Cabot Income Advisor 221

The timing is right for alternative energy.

Alternative energy (also referred to as clean or alternative energy) is by far the fastest growing energy source. The International Energy Agency (IEA) estimates that global renewable power supply will grow 50% in just the next 5 years.

While clean energy has been a story and knocking at the door for a while now, a certain critical mass in growth and development seems to be taking place recently. The market usually gets it. And it’s telling us something.

The iShares Global Clean Energy ETF (ICLN), which tracks 30 stocks in the Global Clean Energy Index, has taken off lately after going nowhere for more than a decade. ICLN soared 100% over the past year and 178% for the past two years, compared to S&P 500 returns of 22% and 44% respectively over the same period.

The market clearly sees big changes looming in the energy sector. It also helps that the Biden Administration will likely reward clean energy companies with more tax breaks and subsidies and other goodies. But more importantly, the focus will draw still more investor attention to the booming growth in alternative energy. And investor intrigue will only accelerate.

This month’s highlighted stock NextEra Energy (NEE) should clearly benefit going forward. It may not be the sexiest clean energy. But it provides a great way for more conservative, income oriented investors to play the trend.

Cabot Income Advisor 221

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Open-Up Stocks Thrive While the Market Struggles
It’s been a rare down week in the market. But there’s nothing to be alarmed about. The S&P 500 is only down a little so far. And the uptrend that has existed for almost a year is still intact.

Even this market doesn’t go straight up without any blips, although it’s close. The S&P has rallied nearly 20% since November and a remarkable 75% since the lows of last March. This is already a bull market for the ages with the fastest start, meaning the steepest move higher in the first year, since the early 1930’s.

The situation begs a question. How long can it last?

But that might be the wrong question. What’s true for the overall market index doesn’t necessarily present an accurate picture of what goes on under the hood. Some stocks and sectors are overvalued while some are still cheap. And the driving force behind the market ascent is changing dramatically.

The first eight months or so of this bull market was driven by technology. The sector soared in the pandemic as people relied on technology more than ever during the lockdowns. The tech-heavy Nasdaq index was up over 40% for calendar 2020.

Cyclical companies got creamed for most of last year as the lockdowns crippled the Main Street economy. The energy and financial sectors were by far the worst performing on the S&P and were still very much in a bear market until the end of last year. But the vaccines are changing everything. And a completely different picture is emerging.

The vaccines promise to end the pandemic. The removal of the remaining restrictions will unshackle the economy and unleash a full recovery later this year. That promise is reigniting energy and financial stocks as a full recovery will create a demand for oil and gas and loans that makes up for lost time. And yesterday’s losers have become today’s biggest winners.

Since September 23^rd, the SPDR S&P Bank ETF (KBE) has soared over 79% and the Energy Select Sector SPDR Fund (XLE) is up 60%. The S&P 500 is only up 21% over the same time frame. These two sectors have been by far the best performing of the eleven S&P 500 sectors for the past 3-month, year-to-date and one-month periods.

This past week the overall market has trended downward on fears of higher inflation and higher interest rates as the recovery accelerates while the country is awash in trillions of Federal stimulus. But energy and financial stocks love it, and have had one of the best weeks yet. Banks love higher interest rates as their loan spreads increase. And energy is helped a lot more by a booming economy than they are hurt by higher interest rates.

Sure, the overall market may be a little frothy. And the S&P could certainly pull back or correct in the near term. But energy and financial stocks still have a lot of upside left at this juncture. For many of these stocks, it’s still May.

The new dynamic is providing a great lift to the previously downtrodden energy stocks Valero Energy (VLO) and Chevron (CVX). These stocks offer value and high yield in an expensive market and a low interest rate world.

Although the prognosis for the rest of the year still looks strong, after a 30% surge for VLO and a 15% move for CVX in the month of February, the stocks may have gotten ahead of themselves in the near term. The situation has created an ideal opportunity to write covered calls and lock in some of the bounty of the recent moves.

What to Do Now
This generally isn’t the best time to buy stocks. Shares in energy, finance and other cyclical sectors have just had a huge run higher and may be due for a consolidation. At the same time, much of the rest of the market is under increasing selling pressure and may be setting up for a more significant, and overdue, downturn.

However, it is a very good time to write high-priced calls in stocks that have been soaring higher. That’s why this portfolio has recently written calls on high-flying positions Valero Energy (VLO) and Chevron (CVX).

As I mentioned, the prognosis is good for these and other energy stocks for the rest of the year. But these stocks also have a tendency to pull back and consolidate after a big surge. It’s a great time to lock in a high income return by selling calls into the euphoria and getting top dollar.

Of course, it appears to have been premature at this point to write the calls on VLO at the $60 strike price, as those shares closed Monday at 74.25. That’s okay. If the shares are called at expiration, the VLO position will still provide a 27.4% total return since being added to the portfolio. If you own the stock but have not yet written calls, the current timing may be optimal. And you can target a higher strike price. I mention the details below.

The timing looks better for the CVX calls as the stock price still hasn’t run far above the strike price after a big surge. If you haven’t done so already, it’s a great time to write the same calls at a higher premium.

