BCX: A Commodities Winner, But Tactically Expensive

Summary

  • BCX invests in companies involved with energy, materials, and agricultural commodities.
  • The fund utilizes a call option buy-write strategy to enhance income supporting a 5.1% distribution yield with a monthly payment.
  • While keeping a bullish outlook on commodities, we highlight three reasons to take a cautious approach towards BCX at the current level.
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The BlackRock Resources & Commodities Strategy Trust (NYSE:NYSE:BCX) is a closed-end fund investing across energy producers and mining stocks, as well as companies benefiting from a broader theme of global resource demand including agriculture. BCX also utilizes a call options buy-write strategy to enhance income supporting a monthly distribution that currently yields 5.1%. Commodities have been trending higher over the past year defined by the higher prices fueled by a combination of strong global growth and supply chain disruptions from the pandemic lows. Indeed, BCX has returned over 30% in 2021 benefiting from the bull market in the segment and positive momentum. While we believe BCX is an overall high-quality fund offering investors a unique strategy and exposure, we are taking a more cautious approach at the current level. We find that BCX appears relatively expensive based on a combination of its narrow discount to NAV and also tight distribution yield.

(Seeking Alpha)

BCX Background

BCX has the stated investment objective to generate a high current income with a secondary objective of capital appreciation. Through the options writing (selling) strategy, across a relatively concentrated portfolio of 46 equity holdings, the management team at BlackRock Inc. (BLK) writes calls covering approximately 34.5% of the overall exposure which generates income through the collection of options premium.

(source: BlackRock)

The options strategy represents a partial downside hedge while the upside appreciation potential on the portion of stocks with written calls is limited to the respective strike prices. All-else-equal, the fund should outperform a non-hedged portfolio in a scenario of steady gains in the underlying equity prices and lower than expected volatility. On the other hand, BCX would likely underperform a traditional long-only portfolio that exhibits significant upward momentum which was the case for a period earlier this year. Separately, the buy-write strategy should help dampen volatility to the downside, at least in theory.

(source: BlackRock)

In terms of the sector exposure, the fund is currently allocated across energy stocks at 37% of holdings, followed by 34% in mining and 29% in agriculture. The current top holding is the France-based TotalEnergies SE (TTE) integrated oil company with a 6.0% weighting, followed by Brazil's Vale SA (VALE) at 5.9%, and Chevron Corp (CVX) at 5.6%. Keep in mind that since BCX is an actively managed fund, the actual portfolio allocations are made at the full discretion of the fund manager and not meant to track any particular index. By this measure, we can conclude that the fund manager is particularly bullish on these names within the sector.

(Source: Seeking Alpha)

Going down the list, the mix includes everything from Royal Dutch Shell Plc (RDS.A) at 4.1% of the fund, agri-business food giant Bunge Ltd (BG) at 3.4%, along with smaller positions in Deere & Co (DE) at 2.9% and Packaging Corp of America (PKG) at 2.4% highlighting the flexibility of the fund's interpretation of commodities and resources.

BCX Performance

With an inception date in March of 2011, BCX's performance over the last decade has been defined by the otherwise difficult environment for commodities with lower energy and metals prices over much of the period including the crash in oil prices going back to 2014. The fund has returned a cumulative 11% over its entire history on a total return basis while the total return on NAV is slightly lower at 6.5%. On the other hand, the fund's fortunes have reversed more recently including a 67% total return on the market price and 40% gain at NAV over the past year.

Chart
Data by YCharts

The challenge in place the fund's return into context against a comparable benchmark is that the strategy investing across energy, materials, and agriculture is relatively unique. For reference, most energy sector CEFs typically offer high-yield strategy build around infrastructure and midstream oil and gas companies.

