This research report was jointly produced with High Dividend Opportunities co-author Jussi Askola.
We are currently in a raging bull market, and since November 2016, "growth and momentum stocks" have strongly outperformed "value stocks". Many high-yield sectors, notably Property REITs, BDCs, and Midstream MLPs, were out of favor and became value sectors.
There is plenty of good news that income investors should take into account:
High Dividend Sectors are Cheap! The good news is that today, several high-yield sectors are trading at their lowest valuations in years and currently offer investors a unique entry point.
Value Stocks outperform growth stocks over the long term: Investors should note that over the long term, "value stocks" tend to outperform "growth stocks". Based on a study by Bank of America/Merrill Lynch over a 90-year period, growth stocks returned an average of 12.6% annually since 1926. At the same time, value stocks generated an average return of 17% per year over the same time frame. "Value has outperformed Growth in roughly three out of every five years over this period".
- Downside Risk is Limited: In a world where equity markets keep trading at "all-time highs" and looking "expensive", value dividend stocks, such as REITs, MLPs, and BDCs, still trade at very cheap valuations. Therefore, in case of any market turbulence or market correction, the downside potential should be very limited.
Currently, the high yield space is offering some unique buying opportunities. At "High Dividend Opportunities", we focus on stocks trading at low valuations, or in other words "value stocks". Today, we highlight two cheap stocks that investors should consider after they reported their 4th quarter earnings - with yields above 11%.
ETP Earnings Report: A Stellar Quarter - Yield 11.8%
Energy Transfer Partners (ETP), a stock we recently covered on Seeking Alpha, reported its 4th quarter earnings, swinging to huge profits.
- Revenue came in at $8.61 billion, up 32% year over year.
- Adjusted EBITDA totaled $1.94 billion for the 4th quarter, up more than 30%.
- Distributable cash flow increased by $240 million to $1.2 billion, or 25% higher compared to the same quarter a year ago.
- The dividend coverage ratio soared to 130% for the quarter and 120% for the year.
In addition, the company raised nearly $2 billion in two transactions that significantly increased parent liquidity. These two transactions included the sale of Sunoco LP common units for $540 million and the sale of the compression business to USA Compression Partners LP (USAC) for $1.7 billion (of which $1.3 billion was in cash and the rest in equity). In the meantime, these shares will demonstrate to the market that ETP, as the new partner, is aligned with the limited partner interests of USA Compression Partners LP.
Investors can look forward to more good news this year. Many capital projects have come on-line. That once-ambitious schedule of growth will now result in a lot of cash flow. The acquisition of the general partnership of USA Compression Partners by ETP's parent company Energy Transfer Equity (ETE) opens another avenue of growth. There is great chance that more good earning news is on the way this next fiscal year. ETP's credit line with the banks now has about $4 billion unused. This could provide an excellent way to acquire more assets and grow in the future.
Valuation
Source: Q4 ETP Presentation
In order to conduct an accurate valuation (using full-year numbers), it is best to back out any "distribution incentive rights" (including relinquishment) and any general partner interest from the "distributable cash flows" ("DCF"). DCF for the 12 months was at $3,494 million; less IDR relinquishment and GP interest of $672 million, we get $2,822 million in DCF.
At the most recent price of $19.21 per share, we get a valuation of 8.0 times DCF, which is a real bargain considering that ETP is one of the largest and fastest-growing midstream MLPs.
The outlook of the midstream sector seems to be solid, with many midstream MLPs having reported solid quarters, including Enterprise Products Partners (NYSE:EPD) and Buckeye Partners (BPL). This can be attributed to record crude oil and natural gas production in the United States.
The future looks bright for the midstream sector. At the current cheap price and yield of 11.8%, ETP is one of our favorite midstream MLPs to own for the year 2018.
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WPG Earnings Report: Operational Resilience vs. Strategic Challenges - Yield 14.6%
Washington Prime Group (WPG), a Retail Property REIT, reported its 4th-quarter and full-year 2017 results, and while the market keeps focusing on strategic challenges, we are encouraged to see continued resilience in operational figures.
To give a little bit of context here, we need to keep in mind that we are discussing about a firm that is trading at 4.0x its cash flow, which is extremely cheap in today’s market place. In this sense, the expectations of the market are very negative and the sentiment very low. WPG, just like CBL, is a class B mall owner, and as such, it is widely expected to eventually become obsolete due to the growth of e-commerce.
The perception is that no one goes to class B malls anymore; and yet, the NOI went down by just 1%, the average sales per square foot remains at close to all-time-highs, and the leasing performance suggests strong demand for space by retailers.
A 1% drop in NOI is really nothing for a firm selling at such a ridiculously low valuation, and shows once again that class B malls remain relevant even in today’s highly digitalized marketplace. What the market seems to ignore is that unlike CBL, WPG owns on average higher-quality properties. In fact, Tier One and Open Air properties accounted for as much as 81.2% of the NOI in 2017, and these properties even showed a 0.9% increase in NOI for the year! It is the remaining 18.8% which are causing the temporary dilution in FFO, but clearly, the large majority of the portfolio has great value which is highly sustainable.
This was the main news to us: Operationally, the great majority of the properties are performing just fine. Therefore, the reason why the FFO is dropping year over year is not due to problems at the property level, but rather, strategic decisions such as dispositions and continued deleveraging.
As the CEO notes:
"Very simply, the $0.12 of annual dilution was attributable to our unsecured notes offering, the second joint venture with O’Connor Capital Partners and the disposition of six noncore assets. As the result was an overall reduction in indebtedness of approximately $400 million, it’s silly to question the prudency of such actions.”
Put in other words, the company is improving its portfolio and balance sheet quality to lower its risk profile at the expense of some short-term dilution in FFO figures. Short term-oriented investors may not like it, but this is the best approach to maximize and sustain long-term value. Eventually, as WPG ends its disposition and deleveraging plan, the FFO will stabilize and the market will realize the progress made and reward the firm with a higher FFO multiple. Given that it stands currently at 4.0 times FFO (using 12-month adjusted FFO of $1.63), even a small bump would result in material upside.
Other relevant highlights
- WPG is making a new acquisition, which was rather unexpected! It suggests that we are approaching the end of the deleveraging plan. Moreover, the property appears to be an attractive investment as a dominant hybrid format retail venue situated in Missoula, Montana. The asset features a Lucky’s Market and a nine-screen dine-in AMC Theater - both newly built - and yields about 10%.
- The dividend is maintained and remains well-covered.
- Redevelopments continue, with 36 projects underway ranging between $1 million and $60 million with an average estimated yield of 10%.
- Property NOI is expected to continue show resilience in 2018.
Bottom Line
Overall, we are happy with the news and glad that the market seems to, for once, agree with us - rewarding WPG with a huge bump after earnings. This is the story of short-term dilution versus long-term potential reward to patient investors. Just like in the case of CBL, we remain optimistic long-term holders and are happy to keep cashing a yield of 14.6% while we wait for upside to materialize.
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