Peering Deep Down Into the Mine for Yields

Includes: AUY, CDE, GXP, NG, NSEC, OLP
by: Yieldpig

As far as singer/songwriters go, few come close to Johnny Cash in terms of using economy with brilliance. In as few words and chords as possible, the Man in Black rarely failed to educate, intrigue, and oftentimes, even haunt the listener. The excellent “Dark As A Dungeon” (best version of this Merle Travis gem is on the mind blowing At Folsom Prison album...the song starts at about 3:07 on the video) is a prime example. In as few words as possible, the narrator warns of the perils of working in a mine. Investors could also learn from the tale. Maybe there’s some value down there but be careful.

We’ve snapped on gold a few times throughout the year and we’ve decided to throw in the towel…sort of. While the gold ETF tracker GLD has burned up the track, the mining stocks, traditionally the equity proxy for the shiny yellow metal before the advent of the ETF tracker, have lagged noticeably. If you must have exposure to gold, which isn’t the greatest idea based on its run, the miners may be the way to do it.

Of course our biggest beef with gold has always been that it pays the owner precisely bubkus. Some of the miners may throw off a dividend which is always nice. Our idea, though, involves writing (selling) call options against the long position of the equity. With the crazy price of gold, out of the money premiums have been quite sexy which is always a plus with underperforming equity prices. For illustration purchases, we’ll discuss Yamana Gold, Inc. (NYSE:AUY), Novagold Resources, Inc. (NYSEMKT:NG), and Coeur D’Alene Mines (NYSE:CDE).

1. Buy AUY at around $11.60. Sell the April 12 call at $0.97 ($97 per contract). The stock pays a $1.03 dividend. If called away, the approximate return in roughly 5 months is 14.5%. Unchanged (not called) would be 12.6%. This includes the dividend. Not a bad turn.

2. Buy NG at around $14.65. Sell the March 16 call at $1.55. If called in about 4 months, total return would be 13.4%. Unchanged equals 10.58%. No dividend but we like that one a lot.

3. Buy CDE at around $24.37. Sell the March 26 call at $2.60. For four months work, your return if called would be nearly 12.45%. Uncalled? Right around 10.6%. CDE doesn’t pay a dividend, either. Still, as Larry David would say: “Prettttay good!”

Always keep in mind, options carry all kinds of risk. That’s why the CBOE prints that little maroon book you get when you puff out your chest and belly up to the bar at the Covered Call Saloon. The most obvious risk, naturally, is capping your upside. If the stock rockets to $25 and you’ve written a 16 call, you’ve got to be ok with that.

Again, we’re not super bullish or bearish on gold. However, there is no denying that it is an asset class that some investors probably should have some kind of exposure to. So…if you must seek some fortune down in the mine, don’t spend too much, hedge a little and get paid for it.

Let's check out these three lil' piggies we dug up fer ye'....

“Lighting up the plains…”

Great Plains Energy, Inc. (NYSE:GXP)

Recent Price: 19.20

P/E: 11.36

Current Yield: 4.32%

The Skinny

Typically, 4.32% doesn’t get our pulse racing. GXP’s a little different. It’s more of a valuation thing. A little background: GXP, an electric utility, serves 820,000 in western Missouri and eastern Kansas. Recently (2008) GXP acquired problem child Aquila, Inc., a Missouri based electric utility. The stock trades close to its tangible book value with a low teens multiple. Although a boring, lumbering utility, GXP trades at a discount to its peers and underlying numbers that low leave some room for upward growth. Throw in 17% or so YOY revenue growth and this idea may merit some thought.

The Danger

Now that the federal government has had its fun with healthcare and financial services reform, it’s time to party with energy policy, although the recent midterm elections may slow that somewhat. Regardless, any utility will deal with some sort of regulated overhang. GXP’s is most likely coal related since the black carbon rocks represent 80% of its fuel sources. The biggest concern, however, was last year’s dividend cut. Hopefully they’re finished with that but you never like that specter floating around. The dividend cut brought the pay out ration down to the 70’s which is still a bit high in our opinion.

“With liberty and property for all…”

One Liberty Properties, Inc. (NYSE:OLP)

Recent Price: 15.10

P/E: 10.4

Current Yield: 7.94%

The Skinny

The pending commercial real estate bloodletting hasn’t quite materialized as expected (let’s don’t kid ourselves…happy days aren’t here again) so, maybe it’s safe to peek out of the bomb shelter and look at some REIT’s. OLP may be worthy of glance. They own primarily improved CRE under long-term net leases. Shares trade relatively close to book so, no fear of over paying there. Due to a smart acquisition, rental income grew this year and, in general, over all revenue was up which says a lot, especially in this environment. OLP’s tenants are some of the best brands out there: Best Buy (NYSE:BBY), Kohl’s (NYSE:KSS), CVS (NYSE:CVS), as well as some better regional players. Management knows what they’re doing and the internal numbers reflect that.

The Danger

Three words: “commercial real estate”. The economy isn’t out of the woods and neither is the sector. Although the onslaught hasn’t occurred as predicted, it will in some form sooner than later mainly as a function of rising interest rates. And though the portfolio hosts some great retail names, there a few clunkers that would make a landlord a bit nervous: Barnes and Nobles (NYSE:BKS), Office Depot (NYSE:ODP), and OfficeMax (NYSE:OMX) have had their fair share of drama which tends to be contagious.

“It’s a matter of National Security…”

National Security Group (NASDAQ:NSEC)

Recent Price: 11.50

P/E: 5.29

Current Yield: 5.21%

The Skinny

With the happy fingers of TSA burning up the 24 hour news cycle, it’s ironic that this one popped up on our screen. NSEC, however, has little if anything to do with the country’s security complex. Headquartered in Elba, AL (yes…publicly traded companies do exist in Alabama), NSEC provides property and casualty as well as life insurance services in the United States. This is an asset idea. The stock trades at almost half of its tangible book value. With the reasonable to cheap valuation and decent yield, stuff like that gets our attention. The company has been around since 1947 and has paid a dividend since 1976 so, it’s not a new idea. Nothing fancy. Just a good steady business (premium growth has averaged around 11% over the last ten years) at a decent price.

The Danger

There’s a lot not to love about an insurance company. The business model is basically a bet: they bet that you’ll continue to pay them more often than they’ll have to pay you. Multiply that by tens of thousands of policy holders and the odds for the house are pretty good. But when that big number comes in (Ivan, Katrina, the Great Chicago Fire), smaller companies rarely survive that kind of body blow. NSEC has been lucky the past couple of years with very little hurricane activity. That trend won’t last forever. Also, with the record bull market in bonds, the general accounts of most insurance companies have enjoyed the flight. It’s pretty obvious that party is winding down. It all depends on how coordinated they are at managing their portfolio, but, typically, no one is immune from downward bumps. Finally, it’s a tiny ($28 million market cap) company. Liquidity is always an issue. Trading volume is all over the map: 600 shares one day, 10,000 the next. Be careful and if you dabble…limit orders…limit orders…limit orders.

Disclosures: None