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The Retirees' Dividend Portfolio - John And Jane's August Taxable Account Update: MLP Update

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Includes: AAPL, ABR, ADM, APLE, BP, BPL, CAH, CLX, CMI, DOV, EAFAX, EEP, EEQ, EMR, ENB, EPD, EPR, ET, GIS, HP, HRL, IRM, JCI, LEG, LTC, MIC, MINDP, MO, MSB, NRZ, O, ORI, PH, PSXP, R, SEP, SKT, SLB, SO, SPG, SXL, T, TLP, TXN, UTX, VZ, WASH, WLKP, WPC, XOM
by: Matthew Utesch
Summary

The Taxable account generated $1,591.52 of dividends in August of 2019 compared with $1,665.95 of dividends in August of 2018.

Fixed income provided an additional $185.34 of income during the month of August.

We acted on several good deals in August and expanded John and Jane's ownership in a handful of stocks.

A total of five companies in the taxable portfolio paid increased dividends during the month of August.

In this article we review the oil-based MLPs in the portfolio because there has been a major turnover in these types of companies.

August is one of four months that provides higher-than-normal income for John and Jane and this is largely because all of their energy (specifically pipeline & oil storage) Master Limited Partnerships (MLP) assets provide distributions during February, May, August, and November. These assets are typically most efficient in a Taxable account because there are potentially unattractive tax consequences if held in an IRA (MLP income is taxable even in an IRA when the income provided reaches $1,000 or more).

MLP companies that pay distributions in the month of August in John and Jane's Taxable portfolio include:

  • Enterprise Production Partners (EPD)
  • Energy Transfer (ET)
  • Phillips 66 Partners (PSXP)

This is significantly different than the MLP assets held in the Taxable account during 2018 which included the following:

  • Buckeye Partners (BPL)
  • Energy Transfer Partners (ETP)
  • Phillips 66 Partners
  • Spectra Energy Partners (SEP)
  • TransMontaigne Partners (TLP)

For those who follow my work on the Taxable account it is well-known that I rarely sell a position, and even when I do, it is typically done at the end or beginning of the year (and typically focuses on getting rid of a stock that we consider to be underperforming expectations in favor of a stock that is attractively priced).

So why such a dramatic change in MLP assets? First, the MLP model is attractive for its above-average returns but the US Federal Energy Regulatory Commission (FERC) ruling "disallowed MLPs from receiving an income tax allowance on pipelines with tolling fees set under the "cost of service" framework. There was an overreaction in the market during this time as many stocks organized as MLP's took a price hit during this time. As the share price of MLP stocks struggled it presented a two-fold opportunity for C-Corps who saw the opportunity to absorb these MLP structures at a discount (which was beneficial because C-Corps were largely unaffected by the FERC ruling).

Even the MLPs that continue to exist to this day (these are currently owned in John and Jane's Taxable portfolio) saw a major impact from the FERC ruling which was released on March 15, 2018.

Chart Data by YCharts

Here is what went down at the four companies mentioned above which are no longer held in John and Jane's portfolio.

Buckeye Partners - BPL was previously considered to be one of the premier pipeline and marine storage terminal entities and suffered a major loss of confidence as it cut its distribution to $.75/quarter per share in November of 2018. When IFM Investors agreed to purchase the company for $41.50/share we gladly accepted $41.80/share and got the heck out. We used some of these proceeds to establish a position in EPD which is largely considered to be the gold standard of MLPs.

Energy Transfer Partners - Let's take a step back and first note that ETP absorbed Sunoco Partners (SXL) and then this combined entity was absorbed by Energy Transfer Equity (NYSE:ET). The goal of this process was to simplify the corporate structure and reduce costs. I think it is fair to note that this resulted in a distribution cut because the 1.28 shares of ETE for each ETP share meant the effective distribution would be dropping from $2.26/share to roughly $1.56/share or a reduction of 31%.

Spectra Energy Partners - SEP was purchased for $3.3 billion by energy giant Enbridge (ENB). ENB also rolled-up Enbridge Energy Partners (EEP) and Enbridge Energy Management (EEQ) making both entities wholly-owned subsidiaries.

