Situation: Commodity producers have a dismal record. Spot prices fall whenever mining (or drilling or harvesting) becomes more efficient. To make matters worse, supply-chain management and investment has become increasingly global and professionalized. Nonetheless, copper sales remain the best barometer of fixed-asset investment, particularly the ongoing proliferation of industrial plants and equipment in China. Silver has a growing role, thanks to the buildout of solar power. And gold remains a check on the propensity of government leaders everywhere to finance their dreams with debt, as opposed to revenue from taxes.
Mission: Use our Standard Spreadsheet to highlight the largest companies producing gold, silver, and copper.
Execution: see Table.
Administration: Gold and silver prices remain stuck where they were 35 years ago but are characterized by high volatility. Commodity prices (in the aggregate) trace supercycles that last approximately 20 years. The most recent came from a 1999 low and fell back to that level in 2016; since then it has ever so slowly risen from that low.
Bottom Line: The basic rule for commodity producers is that 3 years out of 30 will be good years, and you’ll make a lot of money. But over any 20-30 year period, you’ll lose money (measured by inflation-adjusted dollars). Our Table for this week confirms these points but does show that copper (SCCO) is worth an investor’s attention. But beware! That company’s share price is falling because of a falloff in trade with China and could fall further if a trade war takes hold.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 = 5, and gold bullion = 10).
Full Disclosure: I do not have positions in any commodity producers aside from Exxon Mobil (XOM), but do dollar-average into the main provider of mining equipment: Caterpillar (CAT).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
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Showing posts with label pipelines. Show all posts
Showing posts with label pipelines. Show all posts
Sunday, September 9
Sunday, February 1
Week 187 - Barron’s 500 List: Utilities With Good Credit
Situation: Utility stocks work a lot like bonds, since most utilities are ~60% capitalized with bonds backed by a state government. Being monopolies, both consumers and investors are protected by state and federal regulation. The Dow Jones Utility Average (DJUA) consists of 15 stocks that have been selected by a committee chaired by the managing editor of The Wall Street Journal. Since 1928, the DJUA has served as a technical indicator for stock-market health. This is due to the fact that stocks (particularly utilities) perform best in a low interest-rate environment. In the 72 yrs since the DJUA bottomed in 1942 (just before the Battle of Midway), it has risen at a rate of 5.7%/yr (without reinvestment of dividends) vs. 7.9%/yr for the S&P 500 Index without reinvestment of dividends, compared to 5.6%/yr for 10-yr Treasury Notes with reinvestment of interest payments.
Since January of '04, an exchange-traded fund that tracks the DJUA (IDU in the Table) has been available. With dividends reinvested, it has grown 2%/yr faster over the past 11 yrs than the lowest-cost S&P 500 Index fund with dividends reinvested (VFINX in the Table). And, it accomplished this feat with lower risk (see Column D and Column I in the Table). However, part of that performance is unsustainable because the Federal Reserve has kept overnight interest rates (for interbank loans) below 0.2% since November of '08. That policy is projected to end in 6 months and, once it does, utility stocks will gradually return to normal valuations relative to operating earnings. But utility stocks will always be somewhat like bonds in that they’ll represent “portfolio insurance” against stock market crashes.
For this week’s Table, we’ve examined all of the utility stocks in Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges. The Barron’s 500 List is helpful because companies are ranked both by their combined scores on sales growth and cash-flow based Return On Invested Capital (ROIC). For the Table, we have excluded any companies with an S&P bond rating less than BBB+ or an S&P stock rating of less than B+/M, leaving us with 9 stocks. Six are dividend achievers (Col P in the Table) and 5 are in the DJUA (Col T in the Table). Four are on both lists (NEE, ED, SO, D). A good way to get started investing in utilities is to pick two of those 4 stocks, then use dollar-cost averaging to build a “utility position” that eventually amounts to 4% of your retirement portfolio. There is probably no better investment to have in a low interest-rate environment. In a market crash, they’ll serve you almost as well as a corporate bond fund like the Vanguard Intermediate-term Corporate Bond Index Fund (VFICX at Line 15 in the Table). And a crash can’t be that far off, given the inflation in financial assets since '08 when the Federal Reserve began its policy of Financial Repression. For further explanation of Financial Repression, see Week 76 and Week 79.
