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Reaves Utility Income Fund - Life After Rights Offering

Maks F. S. profile picture
Maks F. S.
5.26K Followers

Summary

  • UTG is a closed-end fund sponsored by Reaves, seeking a high level of income and capital appreciation.
  • The fund currently yields a 6.77% managed distribution and is trading at a discount of 8.90% to its Net Asset Value.
  • In-depth discussion and an update on the fund since our first look on 9/22/2017.

The Reaves Utility Income Fund (NYSE:UTG) has been a fund which I have followed for a number of years.

I initially mentioned it in the Summer of 2016 as a replacement for the BlackRock Utilities, Infrastructure, & Power Opportunities Trust (BUI) in the article "5 Utility Closed End Funds You Can Still Buy At A Discount" when BUI realized its significant discount to NAV.

A year later, we took a deep dive into the fund in the article "UTG: Good Trade, Issues As An Investment." Income Idea subscribers can read the article here: "UTG - Good Trade, Issues As An Investment (Income Idea)."

In that article, we arrived at a few conclusions,

First, the fund has been a well-performing closed-end fund which has yet to have a distribution decrease. Second, the current rights offering presents an interesting short-term trading opportunity.

Having stated that, there were a number of big warning signs flashing. Those signs include a currently negative UNII, a new line of credit with a higher spread above LIBOR, on top of the already higher LIBOR rates and a greater dependence on capital gains in order to maintain the distribution. There was also the looming rights offering which will be dilutive to existing shareholders and, of course, the potential end to the long-term money flowing into utilities.

Source: "It's About The Quality - UTG Dividend Case Study."

Even though Income Idea subscribers were quite receptive to the analysis, quite a few of the comments suggested that long-time investors did not want to hear it, and arguments often lead back to "but it always came back in the past."

For that reason, we took a deep dive into the fund's distribution history and did our first distribution primer in "It's About The Quality - UTG Dividend Case Study."

I

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Income Idea subscribers received a more detailed distribution analysis for this fund.

This article was written by

Maks F. S. profile picture
5.26K Followers
Intrepid Leader at an RIA.  My firm and I simplify the lives of busy clients by providing ongoing financial planning and asset management. this is done by providing our clients customized, ongoing comprehensive financial planning, and customized investment advisory services tailored to the clients' needs. As a fiduciary, we have a legal obligation to put the needs and interests of our clients above our own. Specialties: fee based comprehensive financial planning, retirement planning, life insurance and protection planning.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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Comments (39)

HsterInvestigates profile picture
@Maks F. S. This article is useful in thinking about the upcoming rqi rights offering. It’s useful to see Utilities as a group took a beating at end of 2017 so the poor UTG performance is in context and not due to the rights offering.
j
"It’s useful to see Utilities as a group took a beating at end of 2017 so the poor UTG performance is in context and not due to the rights offering."

If you could prove that then it might be useful. How did utg's performance from the announcement of the 2017 rights offer to its completion compare to the performance of other utilities funds for that period of time? As i recall you can't make the same allegation for the 2015 rights offer and the 217 rights offer followed pretty much the same pattern as the 2015. Which, i believe, repeated pretty much the same pattern as the 2012 ro.
HsterInvestigates profile picture
@joel menkes There was definitely declines due to the RO, however there was a serious second leg down later in the year which was in line with other utility CEFs. I had originally thought both legs were due to the RO.

BTW, Who wouldn't have wanted to buy in those prices now!
j
"There was definitely declines due to the RO,..."