TransMontaigne Partners - TLP suffered the worst fate (in my opinion) as ArcLight (the company that rescued it from its previous GP) used its position to offer a buyout of $38. Fortunately, we decided to hold on long enough that a final deal materialized at $41/share and so we gladly accepted $41.07/share. These funds were used to establish/build the current position in PSXP.

Chart Data by YCharts

Since April 1, 2018, there has been an overall improvement in the price of the three oil MLPs in John and Jane's portfolio with the only laggard being ET (which I believe is truly undervalued at this point in time).

If you read articles on SeekingAlpha you will find that many grievances held by investors with the MLP structure is that they issue K-1's at tax time. Personally, I believe the risk largely lies with the quality of the assets and how far the share price can be driven down (especially in situations like BPL and TLP) where many long-term investors were hit the worst. This is why when choosing new MLPs I focused on industry leaders that can't be snagged up at a discount.

Client Background

John and Jane are two real people who asked me to help manage their retirement portfolios. It is important to understand that I am not a financial advisor and merely provide guidance for my clients' account based on a friendship that goes back several years. I call them my clients for simplicity sake, but I do not charge them for what I do. The only request I made to them was that they allow me to anonymously write about them so that I can potentially help others who are wanting to achieve the same thing.

John retired in January of 2018 and is collecting social security along with other benefits while Jane is still working with aspirations of retiring in the next two years. John and Jane have done an excellent job heading into retirement because they currently have no debt or mandatory monthly obligations other than what is expected (such as property taxes, water, etc.)

John and Jane have adopted my philosophy of focusing on cash flow from investments instead of drawing out large sums of money by selling shares of currently held investments. In a nutshell, what John and Jane want is a portfolio of stocks, bonds, and other investments that will provide a steady stream of growing dividend income that will supplement their income during retirement. At some point, it will be necessary for John and Jane to sell shares from their Traditional IRA, whereas the goal of the Taxable and Roth IRA is that they will never need to sell any shares (unless they want to) because the income generated will prevent them from needing to sell shares as a means of "funding their retirement."

Here are some important characteristics to keep in mind about the Taxable Portfolio:

  1. Capital appreciation is the least important characteristic of this portfolio. This doesn't mean we don't care about it (because all investors do to some degree) but it does mean that we are less concerned about the day-to-day fluctuations of stock prices. Since the goal is to never sell (although I make occasional changes by eliminating or adding positions), a focus on capital appreciation doesn't mean a lot when it comes to the game plan.
  2. In the past year, I have typically focused on stocks that paid a qualified dividend because they qualify for the lower long-term capital gains tax rate vs. ordinary dividends which are taxed as ordinary income. This has become less important now that 2018 was John's first year of retirement. Changes in the tax brackets also support this approach because the ranges have been expanded and include basically all of their income in the 22% bracket. (Qualified dividends are subject to a 15% tax so the difference has become less-important).

Fixed Income

I have chosen to separate the fixed income figures from the rest of the portfolio in order to avoid confusion which allows those reading to gain a better understanding of how John and Jane's Taxable Portfolio is generating interest and dividend income.

Certificates of deposit (CDs) are the primary recipient of these funds because we are looking for zero volatility and FDIC insured product. I have received feedback on investing directly into treasuries but haven't had the time to discuss this with my clients'.

The table below represents the income generated by John and Jane's fixed-income investments YTD-2019 August month-end.

Fixed Income - August Update

Source: Consistent Dividend Investor, LLC.

The following colors were used to represent the following details:

  • Green: Dividend received confirmed (an actual dollar amount).
  • Yellow: Dividend expected to be received but not yet confirmed.
  • Red: Security has been sold or has expired and no longer exists.

Dividend And Distribution Increases

August included a total of five companies that paid increased dividends/distributions during the month.

  • Clorox (CLX)
  • Enterprise Production Partners (EPD)
  • Phillips 66 Partners (PSXP)
  • Simon Property Group (SPG)
  • Westlake Chemical Partners (WLKP)

Clorox - CLX is one of those stocks that you can't help but want more of even though it is pretty absurdly priced at the moment with a current P/E Ratio of 25.6x which is well above its average P/E Ratio of 20.4x since the year 2000. The last time we picked up shares was in mid-2018 when shares dropped below the 20x P/E Ratio which was too much of a bargain for us to pass up. We will be purchasing CLX for the Taxable portfolio the next time it looks attractive.

