- BUI has seen a very strong short-term gain, which make me cautious going forward.
- The fund sat at a discount when I recommended it, but now it trades at a premium price.
- The Utilities sector continues to face challenges, with the economy re-opening on only a partial basis.
The purpose of this article is to evaluate the BlackRock Utilities, Infrastructure, & Power Opportunities Trust (NYSE:BUI) as an investment option at its current market price. This was a fund I strongly recommended during the sell-off, and its return has been impressive. Looking ahead, I see merit for continuing to hold it, as utility companies have seen decent financial performance, and investors may continue to crave the relative stability of the sector. However, I see a stronger argument for caution. The fund's discounted price, which I touted in April, has turned to a premium, which I view cautiously given how frothy markets are looking. Further, while partial re-openings are a positive for the sector, if we see a wave of new cases and renewed calls for lock-downs, power usage will certainly take another big hit. Finally, recent tax provisions in the Cares Act did improve liquidity across the Energy and Utilities sectors. However, some of these programs only accelerated refunds the companies were already entitled to. Therefore, while it improved their short term financial positioning, it did not alter the market value of the company.
First, a little background on BUI. The fund is managed by BlackRock (BLK), and its objective is to "provide total return through a combination of current income, current gains and long-term capital appreciation". BUI seeks to achieve this objective by investing in equity securities issued by companies in the Utilities, Infrastructure, and Power business segments and by utilizing an option writing strategy. BUI currently trades at $21.23/share and yields 6.84% annually by paying monthly distributions. I recommended BUI about two months ago, when I felt the fund's discounted price offered a great way to buy in to the Utilities sector, which I felt was due for a rebound. In hindsight, this call was very timely, as BUI has seen a return in excess of 19%, beating passive alternatives as well as the S&P 500, as shown below:
Source: Seeking Alpha
Given all that has taken place since early May, I thought it was an opportune time to take another look at BUI to see if I should change my rating from here. After review, I believe taking some profits here would be justifiable, and I am lowering my rating to "neutral", for the reasons I will explain in detail below.
New Valuation Makes Me Cautious
To begin, I want to focus on the primary reason I am shifting to a more modest outlook on BUI. Specifically, this is the fund's valuation. In fairness, this is my general feeling for the market as a whole. While I had expected equities to rebound, the sharpness of the recovery has taken me by surprise. With bonds rallying due to Fed support, and equities reclaiming the 27k mark in the Dow Jones, I am wary of building on most of my positions here. While I do see pockets of value, I no longer see it in BUI. To understand why, consider that during my review in April, BUI traded at a discount of almost 10% to its NAV. This was a buy signal in my view. Today, that discount has disappeared, and has been replaced with a premium above 2%, as shown below:
Clearly, the valuation situation has changed markedly. While I don't necessary view BUI as "expensive", I am wary of paying premiums in our current climate. With the market close to reclaiming prior highs, and BUI only a couple of dollars away from where it sat in February, I would absolutely be cautious here. On the bright side, the strong gain to the NAV is reassuring. However, the market price has been rising faster. Of course, this is a positive for current investors, but it tells me that for those who missed out on this rally, a better opportunity may very well present itself. If the market continues in risk-on mode, BUI's premium will likely move higher. But if the Fed steps off the gas pedal, or the state re-openings do not go as planned, I expect a discount to present itself once again. This clouded outlook supports my neutral rating.
Earnings Have Been Resilient
While my first point was one of caution, I do want to emphasize that I am not bearish on this fund. Rather, I simply do not expect such strong, short term gains to continue in the second half of the year. But, that said, I do see an environment where BUI could move higher.
A key reason is actual earnings within the broader Utilities sector. As a global fund, BUI holds some of the largest names in the space across the world, as shown by its top holdings, listed below:
Considering the global reach, this is a fairly diverse group. Fortunately, Q1 earnings have been fairly resilient across the board. To illustrate, consider that some of the top players in the sector saw their Q1 earnings handily beat analyst expectations, as shown below:
Considering the environment, this is a pretty strong graph. Energy providers had generally been coming under pressure during the worst of the sell-off, as industrial, plant, and commercial closures had lead to a decline in power usage. However, residential consumption increased, as people stayed in their homes and used more electricity. This was a relief for utility companies.
