Seeking Alpha

A 10%+ Yielding Portfolio That Has Been Beating The Market

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Includes: AFFT, AROC, CCLP, DLNG.PB, MPLX, USAC
by: Darren McCammon
Summary

An update of macroeconomic conditions and key market indicators is provided.

Performance of this income-oriented portfolio is updated both year to date and since inception.

We then discuss specifics and forward expectations for one of our best- and one of our worst-performing investments over the last 30 days (Dynagas Preferred B and Archrock, respectively).

Macroeconomics:

  • The US economy continues to do well despite problematic US-China trade negotiations.
    1. Consumer sentiment was 98.4 in July vs. an 86.6 historic average.
    2. The US consumer is still buying. YTD June retail sales are up 2.9% YoY with the month of June up 3.4% YoY.
    3. The Bureau of Labor Statistics reported the economy continues to add jobs, 164,000 in the month of July. Source: Bureau of Labor Statistics
  • The Powell Put Is In. Back in January the Chairman of the Federal Reserve, Jerome Powell, gave a prepared statement which signalled not only a pause in interest rate hikes, but also a halt to their balance sheet runoff. Later in March on 60 minutes he reiterated that policy was appropriate. Recently, the Fed cut by 25 basis points while Morgan Stanley (NYSE:MS) predicting a return to zero. What should be clear is Mr. Powell has our backs. The Powell put is in.

Negotiations on the US-China Tariff War collapsed as the President accused China of reneging on previously agreed terms, and raised tariffs 10% on a further $300 billion in Chinese imports. Threats and "playing hardball" are a normal part of many negotiations. The US has just never been willing to go there in the past. Nevertheless, the simple fact is the US simply has less to lose in these negotiations.

According to this article, had the President actually put a full 25% tariff on all imports from China (which may still happen), the effect would be equivalent to raising our average tax rate from 26.9% to 27.5% of GDP. Additionally, Chinese exports to the US represent a much bigger percentage of China's economy than do US exports to China so retaliatory tariffs by China are not something to cause significant fear in the US. China is clearly much more hurt by a MAD (Mutually Assured Destruction) trade war than the US is, leaving the US in a relatively strong negotiating position economically.

Additionally, should Hong Kong melt-down, and/or the Hong Kong dollar break its peg with the US dollar, and/or China be pulled off the SWIFT banking system due to issues related to Hong Kong or North Korea, China could lose an important means of international trade and currency. This is looking increasingly possible.

However, China's does have political negotiating strength. China has reason to figure it will have more luck negotiating with the next administration. Previous months of "progress" in the negotiation may in fact have been no more than a delaying tactic by the Chinese. Put simply, to the extent the President may lose the 2020 election, China has reason to believe new leadership will find it more politically expedient to roll over and play dead for them on trade. There is precedent, US leadership has been doing so for decades regardless of whether that leadership was Democrat or Republican. Prior Presidents were always more concerned with getting their party re-elected, and thus sought to "not rock the boat" rather than go into a major election cycle with a negative trade publicity overhang and its resulting economic drag.

Market Indicators:

The Market indicators I follow are currently mixed:

  • 2/10 Yield Curve - Slightly Bullish (16 basis point spread)
  • New Highs vs. New Lows - Bearish (135 new highs, 195 new lows)
  • 200-Day Moving Average Slope - Bullish
  • Investor Euphoria - Bullish

One negative indicator is a very common situation. A situation where I typically make no changes to my investing strategy, proceeding as usual.

The first three measures are probably self-explanatory or can be easily looked up on the internet. The final one however, Investor Euphoria, is a lesser known psychological measurement rather than a financial one. Basically we know non-CFK members - funds, ETFs, most individual investors, etc. - tend to be S&P 500 followers. Thus, when the S&P 500 has achieved a new high sometime over the last 99 trading sessions they feel good about being in the market and there's ongoing pressure to stay in it. If, however, that positive "recent high" pressure doesn't exist, the natural tendency to act on whatever the key fear of the day tends to exert more influence (there's always a key fear of the day). The Investor Euphoria indicator thus goes bearish if the S&P 500 hasn't seen a new high in the last 99 trading sessions. It does this because it's more likely indexers' and closet indexers' fear of the day will cause them to turn risk off.

All four of these measures have been backtested with positive result, usually improving risk vs. return if not improvement in the actual average return. When one measure is bearish, I typically do nothing (unless it's a yield inversion which I tend to weight more heavily). When two are bearish I pretty much stop buying equities, and let the cash from dividend stocks build. When three or more indicators are bullish I actively look for things to sell. Three of the four indicators turning bearish doesn't happen very often, maybe three times since the Great Recession. The infrequency of an overall bearish signal is actually a major benefit, it keeps you in the market most of the time.

In my experience there will always be something to fear in the market. This something is usually exacerbated by the media which find fear a better way to capture ratings than greed. However, if the above mathematically defined indicators don't indicate I should be bearish, I stay long. Anecdotally, these indicators have also managed to get me out of the worst of significant downturns a couple of times, albeit nowhere near highs. I historically have still lost money using these indicators, just less than the market. Basically the indicators help shave a bit off the worst downturns while keeping us invested most of the time.