Caveat Emptor: Utility stocks are presently over-priced. In the Table, this is seen most clearly for the utilities involved in natural gas storage and distribution (SRE and D): see the metrics for P/E (Col J) and EV/EBITDA (Col K). When running the Buffett Buy Analysis (see Week 30) in Cols U through Y, we see that those same companies have lost much of their future value to investors (see Col Y) because of overvaluation (see Col J and Col K).
The utility industry is evolving. It has been my good fortune to serve on the Board of Directors of a private power company for the past 15 yrs that provides heat, electricity, and air conditioning to an urban institution. The changes have been remarkable, as we’ve gone from depending on a coal-fired power-plant that only employed natural gas for “peaking power” to a natural gas-fired cogeneration plant, supplemented by solar, wind, and hydroelectric power. This is the future, happening now.
Bottom Line: High-quality utility stocks are safe and effective investments to include in your retirement portfolio. As a group, the 9 listed in our Table have returned ~12%/yr since '03 while losing less than 20% during the 18-month Lehman Panic. The index fund that reflects the Dow Jones Utility Average (IDU) did almost as well, gaining ~10%/yr while losing 35% during the Lehman Panic. This record beats the lowest-cost S&P 500 Index fund (VFINX), which only gained ~8%/yr while losing over 46% during the Lehman Panic. The rewards from owning utility stocks outweigh the risks, even in times of financial crisis. The question is: How much longer will the current low interest-rate environment (that has been so beneficial to debt-laden utility companies) persist? I would say we’re closer to the end than the beginning 6 yrs ago. Once interest rates start rising, you’ll see prices hold up better in utilities that have adopted a low “carbon footprint.” Likely beneficiaries include Dominion Resources (D) because of its dominant position major in natural gas storage & distribution, and NextEra Energy (NEE) because of its dominant position in wind and solar power.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE and also own shares of D.
NOTE: metrics in the Table are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Since January of '04, an exchange-traded fund that tracks the DJUA (IDU in the Table) has been available. With dividends reinvested, it has grown 2%/yr faster over the past 11 yrs than the lowest-cost S&P 500 Index fund with dividends reinvested (VFINX in the Table). And, it accomplished this feat with lower risk (see Column D and Column I in the Table). However, part of that performance is unsustainable because the Federal Reserve has kept overnight interest rates (for interbank loans) below 0.2% since November of '08. That policy is projected to end in 6 months and, once it does, utility stocks will gradually return to normal valuations relative to operating earnings. But utility stocks will always be somewhat like bonds in that they’ll represent “portfolio insurance” against stock market crashes.
For this week’s Table, we’ve examined all of the utility stocks in Barron’s 500 List of the largest companies by revenue that are listed on the New York or Toronto stock exchanges. The Barron’s 500 List is helpful because companies are ranked both by their combined scores on sales growth and cash-flow based Return On Invested Capital (ROIC). For the Table, we have excluded any companies with an S&P bond rating less than BBB+ or an S&P stock rating of less than B+/M, leaving us with 9 stocks. Six are dividend achievers (Col P in the Table) and 5 are in the DJUA (Col T in the Table). Four are on both lists (NEE, ED, SO, D). A good way to get started investing in utilities is to pick two of those 4 stocks, then use dollar-cost averaging to build a “utility position” that eventually amounts to 4% of your retirement portfolio. There is probably no better investment to have in a low interest-rate environment. In a market crash, they’ll serve you almost as well as a corporate bond fund like the Vanguard Intermediate-term Corporate Bond Index Fund (VFICX at Line 15 in the Table). And a crash can’t be that far off, given the inflation in financial assets since '08 when the Federal Reserve began its policy of Financial Repression. For further explanation of Financial Repression, see Week 76 and Week 79.
