Income Stocks Hitting on All Cylinders

Transcription

1 Income Stocks Hitting on All Cylinders Fellow Investor, Greetings, as I m writing this month s issue I hope I don't jinx The Dividend Hunter portfolio share prices for the next several days. April has been a very good month for the portfolio, with an equal weighted tracking showing right at a 4% increase in total return. The energy and finance stocks in the portfolio have moved up nicely, while the equity REITs have struggled and are showing negative returns for the month. Part of my process for selecting stocks to include in The Dividend Hunter recommendations list is to balance the holdings across a range of market sectors and business types. You too, as you build an income portfolio, need to make sure you own dividend paying stocks are spread across different sectors. In This Issue Hercules Tech Growth Capital (HTGC)... 3 The Realities and Psychologies of Stock Market Corrections and Crashes... 5 LinnCo (LNCO)... 6 Portfolio Update Portfolio Standings Closed Positions... 9 I have realized that information about the individual stocks on the list is pretty spread out, so here is a quick and dirty list of the current portfolio stock symbols and the business sector they are in: AMZA an exchange traded fund covering energy infrastructure ARCX a master limited partnership (MLP) providing energy infrastructure services BXMT a finance REIT for commercial real estate EPR a REIT that owns and leases out properties in entertainment HASI finance REIT funding renewable and energy efficiency projects KMI a large-cap energy infrastructure corporation LGCY an MLP in the oil and gas drilling and production sector LXP a REIT that owns and operates single-tenant office, industrial and retail properties MAIN a business development company (BDC) providing debt and equity financing to medium sized corporations MEMP an MLP in the oil and gas drilling and production sector MIC a diversified infrastructure services company 1

2 NRZ a finance REIT providing residential mortgage services OKS a midstream MLP providing natural gas gathering, processing and transport services RLJ a REIT that owns and operates hotel properties SFL a finance company in the shipping (ships) sector STAG a REIT that owns and operates industrial properties STWD a finance REIT for commercial real estate TCPC a BDC providing debt and equity financing to medium sized corporations If you are investing for yield and income, you will end up primarily in the energy (MLPs or related companies), finance, and REIT (both finance and property owning) sectors. Fortunately, the business results of this small group of sectors are not closely related allowing you to get a level of diversity. As a subscriber, I hope you are working to diversify your income portfolio across the different sectors. It is hard for me to believe that this is the 12th monthly issue of The Dividend Hunter. In its first year, the newsletter has been a very satisfying success. I attribute the successes to date to two factors. First, the feedback from subscribers pushes me to continue to improve the product (keep those s coming at tim.plaehn@investorsalley.com). Second, from what I can find in the newsletter industry, The Dividend Hunter is truly a unique product, helping investors learn about and discovery stocks that pay yields well above the 3% to 4% the finance industry views as attractive yields. Here at Investors Alley, our plans are to continue to make The Dividend Hunter even better to provide an increasing level of benefits to our subscribers. Lastly, one more reminder that I ll be at the Las Vegas MoneyShow May 12 May 14 along with my Investors Alley colleague Bret Jensen. Full disclosure: I am in no way compensated by them. I just like to fill the room with my subscribers as a number of you have already told me you ll be there. MoneyShow management has added another presentation slot for me so now I ll be on a panel as well as doing two presentations in addition to being available at the booth to meet with you and talk about investing. For details and to register, CLICK HERE. Land, fly or die, Tim Plaehn Editor The Dividend Hunter P.S. If the Monthly Dividend Paycheck Calendar is a part of your income investing strategy then be sure to get your copy of the May update: CLICK HERE. 2

