Avoid These Fireworks To Keep Your Fourth Filled With Fun

by: Brad Thomas

The act of investing can most certainly result in attention-grabbing, awe-inspiring “fun,” as it were.

Yet, while you’re not literally playing with fire here, you are literally playing with your money.

“Patience and perseverance have a magical effect before which difficulties disappear and obstacles vanish.” John Quincy Adams.

Happy Fourth! Here’s wishing you an amazing, freedom, friends, and family-filled day from start to finish.

And, to my non-American readers around the globe, I know this isn’t a holiday you celebrate. But I hope it’s full of fireworks for you all the same – fireworks of the safest and most profitable kind, of course.

I had to add that clarification since, contrary to some people’s belief, fireworks aren’t children’s play. When handled correctly, they’re attention-grabbing and awe-inspiring and, let’s face it, just downright fun to watch! And yes, little kids (and their big-kid counterparts) look forward to them every year.

Even so, you’re literally playing with fire when you set them off. That’s why the fire department or fire experts are always involved in every legally sanctioned fireworks display.

At least that’s true in the U.S. I admittedly can’t say the same with complete certainty about everywhere else. However, I’m assuming it probably applies worldwide.

It seems like a safe bet, considering everything involved in such celebratory shows: the materials and mechanics involved.

While there are different kinds of fireworks, they all come down to “a casing filled with explosives and combustible, colorful pellets called stars,” according to LiveScience contributing writer Adam Hadhazy.

Therefore, they’re like mini bombs.

In fact, there’s no “like” about it. They are mini bombs, beautiful and celebratory though they be. And, therefore, they need to be treated with caution.

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Light It Up!

I don’t want to go on too much longer about fireworks. We do have some stock analyses to get to, I know. But since those analyses are safety-focused, I do think it’s worthwhile to keep the focus just a little longer on what we’ll be seeing this Fourth.

Plus, I’ll admit, it’s quite simply fun information to have on hand. So, here’s some more from Hadhazy’s explanation:

The aerial shell is the standard one people use… it’s the mainstay on everything for professional displays,” said Paul Nicholas Worsey, a professor of mining and nuclear engineering at the University of Missouri at Rolla and an expert in fireworks who teaches college courses on the subject.

The shell, which can be a ball or a cylinder, is filled with black powder, or gunpowder, and is typically launched from a mortar tube. “You actually project up a ball in the air, and that ball basically explodes,” Worsey said.

Again, these rockets’ red – and white and blue – glare isn’t meant to intimidate or destroy like “the bombs bursting in air” in 1814. (That was when America’s national anthem, “The Star-Spangled Banner,” was written during the War of 1812.)

However, that’s because they’re specifically constructed and overseen to be that way.

A pouch of that black powder called the lifting charge ignites at the base of the firework, sending the aerial shell rocketing out of the tube. In the process, a delay fuse is lit within the firework. This fuse runs to another black powder pocket known as a bursting or break charge that goes kablooie in a few seconds when the shell reaches a desired height.

In turn, this explosion shoots out and sets on fire the little stars inside the firework.

That’s when everyone goes “Ooh!” and “Aah!”

Again, when it’s done right.

Getting to the Fire-Filled Point

Let’s summarize everything we’ve covered so far about fireworks…

  1. They’re attention-grabbing, awe-inspiring, and fun to watch.
  2. When you handle them live, you’re literally playing with fire.
  3. They’re made up of explosive and combustible pellet-filled casings.
  4. In short, they’re mini bombs.
  5. Gunpowder packed into mortar tubes + ignition = explosion
  6. They lead to guaranteed “Oohs!” and “Aahs!” – when done right.

When done wrong, they can lead to ultimately entertaining fiascos, as a YouTube search for “fireworks fails” will show. But it can also lead to much more serious disasters.

Here’s where we’ll bring the analogy around to our main point: investment safety.

The act of investing can most certainly result in attention-grabbing, awe-inspiring “fun,” as it were. Yet, while you’re not literally playing with fire here, you are literally playing with your money.

So, play smart and play safe in order to play profitably.

If you don’t, you’re probably not going to find any actual explosive, combustible pellets-filled casings going off in all the wrong directions like some crazy cartoon. But you are bound to see some other unfortunate events occur – events that I’d really rather you avoid if at all possible.

It’s with that goal in mind that I’m putting out the following list of companies you really want to keep your hands off.

You may have trained, tried and true investment “firemen” on your hands to help you put out any potential blazes. But why bother risking it when there are much safer – and still enjoyable – fireworks to light up this Fourth of July?

The Dangerous Dozen

As my loyal followers of over 68,677 know, I am a huge fan of dividend-growth stocks because this strategy is one of the best ways to grow wealth. And, for that reason, I spend something like 95% of my time working on the highest-quality names that will help me and you sleep well at night.

The other 5% of my time, however, is spent warning readers about the dangers of investing in a stock that is not growing its dividend, or even worse, possibly cutting it. Hence, the reference to fireworks!

As I scan the REIT lab (within iREIT), I see a few noticeable names that are problematic. And, to help celebrate this extraordinary holiday, I have decided to provide readers with a list of the most dangerous dozen.

