justified the above noted facts in the banking sector. Given that these are at multi-year lows, you’ll know quickly if this support won’t hold, so you can set sell stops within 10% below these levels to keep your risk low. Given the recent highs, the possible risk / reward makes this a worthwhile trade.

     

    For chart see this post at: http:\highdividendstocksguide.blogspot.com

     

     

    Obviously there are other means, like shorting individual banks.

     

    Risks

    Given the manipulations already seen, it is not far-fetched to assume other “extra-market” manipulations means might be used to artificially prop up the banks or other assets. Government imposition of “bank holidays,” currency controls, extraordinary “emergency” legislation have all been used in the past and could be used again. We may be right in our analysis, but still not profit.

     

    Conclusion

     

    Based on the evidence we have, the optimism for the financials is overdone, and the SKFs are a good way to play that, at least for a short term hedge. Of course, if the financials swoon again, so will the rest of the market, so other ultrashorts like SDS, SRS, and TWM are ideas to consider as well.

     

    My readers know I’m more of a buy and hold investor for income, not a short term trader. However, a good investor must be flexible and be willing to look at the facts, draw conclusions, and take appropriate action, even if it goes against one’s nature.

     

    Disclosure

     

    I have positions in most or all of the above mentioned securities.

     

     

     

    Apr 24 3:45 AM | Link | Comment!
  • CANADIAN ENERGY INFRASTRUCTURE INCOME TRUSTS: HIGH DIVIDEND USD HEDGE UTOPIA, PART 10B OF A SERIES

     

     

    Like U.S. Master Limited Partnerships on Steroids: Higher Yields, USD Hedge

     

    Part 10B of a Series

    The High Dividend Investor’s Collapsing Dollar Survival Guide

     

    1. EXECUTIVE SUMMARY FOR THIS SERIES

     

     

    HIGH YIELD STOCKS ARE A FORM OF CASH. THUS INFLATION EATS AWAY AT BOTH YIELD AND PRINCIPLE. AS GOVERNMENTS INFLATE THEIR MONEY SUPPLY TO EASE CREDIT, MOST OBSERVERS BELIEVE INFLATION IS INEVITABLE.

     

     

    THUS FAR IN THIS SERIES WE EXPLORED:

     

    THE CURRENT STATE OF THE MARKET

     

    THE CASE FOR AND AGAINST THE DOLLAR’S DEMISE

     

    RECOMMENDED CRITERIA FOR SELECTING HIGH DIVIDEND STOCKS THAT ALSO GIVE A HEDGE AGAINST THE U.S. DOLLAR’S LIKELY IMPENDING DEPRECIATION.

     

    SPECIFIC STOCK MARKET HEDGES AND HIGH DIVIDEND STOCKS THAT ARE INFLATION RESISTANT MENTIONED BELOW INCLUDE:

     

     

    GENERAL MARKET HEDGES

    UltraShort S & P 500 Proshares (SDS), UltraShort Financials ProShares (SKF), UltraShort QQQ ProShares (QID), UltraShort Real Estate ProShares (SRS), UltraShort Russell2000 ProShares (TWM)

     

    INTERNATIONAL

    Big Oil

    BP, plc (BP), CNOOC Ltd. (CEO), Enid SpA (E), Total Fina Elf (TOT)

     

    Utilities

    Veolia Environmental SA (VE), ENEL-SOCIETA PER AZI (ESOCF.PK or ENLAY.PK)

     

    Communications

    Cellcom Israel Ltd. (CEL), France Telecom (FTE) Telefonica (TEF)

     

    Shipping

    Diana Shipping (DSX), Nordic American Tanker (NAT), Paragon Shipping (PRGN), Seaspan Corp (SSW)

     

     

    Canadian Oil/Gas Energy Income Trusts

    Advantage Energy Income Fund (AAV, TSX: AVN.UN), ARC Energy Trust (OTC: AETUF, TSX: AET-UN), Claymore/SWM Canadian Energy Income Fund (ENY), Enerplus Resources Fund (ERF), Peyto Energy Trust (OTC: PEYUF, TSX: PEY.UN), Provident Energy Trust (PVX, TSX: PVE.UN), Vermillion Energy Trust (OTC: VETMF, TSX: VET.UN)

