ValueWalk Interview With Jack Leslie Of Miller/Howard Investments

Transcription

1 ValueWalk Interview With Jack Leslie Of Miller/Howard Investments

2 ValueWalk Interview With Jack Leslie Of Miller/Howard Investments ValueWalk: How is Miller/Howard different from other asset managers? Jack. Leslie: We probably place more emphasis on a company s dividend policy than most other asset managers. We ask the question Is the dividend safe and will it grow? While a portfolio s yield is often a byproduct of value management for most managers with a value/dividend focus, value is more often a byproduct of our dividend focus. For instance, we have been managing our Income-Equity Strategy, which is the strategy that our mutual fund (Ticker MHIEX) is based on, for almost 20 years. [July 2017 will mark the 20th anniversary.] We have always invested in what we consider high quality companies that share their prosperity with shareholders by way of a high dividend yield, and also enough underlying growth to consistently grow their dividends. That three part formula of high quality, high yield, and dividend growth is no longer uncommon today in our low rate environment but I can tell you that it very unique when we started this strategy in Lowell Miller s book, The Single Best Investment (Creating Wealth with Dividend Growth) was first published in 1999, in the middle of the NASDAQ melt-up. Our approach was truly unique then and it has barely changed to this day. So it s our long-term commitment to the dividend approach to investing that sets Miller/Howard apart from other asset managers. Another unique aspect of our management is the absolute yield that we have been able to deliver to our clients. Income produced from our portfolio gross of fees has averaged 250 bps annually above the income produced by the S&P 500 over the past 15 years. We have seen very few managers able to match the income levels we have delivered in our portfolios. And over the last 4 years income has grown at an annualized rate of over 6% in this strategy. Miller/Howard seems to have a love affair with dividends, how did this come about? Miller/Howard started more than 30 years ago as an institutional research firm. One of our clients asked us to research fixed income alternatives. Lowell Miller, founder and still chief investment officer of the firm, found that utilities was consistently the highest yielding sector. And yet, there were no existing studies of utilities as an asset class. Lowell completed the first ever study of utilities as an asset class, looking at the Dow Jones Utilities index vs. the S&P 500 as well as vs. the long bond over a 45 year period from What the study found was, over this 45 year period, utilities returned 50 bps less than the S&P 500 but did it at roughly half the volatility. Income from utilities was also greater than the income from long bonds. The key ingredient in this attractive risk/reward profile of the utilities sector was the power of rising income. The Dow Jones Utilities stocks had raised their dividends in 41 of the 45 years, resulting in a 14 fold increase in income. Rising income combined with the compounding resulting from reinvested income had resulted in an investment that provided market like returns with less risk while also producing better than bond income. Our first product, in fact, was called Utilities: Better than Bond/Income. (C) ValueWalk All Rights Reserved 1