Income Portfolio Performance Review:

For Calendar 2019 YTD, the CFK Income portfolio has returned 17.1% vs. a 12.2% gain for its primary benchmark, the Russell 2000, and a 16.4% return for the S&P 500. Expected forward yield is 10.3%. While declining a few percent in the last month, performance improved relative to the index.

Source: Verified by E*TRADE

Since Inception:

Since inception (1/1/2016) the CFK Income portfolio has enjoyed a 60.9% return vs. 37.3% for the Russell 2000. Simultaneously, it also provides much higher overall portfolio income typically in the 7-10% range.

Source: Verified by E*TRADE

Outperformance vs. benchmark is always a good sign, and over long periods of time studies indicate dividend producing equities, particularly dividend growing equities with solid coverage, outperform non-dividend stocks.

Source: Study commissioned by Hartford funds

However, the psychological benefit of yield is just as important. A relatively steady income stream exerts a calming influence which helps one to act rationally during times of stress. As equity prices fall, yield increases. The increasing yield helps emphasize that selling in a panic would cause one to lose their income stream. Indeed to the extent there is cash available to reinvest during such times, rising yield can even cause one to see stocks as being on sale with an opportunity to "capture a raise" in the dividend stream. Thus, one of the very positive aspects of dividend-focused portfolios is not just a higher long-term return expectation, but also an increased psychological ability to do the right thing.

Worst Performers:

The biggest loser over the last 30 days was MPLX LP (MPLX); however, this equity was only added to the portfolio recently (See article: "9.5% Dividend Yield Plus 6-7% Growth: MPLX"), so we didn't see most of those losses. The biggest portfolio loser which we actually held in the portfolio for the last 30 days was Archrock (AROC).

Archrock

Archrock is a compression company enjoying high demand due to ongoing increases in US natural gas volumes being transported. You don't move natural gas over land from point A to point B without using a compressor. The more volume being transported, the farther it is transported, the more compressors you need.

Archrock is a classic dividend growth investment 'DGI', paying out less than half its distributive cash flow 'DCF' in dividends, yet still offering a very attractive 6.4% yield at current prices. That dividend yield is not only very well covered, I expect it to grow 10-15% per year for the foreseeable future.

That AROC is down 13% over the last 30 days, and trades below $10 seem frankly ridiculous. It had a strong earnings report with Adj EBITDA and DCF continuing to climb, and revised already strong guidance upward.

Source: Archrock quarterly reports and press release

Its 6.4% dividend yield was covered 2.5x last quarter by DCF, representing a 16% DCF yield.

Source: Archrock quarterly reports and press release

This excellent coverage was even a bit of a sandbag, as the Elite merger increased the share count used to calculate coverage, but the actual benefit to the bottom line from this merger won't be felt until Q3. Going forward, the extra Elite horsepower will hit the bottom line in Q3, which should cause coverage to increase to around 3x. Additionally, I would note not just Archrock, but also competitors, USA Compression (USAC) and CSI Compressco (CCLP) indicate strong continuing leasing demand in the compression sector.

Data Powered by Intrinio.com

Others can give me their own opinion, but I personally think Mr. Market is just lumping compression assets in with the oil services sector despite actual demand having little to do with commodity prices. This is admittedly frustrating, but we need to remind ourselves we do still benefit relative to that index, thanks mainly to the decent and growing dividend payout.

Source: Dividend Channel DRIP Calculator

Best Performers:

The best income portfolio performers over the last 30 days were Amtrust 7.5% Notes (OTCPK:AFFT) and Dynagas 8.75% preferred B (DLNG.PB), both up about 4%. As interest rates fall, fixed income instruments tend to do comparatively well because their high payouts are seen as being more attractive.

In the case of DLNG.PB, we may have also benefited from Dynagas announcing its key refinance, is now out to secondary lenders in the consortium with the terms not including a dividend cut. This usually indicates the primaries have already approved those terms. Additionally, we may have benefited from DLNG.PB recently announcing it dividend.

Priced at $17.99 and offering a 12.2% simple yield Mr. Market still clearly fears Dynagas will be taken private, its preferred delisted, and its dividend eliminated. Indeed this is admittedly still possible. I caution CFK members while I think this a good "bet," or risk/reward trade off, this is not a low risk situation despite being a preferred stock from a firm that can cover the payouts from existing ship contracts on long-term lease.

Both AROC and DLNG.PB are also quite timely buys.

  • Archrock increased its dividend less a month ago. It now has a forward yield of 6.4%. This dividend was covered by DCF 2.5x last quarter, and is expected to be covered by 3x this quarter thanks to compression assets from the Elite merger increasing the bottom line.
  • Dynagas preferred B offers a 12.2% distribution that goes ex-dividend this Wednesday.

Conclusion:

Despite ongoing challenges and concerns, the market continues to have a good year (+12.2%). Furthermore, our income portfolio continues to outperform it on both a YTD (+17.1%) and since inception basis (+60.9%). Notably, it accomplishes this while simultaneously supporting a high portfolio dividend yield (+10.3% currently).

We seek to outperform by looking for specific companies which not only benefit from ongoing macro trends, but are also compelling in their own individual right. In addition, we pay attention to market indicators to try to shave off the worst of recessions, and more importantly help keep us invested most of the time.

Disclosure: I am/we are long AROC, DLNG.PB, AFFT, CCLP. 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.

Additional disclosure: This article discusses risky investments including investments tied to specific sector performance and thinly traded investments. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.