     

    Canadian Income Trust Tax Issues

     

    IN PART 9 WE LOOKED AT BOTH

    The recent uptrend in the stock markets and the U.S. dollar versus the Canadian dollar, and why they’re unlikely to mark the beginning of long term trends

    AND

    Canadian Clean Energy Income Trusts

    Atlantic Power Corporation (OTC: ATPWF, TSX: ATP.UN), Energy Savings Income Fund (OTC: ESIUF, TSX: SIF.UN), Great Lakes Hydro Income Fund (OTC: GLHIF, TSX: GLH.UN), Innergex Power Income Fund (OTC: INRGF, TSX: IEF.UN), Macquarie Power & Infrastructure (OTC: MCQPF, TSX: MPT.UN), Northland Power Income Fund (OTC: NPIFF, TSX: NPI-U)

     

    HERE IN PART 10, WE’LL EXAMINE:

     

    Canadian Energy Infrastructure Income Funds

    Altagas Income Trust (OTC: ATGFF, TSX: ALA.UN), InterPipeline (OTC: IPPLF, TSX: IPL.UN), Keyera Facilities (OTC: KEYUF, TSX: KEY.UN), Pembina Pipeline Fund (OTC: PMBIF, TSX: PIF.UN)

     

    IN COMING PARTS WE’LL EXPLORE:

     

    Canadian Utility Income Trusts

    Bell Aliant (OTC: BLIAF, TSX: BA.UN)

     

    Canadian Health Care Income Trust

    CML Healthcare Inc. Fund (OTC: CMHIF, TSX: CLC.UN)

     

    Canadian Real Estate Income Trusts

    Canadian Apartment Properties REIT (OTC: CDPYF, TSX: CAR.UN), Northern Property REIT (OTC: NPRUF, TSX: NPR.UN), RIOCAN REIT: (OTC: RIOCF, TSX: REI.UN

     

    Canadian Misc Business Trusts

    Yellow Pages Income Fund (OTC: YLWPF, TSX: YLO.UN)

     

    UNITED STATES

     

    Communications

    AT &T Inc (T), Verizon (VZ), Otelco (OTT), Windstream Corp (WIN)

     

    Energy Infrastructure Master Limited Partnerships (MLPs)

    Buckeye Partners (BPL), El Paso Pipeline Partners (EPB), Enterprise Products Partners (EPD), Energy Transfer Partners (ETP), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), Nustar Energy (NS), ONEOK Partners (OKS), Sunoco Logistics Partners (SXL), TEPPCO Partners (TPP), Tortoise Energy Infrastructure Partners (TYG)

     

    Coal MLPs

    Alliance Resource Partners (ARLP), Northern Resource Partners (NRP), Penn Virginia Resources Partners (PVR)

     

    Other MLPs

    Terra Nitrogen Company, L.P. (TNH), StoneMor Partners (STON)

     

    Utilities

    Dominion Resources Inc. (D), Duke Energy Corp (DUK), Progress Energy (PGN), Southern Company (SO)

     

     

    2.  THE MARKET

     

     

    See Part 10A. Here in 10B we get right to our examination of Canadian Energy Infrastructure Income Trusts.

     

     

     

     

     

    3. CANADIAN ENERGY INFRASTRUCTURE INCOME TRUSTS - The Big Picture

     

    A. Comparison to U.S. Energy Infrastructure Master Limited Partnerships (MLPs) – Similarities and Differences

     

    See Part 10A for the full story. Here’s a summary of the key points

     

    We will deal with these U.S. MLPs in depth in future articles. However, for now, here’s a list of our favorites:

     

    ·         Buckeye Partners (BPL)

    ·         El Paso Pipeline Partners (EPB)

    ·         Enterprise Products Partners (EPD)

    ·         Energy Transfer Partners (ETP)

    ·         Kinder Morgan Energy Partners (KMP)

    ·         Magellan Midstream Partners (MMP)

    ·         Nustar Energy (NS) – also has an asphalt production arm that will benefit from both a shrinking number of suppliers and the Obama administration’s push for infrastructure projects like roads.