The SPDR S&P Global Natural Resources ETF (NYSE:GNR) is likely the most closely comparable fund with a passive strategy investing across the largest agriculture, energy, and metals and mining companies. The key difference being GNR is a passively managed ETF with a portfolio twice the size of BCX with over 90 holdings. One advantage is the fund's lower expense ratio at 0.4% compared to 1.1% for BCX. The GAMCO Global Gold, Natural Resources & Income Trust (NYSE:GGN) has a different profile but is possibly the closest CEF to BCX with exposure to energy and materials stocks, with an emphasis on gold and precious metals miners but not agriculture. GGN has an even higher expense ratio at 1.4%. Finally, there is also the Invesco DB Commodity Index Tracking (DBC) which is an ETF that simply tracks the price performance of commodity futures across energy, materials, and agriculture commodity futures. We previously covered DBC with an article here on Seeking Alpha.

What we find is that while BCX has outperformed these peer funds year-to-date and over the past year, the data shows BCX has lagged in terms of total return to NAV. While BCX has returned 67% over the past year on its market price assuming the reinvestment of all distributions, the 40% total return on NAV trails at 46% gain by the GNR ETF and 53% from the commodity futures fund DBC. This large spread between the market price and NAV return suggests the performance in BCX was driven by the change in a discount to NAV.

Chart
Data by YCharts

BCX - Relatively Expensive Discount to NAV

A dynamic at play for BCX is the significant narrowing of its discount to NAV currently at 2.2% from as wide as 19% in Q4 2020. In many ways, the tightening over the period is justified considering the trends in commodity prices surging across energy, materials, and agriculture. Essentially, as the sector became in-vogue again over the past year from the pandemic lows, the supply and demand forces have added a premium to the BCX strategy for this particular exposure. Still, by the fund's own record, a 2.2% discount to the NAV represents a premium compared to the 12% 3-year and the 5-year average.

Chart
Data by YCharts

For investors with enough experience trading CEFs, it's understood that timing the spread to NAV is an art form in itself and there is always the possibility that the discount high can narrow even further or even cross into a premium. Our concern here is that the spread could reverse lower down the line and adds to downside risk for the market price which would manifest through wider volatility. In this scenario, investors would be hit with both falling stock prices and the wider premium.

BCX - Narrow Distribution Yield

As mentioned, BCX's current distribution yield is 5.1% which is paid out monthly. In 2020 BCX cut the distribution to $0.04 from the prior rate of $0.0516 as a response to the collapse in the underlying stock prices and reduced NAV. In conjunction with the higher market price of the CEF, we highlight that fund's current yield is at a historically low level. This is further evidence we present that the fund is relatively expensive.

Chart
Data by YCharts

Note that a large portion of the distribution upwards of 60% in 2020 was classified as a return of capital "ROC". ROC is not taxable but reduces the investor's cost basis by the same amount. Some investors appreciate the ROC component as it can part of a tax efficiency strategy while others see it as an erosion of the fund's value as it continuously pays out more than it earns. Given the underlying NAV performance of the fund this year, we believe the current payout is sustainable for the foreseeable future, but we also do not expect a hike even under the currently strong segment conditions.

Analysis and Forward-Looking Commentary

There's a lot to like about BCX in this current environment as an interesting fund given its diversified exposure across commodities which is unique among CEFs. We are bullish on global growth with a view that the post-pandemic recovery is still in the early stages as COVID vaccination rates gain widespread availability worldwide. The result should be countries normalizing economic conditions sooner rather than later which will allow for a return of air travel and international trade momentum through 2022 and 2023. These factors should represent positive tailwinds for not only energy, but also materials, and agriculture.

That said, we found enough weaknesses that keep us on the sidelines with BCX. First, the GNR ETF as a comparable alternative has delivered a higher total return to NAV this year with a similar underlying exposure at a lower expense ratio. Assuming BCX's discount to NAV simply stays flat at the current level, we believe GNR could outperform on its market price total return going forward. We are also discouraged by BCX's distribution yield at 5.1% which is not necessarily a level to get excited about among other income-focused CEFs and makes it harder to justify the 1.1% expense ratio.

Final Thoughts

Patient investors should keep this one on their radar and look for a better entry point down the line. Tactically, any correction in the share price with the potential to bring the discount to NAV beyond 10% would set up a buying opportunity in our view. On the downside, the risk here comes down to the potential for a deterioration of the global macro outlook. Weaker than expected economic indicators going forward could set up renewed bearish sentiment towards commodities pressuring underlying stocks in the BCX portfolio.

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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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