And this is very relevant for BUI. The graphic above shows six major players, and two of them, NextEra Energy (NEE) and Avangrid Inc. (AGR), (which is a subsidiary of Spanish utility giant Iberdrola SA (OTCPK:IBDSF)), are top ten holdings within the fund. Further, CME Energy Corporation (CMS) and FirstEnergy Corporation (FE) are also held in the portfolio, albeit at lower amounts.
My takeaway from this is the sector's rebound, and BUI's performance by extension, has been justifiable. The sell-off appears to have been overblown, and broad underlying performance showed the Utilities sector is indeed less effected by cyclical factors than many other sectors. With economies beginning to open back up, coupled with some investors who are still scarred from the latest sell-off, many could continue to find BUI an attractive choice.
Liquidity Improved By The Cares Act
Another positive for BUI is that some of its underlying holdings were also able to take advantage of recent Congressional action to strengthen their cash position. Specifically, according to a report from Bloomberg, energy providers, including gas, electric, and oil companies, reported benefits from a variety of tax breaks included in the CARES Act. These included payroll tax deferrals, expanded write-offs for debt interest payments, and accelerated refunds from the now-defunct minimum tax. Some big beneficiaries are listed below, two of which, Sempra Energy (SRE) and Duke Energy (DUK), are held by BUI:
*Another notable mention of a top beneficiary of the law was American Electric Power Company (AEP), which is also in BUI's portfolio.
Overall, I view these developments positively, as it eases the short term tax burden and also accelerates the time-table for receiving the tax credits these companies are entitled to. It is always better to receive cash now rather than later, so this is positive news all other things being equal.
However, I also must caution investors to take this with a grain of salt. While potential cash infusions will certainly help these companies ride out a challenging period, many of these refunds and deferrals are not "new", they are simply being accelerated. So while it is helpful for these energy providers to get liquidity now, it does not really change their financial position over the longer term. A deferred asset is still an asset, and while receiving it early is preferable, it does not add to the company's net asset position. Therefore, I would resist the urge to get overly excited about these developments.
Residential Utility Bills Going Unpaid
My final point again is a word of caution, and speaks to the reason behind why energy providers were offered tax incentives to begin with. Specifically, this relates to the impact of Covid-19 on household finances. With millions of people out of work, the probability of electric and gas power bills going unpaid is sure to rise. Further, most companies are not shutting off power due to unpaid bills, although most will expect consumers to make up missed payments over time. While many states have not forced utility providers to defer disconnections, they are electing to go that route anyway. Further, roughly half of the states have indeed made it mandatory, as shown below:
Source: S&P Global
Essentially, the environment is going to be challenging for energy providers, as they are expected to deliver their services regardless of payment. While I would argue this is the "right" thing to do, that does not make the financial challenge irrelevant. While provisions in the Cares Act have helped to balance out this economic reality, revenues and earnings are certainly going to be pressured until we have a full re-opening of the U.S. economy.
BUI's total return has been impressive over the past two months, so this was a welcome addition to the portfolio. However, I was surprised by the size of the gain, and find it unlikely to continue in the months ahead. While the Utilities sector will perform well as economies open back up, it will be a challenging market ahead, so locking in some out-sized profits may be the right move. BUI's discounted price is a thing of the past, which was a key reason for my prior bullishness. Although its current premium is reasonable, I am reluctant to add to most positions in this market, and especially to those whose valuations have risen by so much. As economic activity has remained subdued and household finances make unpaid electric bills more of a reality, I believe a more neutral outlook on BUI is warranted. Therefore, I would caution investors to think carefully before starting any new positions in BUI at this time.
This article was written by
I began my career in financial services in 2008, at the height of the market crash. This experience has shaped my investment strategy - which is focused on diversification, dividends, and growth opportunities. I am a competitive tennis player, and I competed at the Division I level in undergrad. I have a Bachelors and MBA in Finance.(He is a contributing author for the investing group CEF/ETF Income Laboratory where he specializes in macro analysis. Features of CEF/ETF Income Laboratory include: managed income portfolios (targeting safe and reliable ~8% yields) making use of high-yield opportunities in the CEF and ETF fund space. These are geared toward both active and passive investors of all experience levels. The vast majority of holdings are also monthly-payers, for faster compounding and steady income streams. Other features include 24/7 chat, and trade alerts. Learn more.)
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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