    ·         ONEOK Partners (OKS)

    ·         Sunoco Logistics Partners (SXL)

    ·         TEPPCO Partners (TPP)

    ·         Tortoise Energy Infrastructure Partners (TYG) – actually a fund that serves as a basket of these kinds of businesses

     

    1.   Similarities

     

    Like the U.S. MLPs, these Canadian midstream (pipelines and storage) firms:

     

    ·         Must distribute most of their available cash (90% for the U.S. MLPs in most cases) after that needed for maintenance and of current projects and new ones needed to maintain or grow revenues.

     

    ·         Don’t pay tax at the entity level. Until Canadian tax law changes in 2011, those that don’t elect early conversion to corporations are not taxed at the entity level, allowing higher yields. While there is some uncertainty about how 2011 driven conversions to corporations will affect these trusts, the bottom line is that our selections’ distributions should not be significantly impaired due to various factors discussed below.

     

    ·         Their revenues are generally based on capacity sold in advance to energy producers regardless of whether that oil or gas is actually moved through their pipelines or not.

     

    2.   Advantages

     

    Thus like their U.S. counterparts, they offer reliable, high yields. However, they offer some intriguing advantages.

     

    ·         Higher Yields: Their yields are generally a bit higher than the approximately 9% average of the U.S. MLPs.

     

    ·         USD hedge: They all pay distributions in CAD (usually converted to USD by brokers in the U.S.), thus offering a USD hedge.

     

    ·         Monthly distributions: Most pay each month, not quarterly like their U.S. counterparts.

     

    3.   Risks

     

    ·         2011 Canadian tax changes may adversely affect yield: Yes, the 2011 driven conversion to corporations with an additional layer of tax at entity level raises questions about how well each firm will be able to maintain its yield. As a group, energy infrastructure companies have relatively high depreciation expenses that can offset taxes.

     

    Also, our specific picks are growing their businesses and can be expected to ultimately increase funds from operations and thus distributions to make up for funds lost to taxes. Note that most Canadian companies do not pay full theoretical taxes due to careful tax planning.

     

    ·         Currency Risk: Distributions and share prices in CAD can be a dual edged sword. There will be periodic declines in the value of the CAD against the USD.

     

    See Part 9A for full details on why we believe the CAD will appreciate over the coming years against the USD. In short, a more conservative, healthier banking and housing sector that did not indulge in subprime lending has meant that the CAD supply is not expanding on anything close to the scale of the USD. While that isn’t the only factor to consider, it’s a big one.

     

     

    ·         Market Risk. Like virtually all shares, they will move with the overall market. Note that all of these are relatively thinly traded, and thus volatile, since little selling or buying can really move their share prices.

     

     

    Remember: energy transport and storage is one of the most recession resistant industries. Thus these are great defensive plays that pay you very well while you wait for recovery.

     

     

    4. ENERGY INFRASTRUCTURE INCOME TRUSTS– Specific Recommendations

     

     

    As noted above, consider deferring further purchases until the current rally retests support.

     

    NOTE:

     

    CANADA CURRENTLY HAS A 15% WITHOLDING TAX FOR FOREIGN SHAREHOLDERS, WHICH CAN BE RECOVERED AS A TAX CREDIT BY SUBMITTING IRS FORM 1116 WITH YOUR TAX RETURN. IT’S AS YET UNCLEAR IF OR HOW THAT WILL CHANGE IN 2011.

     

    ALL AMOUNTS QUOTED ARE IN U.S. DOLLARS (USD) UNLESS OTHERWISE NOTED. ALL STOCK SYMBOLS ARE NEW YORK STOCK EXCHANGE UNLESS OTHERWISE NOTED (OTC = OVER THE COUNTER, TSX = TORONTO EXCHANGE). YIELDS ARE AS OF DAY BEFORE PUBLICATION.

     

     

     

    A. AltaGas Income Trust (OTC: ATGFF, TSX: ALA.UN)

    In addition to the usual combination of oil and gas extraction, gathering, transmission, and processing, this firm also has a green power generation division focused on wind and geothermal facilities, thus diversifying into another reliable and growing revenue source.

     

    1.   Advice

    Buy under 12.15, Strong Buy under 1015. Yield over 17%.