3 This study lead directly to Miller/Howard running equity money. Since that time, we have been focused on income-producing equities, primarily ones with recurring-revenue business models. Seeing as you re the dividend experts, what do you look for in the perfect dividend stock? It s interesting that you ask that question. I m not sure that the perfect dividend stock exists as equities are inherently imperfect and uncertain, but we often talk about our goal as dividend managers as trying to create the perfect dividend stock. So we seek to make the portfolio itself, or the mutual fund in this case, a perfect stock. That s why Lowell s book was called Single Best Investment. We re seeking to create the perfect investment by creating a basket of stocks that fit certain needs. One stock might be included for their growth profile, another stock for their high income payout. Some of the characteristics we look for to create the perfect stock are cash flow coverage, interest coverage, payout ratios, future debt obligations, business environment, volatility of earnings, and philosophy of management. We also keep an eye on macro themes such as the graying of America or the migration to cloud computing. Sector diversification is important, but we are still bottom up and sector diversification for the sake of sector diversification has most often not worked out well. Companies that pay substantial dividends to investors are generally considered to be ex-growth. When it comes down to growth, is this something you re looking for, surely you re looking for companies that have scope to grow their dividends. So, what would the perfect dividend-grower look like to you? You ve just highlighted a common myth about investing namely that income producing stocks have less growth than non-dividend paying companies. Consider as we speak today (July 13, 2016) that utilities are up 23% YTD vs. the S&P 500 which is up 6.6%. And over the past 5 years, utilities are up 92.3% vs. 82.5% for the S&P 500. Over 10 years, utilities are up 79.5% vs. 79.2% for the S&P 500. Granted, utilities today are trading at historically high valuations, but these returns are consistent with the 45-year utilities study I mentioned earlier so we don t think investors need to give up growth in exchange for income. Boring dividend stocks often provide a lot of excitement. The difference is that a greater portion of the total return comes from income vs. price appreciation so there may in fact be less growth in stock price but we find that growth of total return has historically been very competitive when compared to non-dividend paying stocks. As for dividend growth, we absolutely look for companies that can grow their dividends. Rising dividends are, in fact, key to our approach. We take the old world view that the value of an asset should be a multiple of the income that asset produces. It s interesting how often a company s stock price will be pulled along by dividends that increase over time. Take a look at a chart of a company s stock price and their dividend history and you will often see a close correlation. Two examples would be Johnson and Johnson or Enterprise Products Partners. This chart pattern is quite common. Rising dividends almost act as a magnet that drags the stock price upward. (C) ValueWalk All Rights Reserved 2

4 Another helpful way to look at rising dividends is an apartment building analogy. What is important to the owner of an apartment building? Unless the owner is selling the property, we would say the monthly rent the owner collects is more important than the valuation of the building. In fact, if the rental income rises each year for each apartment, then the value of the building will also increase. So we re very focused on consistent increases in dividends. You recently launched the Miller/Howard Income-Equity Fund (MHIEX) why did you decide to launch this fund now and what makes it stand out from other equity income funds? We ve been providing our quality income and growth of income approach to high net worth and institutional investors for 25 years. Many of them have asked us about a mutual fund wrapper for many years as separately managed accounts typically have a $100,000 minimum account restriction. So for us, it was a matter of increasing access to our dividend management to a greater number of investors. It is the same approach and portfolio as our managed account portfolios. I should also mention that we have managed this strategy with ESG screens since its inception in In addition to exclusionary ESG screens such as tobacco, firearms, gambling, human rights, and labor issues, we focus on shareholder engagement. We have a track record of engaging with companies to enact change as we prefer engagement over divestment. Our success in this area was recently recognized by Morningstar with a five globe ESG rating. This fund was ranked #2 out of 465 ranked value U.S. mutual funds by Morningstar on their sustainability score. One of the sectors Miller/Howard has a large exposure to is, MLPs. This sector has come under pressure recently. Do you still believe MLPs are a good investment for income investors and where are you finding the best, most sustainable yields today? We ve been investing in MLPs since If you go back to the three-part formula I mentioned earlier high quality, high yield, and dividend growth MLPs are the poster child for that approach. The MLPs in our portfolio own long-life assets with a high percentage of fee-based business, meaning revenues are derived from multi-year take or pay contracts. They consistently pay a high yield and also have grown their yield in the 6-8% range annually. There are two factors I would highlight that have recently impacted the sector. First is, the overall damage done to the energy space by falling crude oil and natural gas prices. This in itself was a result of what we would call the shale revolution as new technologies led to a boom in energy production in this country. The excitement caused by the shale revolution resulted in a lot of money entering the space including the buildout of our energy infrastructure. Infrastructure in some parts of the country did get overbuilt. But I should point out, there is still a need for energy infrastructure in other parts of the country, so good opportunities exist for the right MLPs. This increase in investment likely resulted in some of the big distribution growth numbers we saw from MLPs just a few years back. Valuations for MLPs also got a bit extended. A big reason for this is the overall low-yield environment and investors search for yield. MLPs have historically been a haven for the high-net worth investor who were mostly attracted to MLPs for their tax-deferred income. Investors became limited partners of the MLP and would have to file a K-1 tax form each year. But retail products began appearing a little over 5 years ago that offered a way to invest in MLPs while also blocking the K-1 paperwork. These retail products have their own issues but it doesn t seem to have slowed down investment in this space. By most accounts there was over $30 bil that entered the MLP space through these new products over a very short period of time. It would be an understatement (C) ValueWalk All Rights Reserved 3

