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The Retiree's Dividend Portfolio - Jane's September Update: Adding Vermilion Energy

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Includes: ABBV, ADM, BAC, BNS, BP, BRK.A, BRK.B, BTI, CM, CMI, CTL, DLR, EAFAX, EMRAF, ENB, ETN, EWBC, GILD, GIS, GLOP.PC, HON, IBM, IRM, ITW, JCI, KEY, LOGM, LRCDF, LYB, MAIN, MMM, MO, MSB, NTAP, O, OXLCM, PFBC, PM, POL, PPL, RMD, RY, SCHF, SNX, TD, USB.PH, VET, VZ, WMB, WPC
by: Matthew Utesch
Matthew Utesch
Dividend investing, dividend growth investing, long only, REITs
Summary

Jane's retirement accounts generated a total of $1,553.12 in dividend income for September 2019 vs. $1,465.41 of dividends in September of 2018.

A total of three companies paid an increased dividend or issued a special dividends during the month of September.

We sold the high-cost portions of three positions because share prices exceeded fair value. Selling allowed us to replenish the cash reserves and reduce downside risk.

We added Vermilion Energy to the Roth IRA and believe that the stock is extremely undervalued and presents a reasonable risk/reward opportunity.

Lately, I have emphasized improving the quality of the stocks in the portfolio and that can be seen primarily in the Taxable account where Dividend Kings and Aristocrats have grown to be a larger part of the portfolio. Finding quality companies has become more challenging since the goal is to purchase them at (or below) fair value since this decreases the downside potential, increases the dividend yield and improves the chance of upside in the future.

Vermilion Energy (VET) is an interesting play when we think about quality because the stock price has plummeted which has subsequently increased the dividend yield beyond a reasonable level. Historically speaking (even during volatile times), VET has seen its dividend yield push 6% and today it stands at more than double that level.

ChartData by YCharts

At first glance, this stock looks like a sucker-yield, which is a term that SA author Brad Thomas commonly uses to describe stocks that have an unsustainable dividend based on earnings or other factors that would make an investor want to avoid purchasing shares. When it comes to the oil market we have seen increased volatility over the last three-plus years which has pushed the price of crude to record-low prices on a number of occasions.

When looking at VET it is important to remember that cash-flow is king which means that FFO is a better indicator of how VET is performing. Please note that the FastGraphs image shown below is denominated in Canadian dollars.

VET - FFO GrowthHistorically, VET has traded in line with its average P/OCF average of 9.2x compared with a current P/OCF of 3.2x. At this point, the dividend is more than covered and if a cut occurred it would be more than priced in. Management has conveyed that they have no intention to cut a dividend and I believe them when they say this because management has never cut the dividend even over the last three years of an extremely volatile oil market.

ChartData by YCharts

A long-term look at VET's stock price to WTI Crude prices shows the disconnect in the current price because VET was nearly double the price when crude dropped to half of its current price back in 2016. The graph below provides an even more clear understanding of how disconnected VET's current share price is when compared with WTI crude especially when we consider 2017 share price vs WTI Crude and 2019 share price vs WTI Crude.

ChartData by YCharts

At the end of Q4-2018, VET had an earnings call slide that clarified at what WTI price the company would be able to sustain the business and pay dividends. It also indicates that if crude remains over $50/barrel that it will be able to fund all of the anticipated growth projects for 2019.

VET - Dividend SustainabilitySource: Q4-2018 Earnings

I see VET as a good risk/reward candidate because it has consistently paid a dividend for over 15 years (and in many cases increased it) with the only volatility being a result of currency fluctuations between USD and CAD. I believe that we will see management become extremely interested in share buybacks at these levels which will have a major impact on earnings going forward. As long as VET can produce the cash-flow the stock looks like an extremely promising play.