    Website:  http://www.altagas.ca/

     

    In addition to the usual combination of oil and gas extraction, gathering, transmission, and processing, this firm also has a green power generation division focused on wind and geothermal facilities, thus diversifying into another reliable and growing revenue source.

     

    2.   Why: Q4 Highlights include

     

    ·         15.4% increase in funds from operations (FFO)

    ·         Continued expansion of wind and geothermal generation assets in power hungry Western Canada

    ·         Successful renegotiated credit agreement supports our view that the firm has no credit access problems in a generally restrictive market, and puts the company in a position to make further strategic acquisitions at bargain prices

    ·         Payout ratio remains a conservative 72%, adding security to the distribution

     

     

     

    3.   Concerns

     

    Impact of 2011 tax increases

     

    Both the high yield and low payout ratio provide significant cushion against higher taxes. Cut this by a third and you’re STILL getting around 12%.

     

    Like all energy infrastructure firms, high depreciation expenses will protect a substantial portion of distributions from classification as taxable income to tax free return of capital.

     

    12 month growth in outstanding shares is about 23%

     

    We’d like this below 10%, and consider anything over 20% to be too dilutive. We’ll accept this for now, based on the solid overall results and understandable reluctance to increase debt.

     

    4.   Conclusion

    With their excellent performance in a tough market and timely emphasis on gas and other high demand “green” energy sources, insiders have been buyers on the price dips. Me too.

     

     

    B.  Pembina Pipeline Income Fund (OTC: PMBIF, TSX: PIF.UN)

     

    Owns and operates pipelines in the Alberta Tar Sands. While current energy prices have made tar sands oil unprofitable, that hasn’t slowed Pembina a bit. They get paid on a fixed rate of return basis, eliminating exposure to energy prices and even throughput declines.

     

    1.   Action

    Buy under 12, Strong Buy under 10. Yield over 13%.

    Website: http://www.pembina.com

     

    2.   Why

    To get a quick feel for how healthy Pembina is, consider just the following two facts:

     

    ·         The contracts are obviously long term, and the firm has affirmed that it will be able to at least sustain its current distribution through 2015, despite its plans to convert to a dividend paying corporation (thus taxed at entity level) sometime in 2010.

     

    ·         They continue to expand capacity, adding Horizon Pipeline system in July 2008, and are investing CAD 165 million in the new Nipisi pipeline and CAD 260 million in the Mitsue pipeline.

     

    ·         Debt has grown but remains quite manageable when compared to revenues and cash from operations shown in the below mentioned MD&A. Click on the link to see for yourself. Outstanding share growth over the past 12 months is around 1%. They have the cash they need.

     

     

    ·         A quick review of the Management Analysis and Discussion (MD&A – see  http://www.pembina.com/webcms.nsf/AllDoc/11E467568884F97B87257570000B9ED8/$File/2008MD&A.pdf  ) essentially shows increases in everything you want to see grow: Net earnings, cash from operations, distributable and distributed cash, etc. Debt levels are quite manageable. Enterprise value declined, but that is based on share price and thus much more a reflection on the overall market than the firm itself.

     

    3.   Concerns

     

    Payout ratio is about 95%. We would prefer this to be below 90%, but given the very steady fixed fee revenue stream, this is acceptable.

     

    4.   Conclusion

     

    Pembina is another classic case of a great investment getting unjustly slammed over confusion about its revenue health. While current energy prices may make the tar sands oil unprofitable, that has no effect on Pembina’s financial health or distributions until at least 2015. Ditto its conversion to a corporation in 2010.

     

     

     

     

     

     

     

    C. Inter Pipeline Fund (OTC: IPPLF, TSX: IPL/UN)

     

    Created in 1997, Inter Pipeline Fund is a major petroleum transportation, storage and natural gas liquids extraction business based in Calgary, Alberta, Canada. Inter Pipeline is a publicly traded limited partnership  (not a trust subject to 2011 tax changes) that owns and operates a diversified combination of energy infrastructure assets in western Canada, the United Kingdom, Germany and Ireland. This asset portfolio generates long-term and predictable cash flows, thereby providing unit holders with a growing and stable source of monthly cash distributions.