CLX - FastGraphs The dividend was increased from $.96/share per quarter to $1.06/share per quarter. This represents an increase of 10.4% and a new full-year payout of $4.24/share compared with the previous $3.84/share. This results in a current yield of 2.62% based on a share price of $162.04.

Enterprise Production Partners - August is the first month where John and Jane received a distribution from EPD and we couldn't be happier from the change (as mentioned earlier in the article we sold BPL and began accumulating shared of EPD). The share price has remained range-bound at or under $30/share so we will continue adding to this position based on any weakness (especially if it drops below $25/share again). Shares are undervalued based on a 10-year average P/OCF of 13.6x compared with the current P/OCF of 9.6x.

EPD - FastGraphs The dividend was increased from $.4375/share per quarter to $.44/share per quarter. This represents an increase of .6% and a new full-year payout of $1.76/share compared with the previous $1.75/share. This results in a current yield of 6.15% based on a share price of $28.36.

Phillips 66 Partners - PSXP shares a lot of similar qualities with EPD in that it consistently raises its dividend every quarter and comes in at almost the same exact yield. Personally I see more upside in PSXP and it's largely due to the fact that it hasn't reached the size of EPD so its operational cash flow per share is increasing dramatically. Distribution increases have slowed down quite a bit (in terms of the % of increase) but I am optimistic that the elimination of IDRs will benefit PSXP going forward.

PSXP - FastGraphs The dividend was increased from $.845/share per quarter to $.855/share per quarter. This represents an increase of 1.2% and a new full-year payout of $3.42/share compared with the previous $3.38/share. This results in a current yield of 6.11% based on a share price of $54.49.

Simon Property Group - SPG is considered to be the premier Mall REIT and is an S&P 100 Company with operations all across the world. What I like about SPG is the fact that it is diversified internationally and all of its locations are considered to be high traffic locations which results in added value for the stores it leases to.

  • Class A malls have sales per square foot of $500 or more.
  • Class B malls have sales per square foot between $300 to $500.
  • Class C malls have sales per square foot less than $300.

We recently added 20 shares of SPG @ $147.85/share which means that it will be generating $210/quarter of dividend income or $840/annually. SPG looks attractive as it trades at a P/AFFO of 13.7x which is well below its 10-year average P/AFFO of 19.2x.

SPG - FastGraphs The dividend was increased from $2.05/share per quarter to $2.10/share per quarter. This represents an increase of 2.4% and a new full-year payout of $8.40/share compared with the previous $8.20/share. This results in a current yield of 5.42% based on a share price of $151.25. This is the 2nd dividend increase in 2019.

Westlake Chemical Partners - As usual, WLKP continues to increase its distribution quarterly (18th consecutive) and is 12% higher than the distribution paid during Q2-2018. Distribution coverage has edged down and currently stands at 1.07x and we like the safety net provided by the 95% take-or-pay agreement that protects the partnership from margin volatility. It is worth pointing out in the call report that the drop in net income and distributable cash-flow was largely due to the higher one-time costs associated with the incremental 4.5% interest of the OpCo. As shown by the chart below, WLKP looks extremely attractive at $21/share.

Chart Data by YCharts

WLKP's distribution was increased from $.4452/share per quarter to $.4579/share per quarter. This represents an increase of 2.9% and a new full-year payout of $1.83/share compared with the previous $1.78/share. This results in a current yield of 8.72% based on a share price of $21.01.

Positions

The Taxable account currently consists of 43 unique positions as of September 8, 2019. We made several small purchases in the month of August that increased the number of shares for existing holdings for the following positions. The number of positions was recently reduced from 44 to 43 which will be covered in September's review.

  • Dover Corp (DOV) - Purchased 10 Shares @ $90.90/share.
  • Emerson Electric (EMR) - Purchased 25 Shares @ $60.04/share.
  • Ryder System (R) - Purchased 25 Shares @ $46.45/share.
  • Simon Property Group - Purchased 20 Shares @ $147.85/share.
  • Cummins (CMI) - Purchased 10 Shares @ $143.43/share.