Client Background

I want to emphasize that this is an actual portfolio with actual shares being traded. This article focuses on Jane, who is a few years out from retirement and has requested my help in managing her own portfolio instead of paying a financial advisor. It is important to understand that I am not a financial advisor and merely provide guidance for her account based on a friendship that goes back several years. In this article, I will refer to Jane as "my client" and I do this for simplicity's sake, but I do not charge her for what I do. The only thing Jane offers in return is allowing me to write anonymously about her financial journey with the hope that I can potentially help others who are wanting to achieve the same thing.

Jane is still working and has aspirations of retiring in the next two years which is part of the reason why I write this series separately from her husband John (who is currently retired). Because Jane is not currently retired, I have focused her portfolio on slightly more aggressive investments than her husband and plan to transition to a slightly more conservative mix over the next two years. From a day-to-day finance perspective, readers should be aware that Jane and her husband currently have no debt or mandatory monthly obligations other than what is expected (such as property taxes, water, etc.)

Jane and her husband 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. To briefly summarize this, Jane and her husband are on board with the idea of building a portfolio of stocks that will provide a steady stream of growing dividend income that will supplement their income during retirement.

Because of Jane's age, we are not overly concerned with the impact of required minimum distributions (RMD) from her Traditional IRA. RMDs are important for retirees to pay attention to since the penalties for not withdrawing the mandatory amount is 50% tax on the difference between the RMD and what was actually withdrawn. For example, if the current in Jane's Traditional IRA was $284,000, Jane would be required to withdraw $10,365 at the age of 70.5. If Jane failed to withdraw any funds she would be forced to pay approximately $5,183 as a penalty to the IRS. If she only withdrew $5,000, she would still owe $2,683 (the difference between the RMD and what was actually withdrawn).

The goal for Jane's retirement accounts is that she will be able to rely on dividends for the majority of her near-term Traditional IRA distributions. By doing this, we are making sure that Jane won't need to sell shares from her Traditional IRA until it is absolutely necessary to meet the RMD. Living on dividends vs. selling shares is the key difference between living on the cash flow generated by her investments and needing to sell shares as a means of "funding her retirement."

Here are some important characteristics to keep in mind about the Retirement 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. I am not concerned with owning stocks that have a qualified/non-qualified dividend because both of these accounts are tax-sheltered (Traditional IRA and Roth IRA).
  3. I do trade stocks in the retirement portfolio on a more regular basis because the gains are sheltered from taxes. The number of trades that take place on any given month depends on market volatility and whether or not a stock has reached the price target that I have set for it. I adjust these targets regularly and will be incorporating more information as to how I set these price targets over the next few months.

For those who are looking to understand John and Jane's portfolio I have included the link for the September Taxable account below:

The Retirees' Dividend Portfolio - John And Jane's September Taxable Account Update: Adding McDonald's

Dividend And Distribution Increases

The following companies from the Traditional IRA and Roth IRA paid an increased dividend during the month of September. This includes:

  • Bank of America (BAC)
  • Cummins (CMI)
  • KeyCorp (KEY)

Bank of America - BAC is one of the big banks that everyone loves to hate, however, as an investor it becomes difficult to argue with its business model even though the average consumer often has a negative opinion of BAC. Lately, I have found it to be profitable to add more than a full position around $27/share and to subsequently sell some of the high-cost shares when it peaks over $30/share. This has allowed us to slowly move the cost basis down to $27.95/share on 310 shares. BAC currently trades at a P/E ratio of 11.2x which is below its 5-year P/E ratio average of 13.4x. One major development is that Warren Buffett asked the Fed to allow Berkshire Hathaway (BRK.A) (BRK.B) to increase its total stake above 10%.

BAC - FastGraphs The dividend was increased from $.15/share per quarter to $.18/share per quarter. This represents an increase of 20% and a new full-year payout of $.72/share compared with the previous $.60/share. This results in a current yield of 2.42% based on a share price of $29.73.

Cummins - Reading through my tables I realized that I forgot to include CMI as one of the companies that increased its dividend during the month of September in the Taxable article. I found it even more ironic that I would miss news of its 15% dividend increase! I was originally looking to add more CMI if it were to drop into the $140/share range, however, based on recent events it looks like I will have to settle for adding shares in the $150/share range. Investors' should be aware of the expected impact on earnings in 2020 which is the primary bear case against CMI's current valuation.