3 Hercules Technology Growth Capital The stocks available in business development company (BDC) sector have a lot of appeal for income focused investors. The main attraction is an average yield of about 10%. With that type of yield potential, I would be remiss if a BDC or two were not part of The Dividend Hunter recommendations list. However, out of the 40 or so publicly traded BDCs, I have trouble finding ones that meet my criteria for dividend safety and income growth potential. When you dig into them, these companies have significant issues that can negatively affect investor returns. This month I am pleased to discuss a BDC, Hercules Technology Growth Capital (Nasdaq:HTGC) that should provide the types of returns I look for when making income stock recommendations. At least 90% of a BDC's net income must be paid out as dividends to shareholders. Business development companies are governed by the Investment Company Act of 1940, the same law that governs mutual funds, closed-end funds and ETFs. In actual function, BDCs operate as finance companies, providing loans and equity investments for smaller companies that meet the criteria set out in law. Most BDCs are managed by outside management companies. These management fees can become a big deal and a drain on the returns earned by investors. Internally managed BDCs tend to have their management costs more closely aligned with the interest of common share owners. Of the two BDCs in The Dividend Hunter Portfolio, MAIN is internally managed and TCPC has an external management contract. The primary risk to the BDCs are negative economic growth in the overall economy and/or specific industry sectors served by a business development company. BDC clients are typically in a start-up to early growth phase and could be seriously, negatively affect by an economic slowdown. These companies do not have the financial strength and stability to weather an extended economic downturn. Quick BDC Primer Business development companies operate under special tax rules that allow them to not pay corporate income taxes. To qualify as a BDC a company must be in the business of providing financing for small to medium sized corporations. The financing can be in the form of loans or equity investments. Leverage used by a BDC is limited to one times its equity capital. This means loans and investments can be up to two times a BDC's equity. 3 Hercules Technology Growth Capital Has Carved Its Own Niche HTGC is one of the oldest BDCs, founded in 2003 and into the market with a 2005 IPO. The company is internally managed with a $900 million market cap. In the BDC world, $900 million, with a $1.4 billion enterprise value (market cap plus debt) is one of the larger companies. What sets HTGC apart from its peers is its client focus. Hercules works with venture capital and private equity firms to provide funding for companies that are pre-ipo or being groomed for

4 merger or acquisition. The BDC lives up to its name, providing funding primarily to various types of technology related companies. To assist its client companies and their venture capital backers, HTGC makes only senior debt loans with maturities of 3 to 3 1/2 years. About 90% of Hercules' assets are loan with 10% as equity positions that can pay off very well when a client goes public or is acquired. The loans made by HTGC carry an average "core" yield of 13% to 14%. The typical loan has a 10.5% coupon rate, and the core yield is bumped up by commitment and origination fees. Equity profits and early termination fees have increased Hercules average effective returns to above 16%. The company's relationships with over 500 venture capital type firms has allowed HTGC to steadily grow its book of business, and also steadily increase its annual dividend. Since 2010, the annual dividend has increased from $0.80 per share to $1.24 paid in In 2014, the company had over $500 million (50% of the total portfolio) of loans repaid, often with equity kicker profits and early termination fees. As a result a large portion of the extra profit built into the asset portfolio was realized last year. Also in 2014, $900 million in new loan commitments were turned into new assets, continuing the growth trajectory. The fact that such as significant portion of the portfolio paid off in 2014, means that in 2015 Hercules will not receive as much profit benefit from the payoff of loans and equity positions. The effect of the pull-ahead of a significant portion of expected profits provides two results. First, the dividend rate has been level for five consecutive quarters, and may not start growing again until the asset portfolio "reloads" and the historic cash flow growth profile can resume. At the same time, the share price has leveled off and even declined so far this year, allowing us to buy in at a near 9% yield. My expectation for HTGC is that the dividend rate may stay level into 2016, and then we will see a return to regular dividend growth. 4