Yup, which is in line with what i recalled. So the poor performance for that total time was due to both. Some of us did play the 2017 rights offer decline and did buy at those low prices. Pretty sure i did though i learned of the announcement too late to optimize, too late to sell out very early before prices got hit looking to buy back later in the process at a much lower price. I almost know for sure i got some benefit but not near as much as i could have had i kept current. Also pretty sure i noted later that mgt was either pretty prescient or more likely very lucky to get that 2nd decline you note and be able to put to work at low ute prices the funds they got from screwing us off the rights offer. Ciao
Maks F. S. profile picture
Thanks for reading and your comments! I hope this article was of both of interest and helpful to your due diligence process. If you like this article please hit the "Like This Article" button above and share it.
If you would like more of such content, please give Income Idea a shot and a 14 day Free Trial is available. If you are not ready to subscribe but would still like to help out, become my Patron on Patreon. http://bit.ly/2Dw5wSP
Thank you all! -Maks
h
UTG increases monthly distribution
The Reaves Utility Income Fund (NYSE MKT: UTG) is pleased to announce today a 6.25% increase in its annual distribution, to $2.04 to be paid monthly at the rate of $0.17 per common share. This is the tenth increase since the Fund’s inception in February 2004. The increased dividend rate represents an annualized distribution rate of 7.16% based on the current market price. As of March 13, 2018, the Fund’s market price was $28.50 per share and its net asset value was $31.32 per share.

Ronald J. Sorenson, the Fund's portfolio manager and Chief Investment Officer of Reaves Asset Management, the Fund's investment adviser, noted that “…the Board’s decision results from their continuous review of the Fund’s portfolio, and its distributable earnings from dividends and realized capital gains; largely long term in nature. While the Fund’s net asset value, and related discount/premium, fluctuate in response to investor sentiment and macroeconomic factors, the earnings, and dividend growth characteristics of portfolio companies underpin the current distribution and are the basis for Reaves’ recommendation to the Board to increase the distribution at this time. Reaves’ long held view is that periodic increases in distributions create ‘stair steps of value’ contributing to per share value growth while affording shareholders insight into the effectiveness of Fund management’s asset allocation. With respect to the success of the Fund’s recent rights offering, we believe the proceeds will contribute to the Fund’s capacity to earn and grow its distribution. We thank the Fund’s shareholders for their trust and the opportunity to invest on their behalf.”
l
Hi Maks,
A very good follow up to your previous article. I had been a holder of UTG since 2007 with div reinvestment and regular new purchases but your original article gave me pause to reconsider. But when I saw that the Jan distribution consisted of 70% cap gains it convinced me that it's probably unlikely that the dividend rate is sustainable. With that I sold my entire lot and re-balanced to a safer alternative.

Can you envision a scenario in which UTG is able to maintain the distribution if/when they should run out of cap gains?
Bill Cunningham profile picture
"But when I saw that the Jan distribution consisted of 70% cap gains it convinced me that it's probably unlikely that the dividend rate is sustainable."

larry- There was over $445 million of unrealized cap gains at FYE, so I'm not sure if that's a concern. Even if they didn't have any, they could probably do a return of capital.

That's all bookkeeping in any case. I look at whether it is likely that the bv of UTG is likely to at least be maintained over the longer term. A 7-8% total return on the underlying stocks does not seem unreasonable, which is what would be necessary.
j
agreed Bill
h
All of these equity CEF's & many of the preferred ones , most mutual funds, many ETF's have distributions made up of various amounts of income sources, LT/ST cap gains & ROC. I believe that UTG since its 2004 inception has done a remarkable job managing its distribution with no reductions ,occasional special year end distribution kickers added in . HTD is another sleeper that like UTG is currently being punished ,also started in 2004 has done a super job managing its distribution from various sources. Slow steady eddies ,rare good buys in this current market environments for LT income investors. This is why you pay for active management, if you believe in that , a few of them actually add value & earn their fees.
s
A very fair article on UTG. I am still holding long after taking the rights offering. Not very excited about the outcome, but almost even on my average cost per share. If I get above my cost, I will probably sell half.
$DUST profile picture
Excellent article. What are your current thoughts on BUI/UTF?
c
Negative UNII significant
BeaBaggage profile picture
great points about these levered CEFs and rapidly rising LIBOR rates.. hopefully the rise in LIBOR is not a precursor to a credit crunch (like 2008) and just a symptom of world growth.. in an over-levered world it bears watching.. UTG seems to have strayed from it's original purpose a lot in the reach for yield like so many others in the world..Bea
I Love Hamburgers and Coke profile picture
You seem to dislike everything. Every time I read one of your articles it's the same ole story. Is there anything you do like, or is this your schtick ?
daskapital1000 profile picture
The main goal of this permanent negativity is to create a sense of uncertainty, which consequently would help the reader to make the only "right" decision to joint income idea premium service...
j
"The main goal of this permanent negativity..."