CMI - FastGraphs The dividend was increased from $1.14/share per quarter to $1.311/share per quarter. This represents an increase of 15% and a new full-year payout of $5.244/share compared with the previous $4.56/share. This results in a current yield of 3.15% based on a share price of $166.35.

KeyCorp - We went long on KEY back in April and explained why in the article KeyCorp: Why You Should Buy Before Q1 2019 Earnings. Since then, KEY has reported Q1/Q2 earnings which saw growth in loans and deposits. KEY has continued to focus on improving its efficiency ratio from 61.9% in Q2-2019 down to 54%-56% by the end of Q4-2019. KEY currently trades at a P/E ratio of 10.1x which is less than its five-year average P/E ratio of 13.3x. I personally find KEY compelling when the share price drops below $17/share.KEY - FastGraphs

The dividend was increased from $.17/share per quarter to $.18.5/share per quarter. This represents an increase of 8.8% and a new full-year payout of $.74/share compared with the previous $.68/share. This results in a current yield of 4.16% based on a share price of $17.78.

Retirement Account Positions

There are currently 17 different positions in Jane's Roth IRA and 32 different positions in Jane's Traditional IRA. While this may seem like a lot, it is important to remember that some of these stocks cross over in both accounts and are also held in the Taxable portfolio.

Traditional IRA - The following stocks were added in the Traditional IRA during the month of September.

  • Eaton Corp (ETN) - Sold 20 Shares @ $87.88/share.
  • Illinois Tool Works (ITW) - Sold 15 Shares @ $158.08/share.
  • Digital Realty (DLR) - Sold 25 Shares @ $129.99/share.

2019 - Traditional IRA Trades - SeptemberSource: Charles Schwab

Because we sold these positions we saw modest realized gains during the month of September.

Traditional IRA - September Realized Gains Source: Charles Schwab

There were no shares purchased in the Traditional IRA during the month of September.

Roth IRA - The following stocks were added in the Roth IRA during the month of September.

  • Vermilion Energy - Purchased 200 Shares @ $14.41/share.

2019 - Roth IRA Trades September Source: Charles Schwab

We did not sell any positions in the Roth IRA during the month of September.

September Income Tracker - 2018 Vs. 2019

The following images are intended to provide readers with a better understanding of what Jane's Traditional and Roth IRA accounts look like. The images show represent all updated information for the month of August and Gain/Loss numbers are based on prices from October 15th market close.

SNLH = Stocks No Longer Held - Dividends in this row represent dividends collected on stocks that are no longer held in that portfolio. We still count the dividend income even though it is non-recurring.

On the lists provided below, it is important to know that not all stocks on that list were owned at that point in time (2018 tables represent what holdings were still held at the end of 2018). All of the stocks you see were acquired over the course of a year.

Traditional IRA - September YoY Change

Source: Consistent Dividend Investor, LLC

Roth IRA - September YoY Change

Source: Consistent Dividend Investor, LLC

Here is a graphical illustration of the dividends received on a monthly basis for the Traditional and Roth IRAs.

Traditional IRA - 2019-9 Update

Source: Consistent Dividend Investor, LLC

Roth IRA - 2019-9 Update

Source: Consistent Dividend Investor, LLC

Based on the current knowledge I have regarding dividend payments and share count, the following tables are a basic prediction of the income we expect the Traditional IRA and Roth IRA to generate in FY-2019 compared with the actual results from 2018.

Retirement Projections - 2019-9 Update Source: Consistent Dividend Investor, LLC

In the February Taxable account article, I added a new section that should help readers understand how the account balance fluctuates on a monthly basis. I often receive questions asking if I am able to tolerate a portfolio sitting at a loss and feel that this should help readers understand the big picture.