First off, we have the RMR-managed REITs that are just plain toxic. Because they are externally managed, shareholders are being duped into a promise of repeatable sources of income, but when you check under the hood, you see a completely different picture.

For example, Hospitality Property Trust (HPT) recently said it was acquiring Spirit Master Trust (SMTA) in a $2.4 billion deal with incentive fees to be paid to RMR. The plan is to dispose of $500 million of the properties and another $200 million in hotels. Somehow HPT believes that this will help diversify the TravelCenters of America (TA) exposure and generate more stable income for the lodging assets.

HPT has underperformed year to date (+9.1%), and we expect the overhang to widen as the company attempts to find its true identity. We believe that will be difficult given the “self dealing” interests associated with the highly conflictual management structure.

The other RMR-managed REIT we dislike is Office Properties Income (OPI), which saw a massive dividend cut last year (from $6.88 to $2.20). We telegraphed that cut on multiple occasions and hopefully readers avoided the -55% devastation (total return since August 2018). The growth forecast remains negative for 2020 and 2021, again, another example of a REIT that has no business model built for dividend growth.

Now, moving over to another externally managed nightmare, AR Capital is a New York-based shop that oversees Global Net Lease (GNL) and American Finance Trust (AFIN). Putting the Vereit (VER) track record aside (VER was formerly known as American Realty Capital Trust that previously advised AR Global), these two REITs have very unhealthy payout ratios that lead us to believe a dividend cut could be coming.

Global Net Lease pays out $2.13 in annual dividends (the company pays quarterly dividends now) versus $1.96 per share in FFO (funds from operations). This means that the dividend is not actually paying 100% of the dividend from cash flow, but instead must find a way to cover the gap (payout ratio is 108%).

American Finance has the same problem: The company pays out around $1.10 in dividends and should generate $.95 in earnings (AFFO) in 2019. That’s a 115% payout ratio. Given the track record and conflicts (GNL and AFIN invest in the same properties), I have no interest in the common or even the preferreds.

Moving over to apartments (I just wrote an article on the sector here), we’re avoiding Preferred Apartment Communities (APTS), BlueRock Residential (BRG), and Independence Realty (IRT).

Preferred Apartment is externally managed much like the RMR and AR Global platforms, but instead of engineering a high yield (like RMR and AR), Preferred Apartment has orchestrated a printing press called non-traded preferred shares.

Much like the good ole days when AR Global was behind non-traded shares, Preferred Apartment has found a way to gain some market share by providing investors with a less volatile means to own apartments. But as I pointed out, “the company should consider renaming the business Preferred Properties and remove the 'Apartment' reference” since it owns shopping centers and office buildings.

We recommend that investors dig deeper into the balance sheet before proceeding with APTS.

BlueRock and Independence also scare us because of the lack of balance sheet discipline. BlueRock cut the dividend from $1.16 to $.65 in 2018 and Independence has a dangerous payout ratio of 96% (with no dividend growth whatsoever).

We also recently wrote on the commercial mortgage REITs, and in that article, we called out Apollo Real Estate (ARI) and Colony Credit Real Estate (CLNC) for “taking on more risk by utilizing mezzanine financing, in an attempt to boost returns.” As we pointed out, “around 28% of CLNC’s loans are not senior secured and around 23% of ARI’s loans are not senior secured (first mortgages).”

We also have a SELL rating on Whitestone Realty (WSR). Keep in mind, we previously had a Buy on the company, but the dividend has become vulnerable as earnings have declined. Since 2016, FFO has declined from $1.34 to $1.25 (2017) to $1.16 (2018) to $1.08 (2019 estimate). The current annualized dividend is $1.14 per share (the company pays monthly), and the payout ratio is an unhealthy 105%.

Last, but not least, we have two of the ugly ducklings in the mall sector.

Before I provide the beatdown, I will remind you that ugly ducklings can sometimes turn into beautiful swans, but I just don’t think that’s the case with CBL Properties (CBL) and Washington Prime (WPG). I certainly would not bet all of your hopes in dreams on these stocks (or any one stock as far as that’s concerned).

CBL has returned -44% year to date, and this is a perfect example of why you should never recommend a company that has no growth potential. While other analysts were writing, “it dropped and we’re buying more”, we were downgrading CBL to a Strong Sell (September 14, 2018). Incidentally, shares are down 69% since we hit the Strong Sell button.

As tempting as it may be, we are not jumping on the Washington Prime bandwagon either. If you like high-stakes poker, this REIT may be for you, but we are highly confident of a dividend cut, given the continued earnings erosion – our AFFO model has cash flow before dividends at $.75 per share compared with a dividend of $1.00 per share. If this is not a sucker yield, I don’t know what is.

In closing, I want to thank you all for reading my article today, and I would like to wish you all a safe, healthy, and prosperous Independence Day. In case you are wondering about my stake in Tanger Factory Oulet (SKT) (recent article here), I found this patriotic quote very fitting from one of our founding fathers:

Patience and perseverance have a magical effect before which difficulties disappear and obstacles vanish.

John Quincy Adams

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Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.

Disclosure: I am/we are long VER, SKT. 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.