That's pretty mean. You don't have to read him you know. The idea of the articles is to draw readers, be it to here or his service. If you take issue with his article maybe quantify what you don't agree with instead.
WSLegend profile picture
Lower allocation to utilities does not necessarily mean lower income. For instance, they increased their VZ position which pays more than any utility.
Extreme Income Plus profile picture
Just a quick comment about your statement "the fund has returned to its normal discount of 10%" (paraphrasing).

In fact, according to Morningstar (let the criticism of M* begin), this is the widest discount in 5 years, or very close to it.

This fund normally sells very close to, or above, NAV. I'm a long term holder and won't sell either way, as I think THIS IS ONE OF, IF NOT THE BEST CEF IN THE USA, LONG TERM. Yes, that's a statement, and STK and a couple others, and the Pimco bunch, may give it a run for its money. I still stand on that.

Jim aka Extreme Income Plus

(long UTG in size, and reinvesting each month)
Maks F. S. profile picture
Thanks for reading and your comment.

I included a chart above, http://bit.ly/2FImErh

6 to 8% is very normal for hte fund over the past 5 years and it was over 10 in 2016.

I would also say that since the GFC, the entire time has been relatively abnormal as it was all in a declining rate environment. Prior to the GFC with normal interest rates, ie before artificially kept low, the fund, and most utility CEFs were trading at 10% or greater discounts.

So I should of been a bit more clear.

Generally speaking, we are now entering a completely new time for the fund and I believe in hindsight, the rights offering was their way of cashing out while they can.
Geo168 profile picture
Maks,

Any thoughts pro or con holding a CEF in a IRA or Roth?

Geo168
j
"6 to 8% is very normal for hte fund over the past 5 years and it was over 10 in 2016."

I'm not even paying attention to the discount now. What this sums up for bonds is how i feel about utes.

http://bit.ly/2FMuU9L

I know people don't like to look at utes as a parallel to bonds, and it certainly isn't a perfect one, but i feel the same way about utes now as i do about bonds. Because the same reason which caused the bond bubble caused what i consider to be the ute bubble. Historically low interest rates. I now see the reason i believe was the cause of that bond bubble to be what greenspan's going for, rising interest rates, reversing the course of ute movement, and what we've seen from of the ute hit is only the first step. I see no reason to think what i believe caused the bond bubble, and the ute bubble, will not take down utes as they progress from low to high, at least to higher. Interest rates.

I've only come to think this way in the past maybe 3 months, maybe 4, when i saw the market finally coming to the realization rates have risen, and the further realization they will continue to rise. As long as the market seemingly paid no attention to rising rates i was comfortable enough trying to find a good price spot to get some utg back once the rights offer was over and done. it's also why i took issue with Maks' older article points. Even with the rising interest rate the market wasn't taking notice, and utes were still ok, no interest rate rise effect. So there was a decent chance, in my opinion back then, that utes could still generate cap gains and the distribution could still get earned in full through the combination of short term cap gains and assets' dividend income so i nibbled. But i've held ff the temptation to add since, a couple of times. I stated in my secret heart 23 is the figure that lingers there, though i near certainly, the way i feel now at least, would add some down around 25. I'm also not sanguine about 23 being the bottom for this go 'round, that'll depend for me on further fed action and how macro-economics en toto play out from here.

I'm, obviously, no longer of that opinion. Unless mgt's very adept at short term trading the cap gains just aren't gonna be there. Again, imo. Anyone want this fund to be run by active traders? I've already got that with heebner. You should see his fund turnover rate. Over the longer term of at least a couple of years there's more chance of cap loss than gain for utg and the like as the fed continues to raise rates. So no way i want to add more now to the bit of utg i do hold. I'll hold what i have in the hope that what i'll lose in share price, due to a falling nav, will be made up in earned income distributed. Pretty much my same current schematic with hpi.