5 As a final note, Hercules Technology Growth Capital is internally managed and has been directed by the same founder since the company's inception. Replacing TCPC in The Dividend Hunter Portfolio Since I added TCP Capital Corp (Nasdaq:TCPC) to the portfolio, the results have been under-whelming. The lack of dividend growth potential has keep the share price flat, and the fact that TCPC pays the occasional extra dividend has not helped. Overall, my research shows that HTGC has better dividend growth and total return potential, so it will be added to The Dividend Hunter portfolio as a replacement for TCPC. To be clear, that means we will close our position in TCPC very soon. For those subscribers who own TCPC and want to make the change to HTGC, we are going to use some dividend payment timing to generate some "free cash" by significantly lowering your average cost per share. HTGC should go ex-dividend on May 7 or May 10. With the exdividend, the share price will drop by the $0.31 dividend rate. TCPC will announce its next dividend in the first week of May and go ex-dividend in mid-june. The pending dividend should cause investors to buy shares and push up the TCPC share price. As a result, if you wait until later in May to sell TCPC and then buy HTGC, you should be able to get more on the sale and buy the replacement at a lower price free money. As I write this HTGC is at $13.97 per share and TCPC is trading for $ The goal is to improve the sale and buy prices by more than the $0.31 you would earn by buying HTGC now and collecting the dividend to be paid in May. I track share prices daily, so will send out an to subscribers on the date that the sale of TCPC / purchase of HTGC transaction should be made. If you don't own TCPC, you can either buy HTGC in the next week to earn the May dividend or wait until after the ex-dividend date to buy in at a lower average share cost. My strategy is to lean to the second tactic, but if you are drawing the dividends as cash income for living, just be aware the share price will fall on the ex-dividend date and may take a couple of months to recover. Recommendation: Buy HTGC before or after the ex-dividend date, depending on your cash flow vs. total return goals. The Realities and Psychologies of Stock Market Corrections and "Crashes" One of the great fears, if not the greatest, for stock market investors is that a large portion of their capital will be wiped out in a stock market "crash". This fear of losing it all is a primary reason why so many investors lose out in the stock market by "buying high and selling low". It is difficult, if not impossible, to accurately predict large market drops. They almost always come as a surprise. The only way to manage your stock portfolio in regards to market drops is to understand what they are and what will happen when stock prices take a tumble. Definitions to Know Stock market participants and watchers have developed criteria for what are commonly referred to as a market correction and a bear market. A stock market correction has happened when the major stock market indexes have declined by more than 10% from a previous high. Historically, the stock market has experienced a correction every 18 to 24 months. 5

6 A Bear Market is defined as a stock market drop of greater than 20%. In function, most bear markets have produced declines of 30% to 50% below the peak starting point. Depending how you time the cut-offs, the U.S. stock market has experienced 7 to 10 bear markets since the Big One in The length of a bear market is measured in months, with an average length of about 18 months. Bull Markets are the period between the bottom of one bear market and the start of the next. Historically, bull markets have gone on for years, with 10-year plus upswings more common than not. The current bull market is in its 6th year. You can also have corrections and bear markets in individual sectors of the market or economy. For example, the energy sector of the S&P 500 dropped by 30% from its June 2014 peak to the January 2015 bottom. There is no firm definition for a market crash. To me a crash in the current economy is a really fast moving bear market. Crude oil crashed in the fourth quarter of The only real, wealth wiping crash to date was the wipe out associated with the Great Depression. The use of the word crash in the financial media and the marketing of financial products is mostly just a scare tactic. 6

7 What You Really Need to Know No one that I know of can accurately predict corrections or bear markets. Usually, one of these market events is well underway before we say, "Crap, this stinks and I am losing money!" First and foremost you must tell yourself that these market drops are always temporary and prices will recover. In a market correction, everything is going down. When all of your stocks are dropping it is not that they have become bad investments. It's that fear in the market is causing investors to sell everything. It's when you have a stock going down and everything else is up that you need to take a closer look at that stock. Fear drives a bear market. You will feel it. I will feel it. The investors that come out the other side are the ones who don't give in to the fear and sell when share prices are down. If you have cash available, you should think seriously to adding to your best stocks. Remember that in a bear market, the sellers don't differentiate between good and bad companies. Over the longer term, the stock market drops from corrections and bear markets disappear into the general long term trend of higher values. In history, the market always comes back to exceed its previous highs. It may take years, but the market will come back. In the most 7 recent bull market, the S&P 500 peaked in October 2007, the bottom of the bear market happened in March 2009, and the index passed the previous peak in March Now the S&P 500 is 35% above the 2007 peak. The Current Situation Historically, two-thirds of bear markets are associated with recessions in the economy. Although current economic growth is slow, there are no signs of a pending reversal of growth or any bubble in the markets that could trigger a stock market sell-off. At this point, the only thing I see as a cause of a new bear market would be a correction that turns into a bear when the fear gets out of control. On a strictly timing criteria the stock market is overdue for a correction. The last correction occurred in November 2011, 3 1/2 years ago. A correction at some point in 2015 would not be a surprise. The stock market needs the occasional correction to remind the investing public that investing is stocks is not an always going up, no-brainer decision. However, corrections quickly disappear into the gains of an ongoing bull market, as illustrated by this graphic of the 2011 correction and the market to date.