Taxable Account - August Purchases Source: Charles Schwab

We did not sell any shares from the Taxable account during the month of August.

August Income Tracker - 2018 Vs 2019

August 2019 saw income drop slightly from $1,591.52 compared with $1,665.95 (which includes $195.63 of non-recurring income from eliminated positions in August of 2018). This drop in income is readily explained by the reinvestment of funds from closed positions into new stocks that pay dividends during a different month.

Images will explicitly state if they take into consideration the income generated by the Fixed Income holdings.

Dividend Income - 2018 vs 2019 Breakdown

Taxable Account - August Income

Source: Consistent Dividend Investor, LLC.

Here is a graphical illustration of the dividends received on a monthly basis.

Taxable Account - August Update

Source: Consistent Dividend Investor, LLC.

Based on the current knowledge I have regarding dividend payments and share count, the following table is a basic prediction of the income we expect the Taxable Portfolio to generate in 2019 compared with the actual results from 2018. (Future estimates were last updated on August 11, 2019).

Taxable Account - August Income Update

I have also included account balances to help readers' understand how the size of the portfolio has changed over time. By showing when additional funds were added to the account I hope it will help explain certain changes in income, etc. Please note that this includes the Fixed Income holdings in the total account balance.

Taxable Account - August Ending Balance To wrap up the August assessment I always like to include a gain/loss for each position in the Taxable Portfolio because it is important to consider that some positions will be showing gain while others sit at a loss. If you plan to have your own dividend growth portfolio you will need to learn to live with this volatility because even the highest quality portfolio will be subject to some degree value of fluctuation.

All figures in the images above were accurate as of market close on 9/6/2019.

Conclusion

Changes in the portfolio impacted the income generated for the month of August which also includes changes in the dividend payment date for some of the stocks held in the Taxable account. If we exclude these changes, the tables above demonstrate the power of dividend growth investing with improvements across the board in terms of dividend increases.

The total amount of income generated by the Taxable account was $1,776.86 and consisted of the following:

  • Fixed-income - $185.34
  • Dividends - $1,591.52

Based on the data we have collected and estimates for the remaining four months of 2019, the Taxable Account is estimated to be generating an average of $1,181.42/month of regular dividend payments (Estimated FY-2019).

What does your dividend growth portfolio look like? I'd love to hear feedback on your personal strategy and potential stocks you think I should consider.

In John and Jane's Taxable account, they are currently long the following mentioned in this article: Apple (AAPL), Arbor Realty (ABR), Archer Daniels Midland (ADM), Apple REIT (APLE), BP (BP), Cardinal Health (CAH), Clorox (CLX), Cummins (CMI), Dover Corporation (DOV), Eaton Vance Floating-Rate Advantage Fund A (EAFAX), Emerson Electric (EMR), Enterprise Product Partners (EPD), EPR Properties (EPR), Energy Transfer (ET), General Mills (GIS), Helmerich & Payne (HP), Hormel (HRL), Iron Mountain (IRM), Johnson Controls (JCI), LTC Properties (LTC), Leggett & Platt (LEG), Macquarie Infrastructure (MIC), Mitcham Industries Preferred Series A (MINDP), Altria (MO), Mesabi Trust (MSB), New Residential (NRZ), Realty Income (O), Old Republic International (ORI), Parker-Hannifin (PH), Phillips 66 Partners (PSXP), Ryder Corporation (R), Tanger Factory Outlet Centers (SKT), Schlumberger (SLB), Southern Corp. (SO), Simon Property Group (SPG), AT&T (T), Texas Instruments (TXN), United Technologies (UTX), Verizon (VZ), Washington Trust (WASH), Westlake Chemical (WLKP), W.P. Carey (WPC), and Exxon Mobil (XOM).

Disclosure: I am/we are long APLE, ET, EMR, T. 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 reflects my own personal views and is not meant to be taken as investment advice. It is recommended that you do your own research. This article was written on my own and does not reflect the views or opinions of my employer.