5 to say that the market had difficulty in absorbing this influx of assets. Keep in mind that the MLP space is fairly confined. If you combined the energy MLPs into one entity, it would not even be the biggest publicly traded company. All this is to say that the MLP space has become very volatile far greater than what we had seen in our first 15 years of investing in MLPs. We re talking about price volatility. The income picture has become more stable and for income investors, we see MLPs as offering good value. Even though they are over 50% above their lows of February 2016, we consider them to be in the fair value range (reminder they are still 30+% below their high while the S&P trades at an all-time high). However, in the current low-yield environment, and considering the attractive assets owned by the MLPs, it would be reasonable to expect MLPs to trade at a premium so we certainly see upside in prices from here. We continue to evaluate our MLP exposure at this time due to the somewhat extreme price volatility, the increasing clarity on the income and income growth side look compelling. You can buy into a 6% yield with 4-6% growth of yield as long as you can tolerate the sector volatility. As for the most sustainable yields in the space, we think you need to be very selective as roughly 35 of 120 MLPs have cut distributions over the past 12 months. Some of the factors we look at are growth in distributable cash flow, debt levels and maturation profile, current Incentive Distribution Rights structure, amount of fee-based contracts in their revenue stream, the quality of their counter-party relationships, and current valuations. What's your average turnover for your dividend funds? Our portfolio turnover is typically between 30-40% which is consistent with our 3-5 year hold period. Another mutual fund you run is the Miller/Howard Drill Bit to Burner Tip Fund. Could you tell our readers a bit about this? Of course. Miller/Howard Drill Bit to Burner Tip Fund (Ticker DBBEX) is an integrated approach to investing in energy. Much of the money currently invested in energy in concentrated in the upstream production companies, in particular in the larger multi-nationals. We take a more diversified, multi-industry approach. We allocate to four different buckets upstream, midstream, downstream, and enabler/beneficiaries. Our goal in doing this hopefully provide a smoother ride for the investor by portfolio diversification. Also important is our ability to manage the weights between these four buckets. Some industries, such as the upstream producers, benefit from high commodity prices. Others, such as utilities and petrochemical companies, benefit from low commodity prices. We have the ability to shift our allocations between these buckets in response to what we are seeing in the energy space. I would point out two things about this fund. Though it is well positioned to benefit from the reemergence of the United States as an energy powerhouse as we move toward energy independence, we think it should be seen as a long-term core portfolio allocation as it provides exposure to energy production, energy transportation/energy infrastructure, and the largest customers that benefit from abundant supplies of affordable natural gas in this country. The portfolio is decidedly tilted toward natural gas. Natural gas is the cleanest burning fossil fuel and is (C) ValueWalk All Rights Reserved 4