Here is a table to show how the account balances stack up year-over-year (I previously used a graph but believe the table is more informative)

Retirement Account Balances - 2019-9 Update

Source: Consistent Dividend Investor, LLC

Lastly, on the topic of transparency, I like to show readers the actual gain/loss associated with each position in the portfolio because it is important to consider that in order to become a proper dividend investor, it is necessary to learn how to live with volatility. The market value and cost basis below is accurate as of the market close on October 15th.

Here is the Gain/Loss associated with Jane's Traditional IRA.

Traditional IRA Gain-Loss - 2019-9 Update

Source: Consistent Dividend Investor, LLC

Here is the Gain/Loss associated with Jane's Roth IRA.

Roth IRA Gain-Loss - 2019-9 Update

Source: Consistent Dividend Investor, LLC

The Gain/Loss associated with both accounts has leveled off in the last two weeks although I am particularly happy about the improvement in Synnex (SNX) share value after their really solid Q3-2019 earnings report.

  • Traditional IRA - Current gain/loss of $720.60 vs $1,618.13 when the August retirement article was written.
  • Roth IRA - Current gain/loss of -$3,382.40 vs -$4,451.39 when the August retirement article was written.

Conclusion

Jane's retirement accounts sit at their highest balances YTD and that is even despite some less-than-stellar value declines from some of the positions in her portfolio. We continue to look for positions that are overvalued and will trim accordingly to rebuild cash reserves (most of this is taking place in the Traditional IRA). October started off with many of my favorite stocks edging closer towards my price targets but trade and other developments made those opportunities disappear. As much as I want to deploy capital I have decided to maintain discipline and follow the price targets that have been established.

Overall I am very pleased with the continued improvement in the average cost per share of investments in the portfolio. As with the taxable account, we are looking to continuously improve the quality of the portfolio but that means we aren't objecting to taking on additional risk. In September we added 200 shares of VET (I am personally long VET as well) which adds nearly $35/month of income going forward.

New Article Format: Let me know what you think about the new format (what you like or dislike) by commenting, liking, following, etc. I appreciate all forms of criticism and would love to hear what I can do to make the articles more useful for you!

In Jane's Traditional and Roth IRAs, she is currently long the following mentioned in this article: AbbVie (ABBV), Archer Daniels Midland (ADM), Bank of America (BAC), Bank of Nova Scotia (BNS), BP (BP), British American Tobacco (BTI), Canadian Imperial Bank of Commerce (CM), Cummins (CMI), CenturyLink (CTL), Digital Realty (DLR), Eaton Vance Floating-Rate Advantage Fund A (MUTF:EAFAX), Enbridge (ENB), Eaton Corporation (NYSE:ETN), Emera Inc. (OTCPK:EMRAF), East West Bancorp (EWBC), General Mills (NYSE:GIS), Gilead Sciences (GILD), Gaslog Partners Preferred C (GLOP.PC), Honeywell (HON), International Business Machines (IBM), Illinois Tool Works (ITW), Iron Mountain (NYSE:IRM), Johnson Controls (NYSE:JCI), KeyCorp (KEY), Laurentian Bank of Canada (OTCPK:LRCDF), LyondellBasell (LYB), LogMein (LOGM), Main Street Capital (MAIN), 3M (NYSE:MMM), Mesabi Trust (NYSE:MSB), Altria (NYSE:MO), NetApp (NTAP), Realty Income (NYSE:O), Oxford Lane Capital Corp 6.75% Cum Red Pdf Shs Series 2024 (NASDAQ:OXLCM), Preferred Bank (NASDAQ:PFBC), Philip Morris (NYSE:PM), PolyOne Corp. (NYSE:POL), PPL Corporation (NYSE:PPL), Royal Bank of Canada (NYSE:RY), Schwab International Equity ETF (SCHF), Synnex Corp. (NYSE:SNX), Toronto-Dominion Bank (NYSE:TD), US Bank Preferred H-Series (USB.PH), Vermilion Energy (VET), Verizon (NYSE:VZ), Williams Companies (WMB), W.P. Carey (NYSE:WPC).

Disclosure: I am/we are long ADM, CTL, ETN, HON, MAIN, MMM, VET. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.