     

    Note: As a Limited Partnership under the laws of Alberta, only Canadian residents can own units. Bummer for the rest of us, and thus vastly limited demand for shares that will limit price appreciation for Canadian residents.

     

    1.   Action

    Buy under CAD 7.5, Strong Buy under 6.5. Yield about 13%.

    Website:  http://interpipelinefund.com/overview/index.html

     

    Since this is only for Canadian investors, I’ll limit coverage to this brief mention and refer Canadians to the website for more info. Like the others above – steady revenues, great yield, plus exposure to the Euro as well as the CAD.

     

     

    D. Keyera Facilities Income Fund (OTC: KEYUF, TSX: KEY.UN)

     

    Keyera operates one of the largest natural gas midstream businesses in Canada. Its three business lines consist of:

     

    ·         Natural gas gathering and processing

    ·         Processing, transportation, and storage of natural gas liquids (NGLs) and crude oil

    ·         Marketing of Natural Gas Liquids (NGLs) and sulphur. This gives them both added risk because this segment is exposed to prices for these commodities, and added reward when these prices are strong or their hedging strategies work well.

     

    Keyera's gas processing plants and associated facilities are strategically located in the west central and foothills natural gas production areas of the Western Canadian Sedimentary Basin. Keyera’s NGL infrastructure includes pipelines, terminals and processing and storage facilities in Edmonton and Fort Saskatchewan, Alberta, a major North American NGL hub. Keyera also markets propane, butane and condensate to customers across North America.

     

     

    1.   Action

    Buy under 12.50, Strong Buy under 12. Yield over 14%.

    Website: http://keyspancanada.com/titanweb/keyera/keyera.nsf/frmHome?openform

     

     

    2.   Why

    In short, great results.

     

    Record earnings and distributions, declining debt levels: For details, see highlights from the annual report: (http://keyspancanada.com/titanweb/keyera/keyera.nsf/AllDoc/132F8F32E5B7CBE587257567007788FA/$File/2008%20Q4%20final.pdf 

     

    Continued ability to obtain affordable financing: On April 14th 2009, the firm announced a long term senior unsecured debt private placement for CAD 97 million at 8.06% and will mature May 1, 2016. The funds will be used to repay CAD 90 million of existing long term debt when it matures on October 1 2009. In the words of CFO and VP Dean Setoguchi:

     

    “Our ability to complete this transaction at favourable rates, given the current economic situation, is a testament to the strength of Keyera’s business model and conservative approach to our financial management”.

     

    Continued expansion:  Not surprisingly, Keyera’s ability to prosper and obtain funding in this environment has allowed them to acquire strategic growth assets at favorable prices. In December 2008 the firm acquired additional interests in three gas gathering and processing facilities in West Central Alberta.

     

    Reliable distributions: Payout ratio is a very conservative 55%, share growth a conservative 10%. Except for the NLG by products sales, revenues are protected by capacity based contracts unaffected by oil prices or throughput. That is, customers contract on a long term basis to pay fixed fees to reserve a given volume of product to move through Keyera’s pipelines and storage facilities.

    3.   Concerns

     

    Revenues can be adversely affected by declines in the NLG by products sales.

     

    4.   Conclusion

     

    Even with risks from some exposure to the NLG by products prices, the high yield and ultra conservative payout ratio provide a large margin of safety. As energy prices recover, the NLG business will be a bonus.

    5. Conclusion, Disclosure & More Info

     

    Here in Part 10B presented specific recommendations of the best of the Canadian  Energy Infrastructure Income Trusts.

     

    In sum, they provide among the best risk/reward available for high dividend investors. They are similar in many ways to U.S. Energy Infrastructure MLPs, with the added advantage of generally higher yields and a valuable USD hedge. While the 2011 tax changes will cause these to convert to corporations, impact on the dividends of these specific recommendations should be minimal to none for at least the next number of years.

     

    Part 10B will look at specific recommendations in this sector

    Part 11 will deal with another superb Canadian income trust sector.

     

    Disclosure: I have positions in most of the above mentioned investments.

     

    Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendstocksguide.blogspot.com

     

     

    Apr 22 1:08 PM | Link | Comment!
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