6 the chosen bridge fuel between the present fueled by coal and oil to a future that is carbon free. That future is likely 20 years or so away. The second point is that even though we recently launched this mutual fund, we have been managing this strategy for high-net worth individuals for over 5 years so this is not a new approach for us. Beyond that, roughly 70% of the portfolio consists of stocks we hold in one of our other strategies so a good way to look at the Drill Bit to Burner Tip mutual fund is that it is a best ideas portfolio from our existing utilities, energy infrastructure, and dividend strategies. As I stated, we see it as a core energy allocation. It should be utilized with a long-term time horizon as we are dynamically adjusting the allocations within the fund similar to a multi-asset or multi-sector fund. We believe it to be the most comprehensive way to capture the broad benefits of the North American energy revolution. This is first and foremost a technological revolution and from an investment standpoint the biggest beneficiaries of these breakthroughs are very likely to be companies that are not traditional energy players, but those benefitting from a newfound abundance of inexpensive domestic supply. Finally, last 24 months have reminded us that energy is cyclical. The breadth of this portfolio s investment universe allows us to leverage 3 decades of experience investing through energy cycles as we seek to achieve maximum returns with reduced volatility. What s your outlook for the oil sector going forward? Our expectations have been that crude oil markets would rebalance by the end of this year or early 2017 meaning that demand would catch up with the excess supply. Barring an unexpected recession, global demand growth coupled with falling production due to the collapse in new drilling should continue to bring the market into balance. Conventional wisdom is that the solution to low oil prices is low oil prices. The latest data from the U.S. Energy Information Administration indicates that U.S. oil production fell to 8.9 million barrels per day in April, down from 9.7 million barrels per day at the peak last year. Moreover, the declines are accelerating, due to a lack of drilling activity, with activity falling in April alone by 200 thousand barrels per day. We believe that oil demand will grow by about 1.2 million barrels per day globally in The biggest threat to that isn t substitute from renewables, or weather. Very simply, it s economic growth. The IMF recently lowered its global GDP growth outlook in the wake of Brexit. While the revisions don t appear enough to jeopardize those initial growth expectations, we are watching closely. A Brexit induced recession in Europe, or worse, a Brexit induced recession that spreads globally, would greatly undermine the process of rebalancing in the oil markets, and would likely lead to a further pullback in prices and activity. But this is uncharted territory for all involved, and even the markets appeared to have a difficult time assessing the impacts, gyrating from large losses to gains in a matter of hours. (C) ValueWalk All Rights Reserved 5

7 It s hard to overstate the importance of commodity prices to dictate activity across the industry in the short term (i.e. from year-to-year). Last month, we had the opportunity to meet with over a dozen executives from leading North American oil & gas producers. What struck us was the amount of sensitivity and operating leverage in their business models. In simple terms, every $0.10/mmbtu increase in natural gas prices and $1/bbl increase in oil prices provides an extra $6 billion in cash for the industry to spend either on new development wells, more completion activity, or to return to shareholders. Just a $10/bbl move in crude oil prices is a $60 billion swing in oil spending in the U.S.! Crude oil prices should normalize to $60/bbl by year end, a level we believe required to incentive sufficient drilling activity to maintain supply/demand balance. Prices could well trend below or above this depending on idiosyncratic developments, but are unlikely to persist there indefinitely. On the natural gas side, production continues to slowly roll over in the U.S., and prices have risen faster than expected due to heavy power generation demand, due to coal plant retirements. Long term, we don t believe that gas prices can sustain much above $3/mmbtu, as the shale revolution provides the technological capability to bring on massive additional supplies above those levels. (C) ValueWalk All Rights Reserved 6

8 Disclosures Past performance is not indicative of future returns. This information should not be used as a general guide to investing or as a source of any specific investment recommendations, and makes no implied or expressed recommendations concerning the manner in which an account should or would be handled, as appropriate investment strategies depend upon specific investment guidelines and objectives. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This document contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. The views expressed here are the current opinions of the author and not necessarily those of ValueWalk. The author s opinions are subject to change without notice. There is no guarantee that the views and opinions expressed in this document will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. No representations, expressed or implied, are made as to the accuracy or completeness of such statements, estimates or projections, or with respect to any other materials herein. Under no circumstances does the information contained within represent a recommendation to buy, hold or sell any security, and it should not be assumed that the securities transactions or holdings discussed were or will prove to be profitable. No part of this material may be copied, photocopied, or duplicated in any form, by any means, or redistributed without ValueWalk s prior written consent. (C) ValueWalk All Rights Reserved 7