What this greenspan article does point me to is the desire to add more short term paper so as interest rates rise and maturities are quickly reached i'll get the quick turnover and the benefit from the rising rate returns. It's what i'm trying to do with pko but i want to add a fund that has its holdings in higher quality. Short term maturities, higher quality. Anybody know of any such fund? Don't want junk like senior floating rate, already have enough of that in ppr, and as i've expressed before i think the spreads are too narrow comparion to historical stats. If they widen appreciably and rates still aren't high enough to start threatening survival of the issuing companies, maybe then i'll add if the price is right. Tia
Steve Rasher profile picture
Maks: Thanks for the update. One of the concerns I have with UTG, although I still have a sizable position, is that the vast majority of the dividends are comprised of capital gains, mostly long term, rather than from ordinary income. I don't know if some of this is already booked, but with the decline in values recently, I wonder whether this could have an impact on the safety of the dividend. Do you have any thoughts in this regard? Steve
Maks F. S. profile picture
Thanks for reading and your comment.

The distribution is a big concern for the exact reason you posted.
I went into it in the Income Idea version so sign up for the free trial and check it out or send me a message and I will send you the section via email.
J
And the leverage.

Ladies, liquor, and leverage.
j
One of the concerns I have with UTG,...is that the vast majority of the dividends are comprised of capital gains, mostly long term,..."

Mine also, though i really don't care if long or short term. As far as i know holdings in an ira, roth or regular, don't get affected by whether it's long or short term. As the tax liability's passed through to the shareholder i doubt the company cares, either.

When the cap gains kept coming all was fine. Even when they got harder to get but still were available, things were ok. Now??? With the rate increase effect finally taking hold that's gone by the boards imo, and that's the main reason i've turned since Maks' last piece, the effect of the increase of rates on the possibility of cap gains, and to be continued for the foreseeable future.

Regards the safety of the divi, wouldn't be surprised to see it maintained. They'll keep using up the long term unrealized gains, the portion that'll remain after the asset prices got hit, get hit more, keep on getting hit, so you won't see roc in the distribution breakdown. For as long as those gains remain gains and can be utilized. The long term unrealized gains accounting line in the next q report may be an eye opener given the knock to the chin that's already been delivered to assets' prices.

The qoq change i imagine will be significant, though that'd be my version of what significant is, and don't ask me what that is because i haven't thought about it. If that continues, as i expect it to, then share price of the fund should also continue to get hit. The one good thing; if they decide to take those gains to cover the distribution so they don't have to show as roc at least they'll be selling those gains before they become that much less or even turn into losses, simply from declining prices of assets' shares.

All that if it happens still may not be enough to see a distribution level cut. Could eventually wind up seeing roc actually stated instead after realized gains and unrealized gains are no longer there. Hasn't hurt dnp in the eye of its holders all these years and utg mgt may decide to follow that schematic/scheme. But any hope of outperforming dnp'll probably fly out the window for at least the next upturn.
j
Haven't had a chance to get through it yet Maks, only got to the point where you noted utilities make up less than 50% of the fund, just want you to know telephone is considered utility. I guess since things have progressed since telephone was the latest thing in communications, extending that label utilities to telecommunication wouldn't be too long a stretch. See you later, and i have been advising people to read your last piece to get the utg negatives we palavered over. Good to know the negs as well as the pluses. And i have altered my opinion on utg since then. Ciao
Maks F. S. profile picture
Thanks for reading Joel.

You are quite right, telephones are, but is Tmobile a utility? But yes.. it is still sticky business.

One key difference I would think, while our utilities are always increasing prices, my cell phone bills keep on decreasing every year as we get more competition.
richjoy403 profile picture
"You are quite right, telephones are [utilities]"
_____________

Maks -- Not exactly. Utilities are one of the 11 S&P/MSCI GICS sectors, as is Telecom--though effective Sept 28th, Telecom is being considerably enlarged with the addition of some present members of the Technology sector*.

OTOH, utes and telecom (along with healthcare) are generally considered defensive sectors.

http://bit.ly/2FHOdkf
Maks F. S. profile picture
Hey Rich,

Thanks for being captain obvious... YES, telecom is not a utility! BUT... they are in essence a utility which people will use and think of.

I meant utilities in the definition, not classification.
Kelbor Del profile picture
Excellent! Thank you!
Maks F. S. profile picture
Thanks for reading and your comment!
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