8 As the writer and editor of The Dividend Hunter, I believe that one of my biggest duties to subscribers is to help you navigate the choppy waters of any correction, crash, or bear market. My strategy is to select stocks that can continue and increase their dividend rates through changing economic conditions and that those steady income streams will over the longer term also protect and enhance principal values. If dividends are secure, lower stock prices are the time to add to positions, average down in price and increase effective yields. LinnCo LLC Hit hardest by the late in 2014 drop in the price of crude oil were the exploration and production (also known as upstream) energy producers. These are the energy companies that drill and own oil wells and their revenues are based on commodity energy prices. The high-yield side of the energy E&P space consists of the upstream MLPs. With current lower energy prices, almost every upstream partnership has been forced to reduce it distribution rate. At the same time, unit prices have fallen drastically. However now, following the 2015 first quarter, both energy prices and upstream MLP prospects have stabilized and I am adding another high yield E&P investment to The Dividend Hunter portfolio. Note: I covered how upstream MLPs operate in detail in the October 2014 issue of The Dividend Hunter. Note-squared: Also in October, and before the collapse in energy prices I added two upstream MLPs to the newsletter recommendations list. Find recent news about these two in the portfolio update section of this issue. LinnCo LLC Linn Energy LLC (Nasdaq:LINE) is the largest, and one of the oldest upstream MLPs. As the Big Dog in the upstream MLP patch, I have kept close watch on Linn. Starting in early 2012 it became apparent that the company and its management team were struggling to sustain the company's historic growth rate. Through 2012 and 2013 Linn made acquisition after acquisition (some quite large), but was not able to generate per unit cash flow growth, and the distribution rate remained unchanged from April 2012 until Linn was forced to make a drastic distribution reduction in January of this year. However, in early 2014 Linn gave up on its growth through acquisitions path and initiated a strategic plan to sell, swap and buy assets to radically change the mix of types of energy production assets without trying to grow the portfolio. The goal was to reload the portfolio with low decline rate assets that would require less capital spending to offset the natural decline rates and maintain production levels. These moves from last year will serve Linn well in 2015 and into the future. As part of the early in the decade growth frenzy, Linn Energy formed LinnCo LLC (Nasdaq:LNCO). LNCO was set up to function as another form of deal currency. LinnCo is a limited liability company that has elected to be taxed as a corporation. This means that investors in LNCO receive a form 1099 for tax filing instead of the more complicated Schedule K-1 that LINE investors receive. LinnCo owns one unit of LINE to back each LNCO unit. Since LNCO units were first issued in October 2012, LNCO has paid the same distribution rate as LINE. There is a slim possibility that the LNCO distributions could be lower if LinnCo ever had a corporate income tax liability. Due to the nature of E&P operations (lots of non-cash tax deductions) I do not expect any reductions in the LNCO distributions due to taxes owed by LinnCo. 8