The remaining stocks in the portfolio are not presenting great call writing opportunities at this point. But things can change fast. Please be on the lookout for “Trade Alerts” via email.

Don’t forget to tune into the monthly Cabot Retirement Club (CRC) video at 2pm on Thursday February 25^th for an in-depth round up of the current market and the investment portfolios.

Monthly Recap
January 27
Purchased Digital Realty Trust (DLR) $149.17

February 10^th
Sold VLO March 26 $60 call at $6.50 or better

February 19^th
BGS February 19 $27.50 call at $2.40 - Expired
B&G Foods (BGS) stock – Called
Sell CVX April 1 $95.50 call at $4.30 or better

February 24^th
Purchase NextEra Energy stock (NEE)

Featured Action

Buy NextEra Energy, Inc. (NEE)
Utility stocks fill a great niche in any investment portfolio, especially when stock prices get a little frothy. The sector is the most defensive on the market as earnings are virtually immune to economic cycles. Stocks also pay high dividends and typically hold up very well in down markets.

NextEra Energy provides all those advantages plus exposure to the fast-growing and highly sought-after alternative energy market.

NextEra Energy is the world’s largest utility. It’s a monster with about $18 billion in annual revenue and a $147 billion market capitalization.

Ordinarily, when you think of a huge utility you probably think it has lackluster growth and a stable dividend. But that’s not true in this case. Earnings growth and stock returns have well-exceeded what is normally expected of a utility.

For the last ten-, five-, three- and one-year periods, NEE has not only vastly outperformed the Utility Index, it has also blown away the returns of the overall market. NEE stock has returned more than double that of the S&P 500 over the last ten years (640% with dividends reinvested). It has also more than tripled the index return over the last 5 years, 3 years and one year.

How can that be? It’s because it isn’t a regular utility. NEE is two companies in one. It has one of the best regulated utilities in the country, which accounts for about 55% of earnings and provides steady cash flow, and also a world-renowned alternative energy company, which accounts for about 45% or earnings and provides a higher level of growth.

Investors love it because they get the safety and income of a utility and still get great growth and capital appreciation. It’s the best of both worlds.

Florida Power and Light is the largest regulated utility in the U.S. It has over 5 million customers in Florida. It is one of the very best electrical utilities in the country. There are a few good reasons why Florida is a great place to operate a utility.

The state has a growing population. Utilities have a limited geographical range and a stagnant population can make it tough to grow. Plus, it is one of the most regulator-friendly areas in the country. That’s huge for getting approvals for periodic expansions and price hikes. It also doesn’t hurt that Floridians run their air conditioners like crazy, and just about all year long.

The alternative energy company, NextEra Energy Resources, is the world’s largest generator of renewable energy from wind and solar. Alternative energy is the future and this company is the top of the heap. The government and regulators love them for it. It’s also a huge benefit that the cost of clean energy generation constantly gets cheaper as technology advances.

There is also a huge runway for growth projects. This part of the company grew earnings 13.8% during the pandemic in 2020. And the company plans to deploy $50 to $55 billion between 2019 and 2022 on growth expansions and acquisitions.

From 2004 through 2019 the company grew earnings by an average annual rate of 8.4% and grew the dividend at an average rate of 9.4% per year. That was behind the market returns stated above. The company is targeting 6% to 8% earnings growth through 2022 and 10% annual dividend growth thru at least 2022. NextEra has a long track record of meeting or exceeding goals.

A key aspect of this recommendation is timing. The chart on this stock is a thing of beauty. Very rarely does it provide a cheap entry point. But the stock has recently pulled back 16% from the high in late January as investors have focused on more cyclical stocks. It’s a rare blip and a buy point I’ve been waiting on for a while.

The emphasis of the new Administration in Washington on clean energy can’t hurt the largest clean energy producer in the U.S. either. It should also increase investor interest in the sector. The dividend yield is rather lame at 2.1%. But the stock should move higher and create attractive call writing opportunities in the months ahead.

Portfolio Updates

AGNC Investment Corp. (AGNC)
Yield 8.8%
This high-paying mortgage REIT has been doing exactly what I thought it would do since being added to the portfolio, trending higher very slowly. Things look good going forward as interest rate spreads should continue to grow in the improving economy. Meanwhile, the stock continues to pay a huge yield on a monthly basis. We’ll look to write a call at a higher price and probably go out to a further expiration than normal to collect more dividends. BUY

Brookfield Infrastructure Partners (BIP)
Yield 3.8%
After the market fretted that the offer to buy Canadian midstream energy company Inter Pipeline would be raised, Brookfield reiterated the original bid in a hostile offer of C16.50 per share ($5.6 billion) in shares and cash. Shares have since rallied back. Midstream energy companies are still dirt cheap after the recession, and these assets could give a big boost to earnings in a short time. We’ll see how it develops.