Caveat Emptor: Utility stocks are presently over-priced. In the Table, this is seen most clearly for the utilities involved in natural gas storage and distribution (SRE and D): see the metrics for P/E (Col J) and EV/EBITDA (Col K). When running the Buffett Buy Analysis (see Week 30) in Cols U through Y, we see that those same companies have lost much of their future value to investors (see Col Y) because of overvaluation (see Col J and Col K).
The utility industry is evolving. It has been my good fortune to serve on the Board of Directors of a private power company for the past 15 yrs that provides heat, electricity, and air conditioning to an urban institution. The changes have been remarkable, as we’ve gone from depending on a coal-fired power-plant that only employed natural gas for “peaking power” to a natural gas-fired cogeneration plant, supplemented by solar, wind, and hydroelectric power. This is the future, happening now.
Bottom Line: High-quality utility stocks are safe and effective investments to include in your retirement portfolio. As a group, the 9 listed in our Table have returned ~12%/yr since '03 while losing less than 20% during the 18-month Lehman Panic. The index fund that reflects the Dow Jones Utility Average (IDU) did almost as well, gaining ~10%/yr while losing 35% during the Lehman Panic. This record beats the lowest-cost S&P 500 Index fund (VFINX), which only gained ~8%/yr while losing over 46% during the Lehman Panic. The rewards from owning utility stocks outweigh the risks, even in times of financial crisis. The question is: How much longer will the current low interest-rate environment (that has been so beneficial to debt-laden utility companies) persist? I would say we’re closer to the end than the beginning 6 yrs ago. Once interest rates start rising, you’ll see prices hold up better in utilities that have adopted a low “carbon footprint.” Likely beneficiaries include Dominion Resources (D) because of its dominant position major in natural gas storage & distribution, and NextEra Energy (NEE) because of its dominant position in wind and solar power.
Risk Rating: 4
Full Disclosure: I dollar-average into NEE and also own shares of D.
NOTE: metrics in the Table are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, March 24
Week 90 - Pipelines
Situation: Pipelines are another sector of critical infrastructure that the government "builds out" by making tax expenditures. In order to tempt investors into funding the massive up-front costs of laying a new pipeline, the IRS offers these “tax breaks” as an incentive. Pipeline operators get direct support from the Internal Revenue Service (IRS) in the form of a letter stating that no corporate taxes need be paid as long as at least 85% of any profits are returned to shareholders--who also get a tax break (see below). The pipeline company, which is structured as a Limited Partnership that receives initial funding from a General Partner, has to issue bonds if it wants to further expand its pipeline network. Those bonds aren't backed by the government. That's the catch. All of the pipeline companies have to expand their networks (given the ever-growing demand) but also have to maintain an investment-grade rating on their bonds to obtain low-cost financing. They all "push the edge of the envelope" and issue as much debt as the 3 rating agencies (S&P, Moody's, and Fitch) will allow before the rating is dropped to "junk" status. If you’re still reading, you’ve probably figured out that a pipeline company is set up much like a real estate investment trust (REIT).
The fixed costs of a pipeline can be depreciated in 20 yrs even though the pipeline itself has a much longer life. That means “distributions” (i.e., each investor’s share of operating profits minus interest, capital expenditures and payments to the General Partner) are mostly tax-deferred. Investors receive a K-1 tax form each year noting that taxes owed on their share of the return on invested capital (ROIC) are only about 20%. The remaining 80% represents non-taxable depreciation which reduces the investor’s cost basis to zero over time. After that point, distributions are taxed at the going rate for capital gains. When the stock is sold, any gain that is realized (because of price appreciation) is taxed as income. Considering the unusual structure of this investment, it is a great way for you to grow your wealth. Granted, there are tax headaches, e.g. some pipeline routes cross states that require a tax form to be filed.