9 Energy Patch Stabilizes in 2015 On almost the first day of 2015, Linn Energy announced a revised business plan for 2015 and slashed the LINE and LNCO distribution rates by 57%. With the new plan, Linn Energy set its spending budget to cover both its planned capital expenditures (previously paid for with added debt) and distributions for the year out of internally generated cash flow. With its 2015 first quarter earnings report on April 29th, the Linn management team noted that compared to the first quarter, the combination of costs coming down and energy prices going up has improved the view of future cash flow. If you haven't been watching energy prices, it seems that the lows of this commodity prices bear market were set in the first quarter. Now into May, the spot price of crude is in the high $50's, compared to the mid $40's for most of Q1. temporary pull back from the current $58.50 per barrel price for the benchmark West Texas Intermediate (WTI) crude. If you are a conservative investor you may want to initially invest in LNCO with a smaller than your usual position and be ready to buy more units if the share price falls back. LNCO has swung between $9.30 and $13.80 so far in Load up the truck if the unit price falls back into the low $10 range. Final note: LNCO is an acceptable highyield IRA investment. No tax issues. Recommendation: Buy LNCO below $12.50 to lock in a 10% yield. Since Linn has no need to tap the debt or equity markets this year, as long as the bottom does not completely fall out for energy prices, the current distribution rate is secure for the rest of 2015 and well into To fund any attractive growth projects it finds, Linn has made a pair of profit sharing agreements with two investment funds to provide the capital needed to pay for the projects. Going forward Linn is going to pay for growth with OPM other people's money. I am not looking for distribution growth in 2015, but Linn is well positioned to generate growth at some point when energy prices move higher or production assets get a lot cheaper. High Yield and Monthly Dividends As I write this, LNCO yields 10%. LINE units are price higher and yield 9.2% on the same distribution rate. LINE and LNCO pay monthly dividends, which is always an added bonus. One factor that you need to be aware of is that the LNCO unit price has been fluctuating with changes in the price of crude oil. With its distribution rate secure, this does not make logical sense, but that is how the market is reacting to up and down periods for crude oil. It's probable that crude will again make a 9

10 Portfolio Update On average it was a good month for The Dividend Hunter portfolio recommendations. Here are some of the events affecting individual holdings. Main Street Capital Corporation (NYSE: MAIN) announced a supplemental cash dividend of $0.275 per share payable on June 25 for shareholders of record on June 18. Ex-dividend date is June 16. Since MAIN was added to The Dividend Hunter portfolio 10 months ago, the monthly dividend has been increased twice and two supplemental dividends have been declared. Cha-ching! Memorial Production Partners LP (Nasdaq: MEMP) declared a $0.55 per unit quarterly distribution to be paid on May 13. MEMP is the only upstream MLP that has not reduced its distribution rate since to collapse in the price of crude oil. The Dividend Hunter position in MEMP is still down about 13% in total return since it was added in October and before most of the crude oil drop. However, the unit price is up 50% from the low hit in late December. The current 12.25% yield on MEMP is above its peers and I would not be surprised to see the unit price go higher to lower the yield, as one would expect for the best company in its sector. The other upstream MLP in the portfolio, Legacy Reserves LP (Nasdaq: LGCY) did reduce its distribution by 42% to $0.35 for the quarter, down from the $0.61 paid for two quarters since LGCY was also added in October. On a total return basis, LGCY is down 50% from when it was added to The Dividend Hunter recommendations. The unit price is up over 60% from the December bottom, but it will be a long time before the price moves back into the mid to high $20's where it traded late last summer. From this point, I am keeping Legacy in the recommendations list because I believe the recovery in energy prices will provide additional positive returns from here and the company as a good chance to declare higher distributions later in the year. For the first time since 2009, Oneok Partners LP (NYSE: OKS) failed to increase its distribution quarter-overquarter. The declared distribution remained level with the rate paid for the previous quarter. Right now I am fine with the level distribution for one quarter, but I will be listening closely to next week's earnings conference call. OKS current yields 7.5% and the unit price is still close to the value when the MLP was first recommended. Kinder Morgan Inc (NYSE: KMI) increased its quarterly dividend by 6.7% and management expects to keep growing the dividend every quarter. KMI yields about 4.5% and should be in every income investors portfolio. The share price is down a little since the shares went exdividend on April 28, making an attractive buying opportunity. Property owning REIT prices have been soft in April, resulting in lower share prices for EPR Properties (NYSE: EPR), Stag Industrial Inc (NYSE: STAG), Lexington Realty Trust (NYSE: LXP), and RLJ Lodging Trust (NYSE: RLJ). All will report first quarter earnings during the first half of May. I do not expect any negative news, and positive reports could help support share prices. These are all quality REITs with better yields than they had a month ago. Please drop me an note if you any questions concerning any of The Dividend Hunter portfolio holdings. I can be reached at tim.plaehn@investorsalley.com. 10