Brookfield is well set up otherwise with $2.5 billion in acquisitions last year to boost the bottom line, a rebound in transportation and energy assets with a full recovery, and an emphasis on infrastructure by the new Administration in Washington. BUY

Chevron Corp. (CVX)
Yield 5.4%
This best-in-class energy giant has gotten red hot of late, soaring over 15% in the month of February so far. The energy sector has really ignited, and Chevron is a beneficiary. The stock still has a way to go to get to the 120 per share pre-pandemic level, currently 98.39. But conditions in the industry weren’t great before the pandemic. Crude oil prices have already reached pre-pandemic levels while analysts see even higher prices over the rest of the year. Calls were written on Friday on the stock and a “Trade Alert” was issued via email. If you missed it, don’t worry. The calls are priced higher after Monday’s big gains in the stock. HOLD

Digital Realty Trust, Inc. (DLR)
Yield 3.2%
This data center REIT has had weak performance since the vaccine announcements last November as investors focused on more cyclical stocks and away from pandemic beneficiaries. But the main story remains intact. Data centers are a growth business and they are likely to continue to grow as needs continue to increase and new technologies proliferate. This stock has a history of bouncing around and, historically, when it goes below the 50-week moving average, where it is now, it bounces back strongly. BUY

Valero Energy (VLO)
Yield 5.4%
This refiner stock is a high leverage play on a full recovery. And that fact is playing out well of late. It’s up 32% for the month of February so far. At just under 75 per share, VLO still has a lot of upside to get to the pre-pandemic high of 100. But the environment later this year could be a lot better than before the pandemic. But this stock can be very volatile. Even on upward trajectory for the rest of the year, VLO can have some wild ups and downs. We wrote the calls after this huge recent run to lock in a strong return no matter what. HOLD

Existing Call Trades
Sell BGS February 19 $27.50 call at $2.40 - Expired

Sell VLO March 26 $60 call at $6.50 or better
The stock is running away. It’s up over 30% in February alone. The calls targeted at $6.50 of better are now selling at $15.05 per call. Shares have moved far from the targeted strike price of 60 all the way Monday’s close of 74.25. VLO was trading near the high point of the recent range when the calls were targeted, but has since broken out for now. But having not chosen the optimal time to write the calls, the portfolio position will still provide a return of 27.4% since being added to the portfolio if shares are called at expiration.

Of course, if you own the stock but have not yet written calls, there is still a great opportunity after a huge run higher in the shares. The same March 26^th expiration with a $70 strike price is currently selling at $7.23 and the 65 strike price is selling at $11.34.

Sell CVX April 1 $95.50 call at $4.30 or better
These calls were targeted with a “Trade Alert” via email last Friday as CVX reached the high point of the recent range. As shares have moved higher since (98.39 at Monday’s close), the call price is now $6.41. If you haven’t done so already, it is an even better time to write the calls at a price well above the target after a 15% run up in share price in the month of February.

The Timing is Right for Alternative Energy
Rapid and transformative change is looming in the energy sector.

Fossil fuels (oil, natural gas and coal) have been the world’s primary energy source for well over a hundred years. In fact, these fuel sources go back so far that they actually replaced horses as the primary energy source for transportation. An upgrade is long overdue.

Fossil fuels are dirty. They pollute the atmosphere and release carbon. The other huge problem is that they are finite. Oil and gas reserves deplete and run out. It’s estimated that the world probably has about 50 years before the world’s fossil fuel supply is exhausted.

It’s high time to move on. We have the technology to replace these fuels with clean and renewable energy sources. And it’s already happening.

Alternative energy is by far the fastest growing energy source, with usage growing 100% in the first 18 years of this century. It’s really about to take off now. The International Energy Agency (IEA) estimates that global renewable power supply will grow 50% in just the next 5 years.

Renewable energy (also referred to as clean or alternative energy) has been a story and knocking at the door for a while now. But a certain critical mass in growth and development seems to be taking place recently. The market usually gets it. And it’s telling us something.

The iShares Global Clean Energy ETF (ICLN), which tracks 30 stocks in the Global Clean Energy Index, has taken off lately after going nowhere for more than a decade. ICLN soared 100% over the past year and 178% for the past two years, compared to S&P 500 returns of 22% and 44% respectively over the same period.

Consider the recent performance of some of the big players in the clean energy space. Electric car company Tesla (TSLA) has soared 1100% in the last two years. Hydrogen fuel cell company Plug Power (PLUG) moved 834% higher in just the last year.

The market clearly sees big changes looming in the energy sector. It also helps that the Biden Administration will likely reward clean energy companies with more tax breaks and subsidies and other goodies. But more importantly, the focus will draw still more investor attention to the booming growth in alternative energy. And investor intrigue will only accelerate.

This month’s highlighted stock NextEra Energy (NEE) should clearly benefit going forward. It may not be the sexiest clean energy. But it provides a great way for more conservative, income oriented investors to play the trend. Although the dividend yield isn’t nearly as high as most stock in this portfolio, the rising price and high call premiums should more than make up for the lower dividend income.

Income Calendar
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Income Advisor for an explanation of how dates are estimated.

The next Cabot Income Advisor issue will be published on March 24, 2021.

Cabot Wealth Network
Publishing independent investment advice since 1970.

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Chairman & Chief Investment Strategist: Timothy Lutts
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