The current energy boom that has been touched off by “hydrofracking” and horizontal drilling has ignited ~$10 Billion/yr of investment in pipelines that will continue for ~25 yrs. Once a pipeline is built, the fees charged for transporting oil and gas are relatively inelastic, i.e., changes in the price of natural gas or oil have little influence on pricing.
The Table lists 10 Limited Partnerships that represent the spectrum of over 70 such companies. In the past, total returns (distribution rate + rate of growth in the distribution rate) have averaged 13-14%/yr. The Table calls those distributions “dividends” because that is how most investors think of them. But if you’ve read this far, you know that distributions are quite different from dividends. Just remember this: payouts are high and grow smoothly but price appreciation is slow and bumpy. You’ll build your after-tax wealth from the quarterly distributions, not from selling the stock (when you’ll have to pay full income tax on any profits). You’ll need a good accountant to do your taxes.
Bottom Line: Do you want to make real money (after inflation, transaction costs and taxes)? Then look at investing in MLPs (Master Limited Partnerships). Those are mainly pipeline companies that have great economics once the pipeline is built and long-term contracts are in place. There are two main problems you run into: 1) Your accountant will have to file more tax forms; 2) These companies carry a lot of debt and that debt is rated just one or two notches above junk. So you’ll have to do some digging and find companies that have good management. Then keep track of the company’s business plans. We think Kinder Morgan Enterprise Partners (KMP) has exemplary management, and S&P gives Enterprise Products Partners (EPD) an A-rating (the others haven’t yet been assigned a rating).
Risk Rating: 8.
Full Disclosure: I have no stock in an MLP but do have stock in one of the General Partners: Kinder Morgan (KMI).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The fixed costs of a pipeline can be depreciated in 20 yrs even though the pipeline itself has a much longer life. That means “distributions” (i.e., each investor’s share of operating profits minus interest, capital expenditures and payments to the General Partner) are mostly tax-deferred. Investors receive a K-1 tax form each year noting that taxes owed on their share of the return on invested capital (ROIC) are only about 20%. The remaining 80% represents non-taxable depreciation which reduces the investor’s cost basis to zero over time. After that point, distributions are taxed at the going rate for capital gains. When the stock is sold, any gain that is realized (because of price appreciation) is taxed as income. Considering the unusual structure of this investment, it is a great way for you to grow your wealth. Granted, there are tax headaches, e.g. some pipeline routes cross states that require a tax form to be filed.
The current energy boom that has been touched off by “hydrofracking” and horizontal drilling has ignited ~$10 Billion/yr of investment in pipelines that will continue for ~25 yrs. Once a pipeline is built, the fees charged for transporting oil and gas are relatively inelastic, i.e., changes in the price of natural gas or oil have little influence on pricing.
The Table lists 10 Limited Partnerships that represent the spectrum of over 70 such companies. In the past, total returns (distribution rate + rate of growth in the distribution rate) have averaged 13-14%/yr. The Table calls those distributions “dividends” because that is how most investors think of them. But if you’ve read this far, you know that distributions are quite different from dividends. Just remember this: payouts are high and grow smoothly but price appreciation is slow and bumpy. You’ll build your after-tax wealth from the quarterly distributions, not from selling the stock (when you’ll have to pay full income tax on any profits). You’ll need a good accountant to do your taxes.
Bottom Line: Do you want to make real money (after inflation, transaction costs and taxes)? Then look at investing in MLPs (Master Limited Partnerships). Those are mainly pipeline companies that have great economics once the pipeline is built and long-term contracts are in place. There are two main problems you run into: 1) Your accountant will have to file more tax forms; 2) These companies carry a lot of debt and that debt is rated just one or two notches above junk. So you’ll have to do some digging and find companies that have good management. Then keep track of the company’s business plans. We think Kinder Morgan Enterprise Partners (KMP) has exemplary management, and S&P gives Enterprise Products Partners (EPD) an A-rating (the others haven’t yet been assigned a rating).
Risk Rating: 8.
Full Disclosure: I have no stock in an MLP but do have stock in one of the General Partners: Kinder Morgan (KMI).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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