11 Current Portfolio Stock Entry Date Entry Price Recent Price Buy Up To Annual Div Proj. Yield Cash Return LinnCo LLC (LNCO) 04/30/15 $12.75 $12.75 $12.50 $ % Hercules Tech. Growth Capital (HTGC) 04/30/15 $13.90 $13.90 $ % RLJ Lodging Trust (RLJ) 03/31/15 $31.31 $29.67 $33.00 $ % InfraCap MLP ETF (AMZA) 03/31/15 $21.51 $22.37 $22.51 N/A N/A 2.35% Lexington Realty Trust (LXP) 02/27/15 $10.83 $9.27 $ % 1.58% Kinder Morgan (KMI) 01/30/15 $41.05 $42.95 $43.00 $ % 1.17% Blackstone Mortgage Trust (BXMT) 01/30/15 $29.90 $30.73 $30.00 $ % 1.78% Stag Industrial (STAG) 12/30/14 $24.86 $21.73 $25.50 $ % 1.84% ONEOK (OKS) 11/28/14 $44.08 $41.95 $45.60 $ % 3.82% TCP Capital Corp. (TCPC) 10/30/14 $16.51 $15.93 $17.00 $ % 4.66% EPR Properties (EPR) 10/30/14 $55.64 $57.67 $57.00 $ % 3.20% Memorial Production (MEMP) 09/30/14 $22.02 $17.92 $23.00 $ % 5.00% Legacy Reserves (LGCY) 09/30/14 $29.68 $12.93 $30.00 $ % 5.29% Hannon Armstrong Sustainable 08/28/14 $14.49 $19.00 $15.00 $ % 5.11% New Residential Investment (NRZ)** 07/30/14 $12.16 $17.04 $12.50 $ % 9.13% Arc Logistics Partners (ARCX) 07/30/14 $25.10 $19.47 $28.00 $ % 4.86% Main Street Capital (MAIN) 06/27/14 $32.51 $31.33 $32.50 $ % 6.08% Starwood Property Trust (STWD) 05/30/14 $24.39 $24.01 $25.00 $ % 7.87% Ship Finance International (SFL) 05/30/14 $18.46 $15.76 $19.00 $ % 8.91% Macquarie Infras. Company (MIC) 05/30/14 $61.48 $82.76 $63.50 $ % 4.80% Closed Positions Stock Entry Date Entry Price Close Price Close Date Div Earned Total Return Cash Return Ventas (VTR) 05/30/14 $66.80 $ /30/15 $ % 2.17% Oaktree Capital Group (OAK) 05/30/14 $49.98 $ /09/15 $ % 2.34% Salient Midstream & MLP Fund (SMM) 08/28/14 $31.23 $ /31/15 $ % 2.97% 11

12 Notes: Entry price is determined by the last "Ask" price at the closing of the market on the day before publication. Recent price is determined by the last "Ask" price at the closing of the market on the day before publication; most recent update 04/30/15. Annual Div is the dividend payment as declared by the company and made publicly available. It is as of the closing of the market on the day before publication. Proj. Yield may deviate from current yield as it s based off the share price at the time of initiating the position, not the current share price. We make no guarantee that any company in the portfolio will continue dividend payments. For a more detailed look at the portfolio, log on at ** NRZ entry price adjusted for 1 for 2 split on 10/20/14. Original entry price on 07/30/14 was $ Investors Alley Corp. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Investors Alley Corp., 41 Madison Avenue, 31 st Floor, New York, NY or For complete terms and conditions governing the use of this publication please visit 12