You can still find sky-high yields.
Despite the recovery in the overall market, there are still lingering pockets of high yields. It reminds me of the years following the financial crisis. You could still find good stocks that paid a sky-high income relatively easily. But the situation didn’t last. Those high yields on quality stocks evaporated as investors realized the opportunity.
Some of the current high yields probably won’t last long either.
At the same time, it’s a great time for cyclical stocks. The economy is still booming. Plus, we are likely at the point in the economic cycle where such stocks tend to do best. We are likely still in the early stages of a bull market and recovery.
In this issue, I found a stock that benefits from both opportunities. It has a stratospheric 11.5% yield that likely won’t last. At the same time, the yield should be safe and growing as the company is highly cyclical.
Market Overview
Back in Cyclical Heaven
The market is at another new all-time high. The S&P 500 is up almost 100% since the bear market low in March of last year. Stocks have fully recovered from the pandemic and then some, or so it may seem.
In terms of pricing for the overall market, we’ve moved well beyond the pandemic. But there are still pockets that haven’t recovered. There are aberrations that have not yet gotten the memo. You can still find value, especially in certain high-yielding stocks.
Unusually high yields are still around as several high-yielding stocks are still well below pre-pandemic prices. It reminds me of the years following the financial crisis. You could still find good stocks that paid a sky-high income relatively easily. But the situation didn’t last. Those high yields on quality stocks evaporated as investors realized the opportunity.
The recovery isn’t as complete as it may seem. And you can still get abnormally high yields. But they are unlikely to last much longer.
At the same time, it’s a great time for cyclical stocks. The economy is still booming. Plus, we are likely at the point in the economic cycle where such stocks tend to do best. That is, we are likely still in the early stages of a bull market and recovery.
In this issue, I found a stock that benefits from both opportunities. It has a stratospheric 11.5% yield that likely won’t last. But for now, the dividend should be safe and growing as the company is highly cyclical.
What to Do Now
It looked ugly for a while in September. But the market came right back and is at a new all-time high. Now, we’re back in cyclical heaven.
Earnings, which have buoyed the market all through this pandemic recovery, are doing it again. So far, it appears that the consumer is strong and businesses are overcoming the supply-chain problems and inflation for now. Another anticipated better-than-expected earnings quarter along with a still strong economy is outweighing concerns about the supply chain and inflation.
Energy is on fire. It has been by far the best-performing sector of the market over the past month. The benchmark Energy Select Sector SPDR Fund (XLE) is up about 30% in the past few months as oil prices are soaring to their highest level since 2014 amidst supply constraints and strong demand.
The rally could last a while longer, or the sector could take a break and consolidate. This portfolio has it covered either way. We wrote calls on ONEOK (OKE) after a huge surge at a high premium and we continue to hold Enterprise Product Partners (EPD) in case the sector keeps moving. We locked in a high income and positive total return and will still benefit if the surge continues.
The market is looking strong and making new highs. This is when call premiums are high. While it’s tempting to let everything ride and not limit appreciation potential by writing a call, it’s an ideal time to turn recent stock surges into high income. Plus, the market could sputter at any time. Even if your position gets called, you’re selling while the market is high.
We recently wrote calls on U.S. Bancorp (USB) and, as I just mentioned, ONEOK (OKE). And in this issue, I highlight a call for KKR & Co. (KKR). It’s a great way to use recent upside in the stock to get a high income and total return, especially after a stock has had a big surge.
There are also some buying opportunities. In addition to the highlighted stock below, AGNC Investment Corp. (AGNC), Qualcomm (QCOM) and Excel Energy (XEL) offer good entry points. QCOM will report earnings next week and is still dirt cheap. AGNC has gotten momentum as yields are rising. And XEL is a great price for both the long and short terms.
Monthly Recap
October 12
Purchased Xcel Energy Inc. (XEL) - $63.00
October 15
Brookfield Infrastructure Partners (BIP) – Called
BIP October 15 $55 calls at $2.00 – Expired
October 20
Sell OKE November 26 $65 calls at $2.25 or better
October 27
Sell KKR December 17 $75 calls at $3.50 or better
Buy FS KKR Capital Corp. (FSK)
Featured Actions
Featured Actions
Buy FS KKR Capital Corp. (FSK)
It may seem like a contradiction. I spent the issue so far bad-mouthing the market. Now, I’m turning around and saying buy these two stocks. Sure, a market correction would pull the prices down somewhat from here. But these stocks have already been pulled down by other factors and there is a strong prognosis for the rest of the year even if there is a correction (which may not even occur).
The yield curve has flattened and two stocks in the portfolio, AGNC and USB, have pulled back as a result. I believe this interest rate dynamic is temporary and these stocks are good buys ahead of a likely reversal. Let me explain.
A yield curve is the difference between long- and short-term interest rates. Certain companies profit from the difference between the two. They borrow at short-term rates and lend at longer-term rates, profiting from the spread.
Short-term rates, largely defined by the benchmark Fed Funds rate, are currently between 0% and 0.25% and has been since the pandemic hit. The Fed has announced it does not intend to raise that rate until 2023. Longer-term rates, gauged by the benchmark 10-year Treasury rate, have fallen from 1.75% in March to below 1.2% in early August (currently 1.61%), thus flattening the yield curve.
But the economy is strong. Companies just posted the strongest earnings growth in decades. Interest rates historically rise under such circumstances. Why have they fallen?
There are a few reasons. One, the market anticipates beyond this pandemic recovery to a more normalized environment. Two, the delta variant is stoking fears about economic growth. Three, the Fed’s current $120-billion-per-month bond buying program puts downward pressure on interest rates.
But I believe rates have moved far too low. Sure, the economy will normalize. But rates are still well below what has been defined as normal for the last decade. The 10-year rate is still well below the pre-pandemic level. Plus, the benchmark rate averaged between 2% and 3% during both the Obama and Trump Administrations.
The other issues are temporary. The virus will abate eventually. And then economic growth will likely make up for lost time and last longer. And the Fed bond buying program will have to end. In fact, the Fed is near announcing a date for tapering either later this year or next. The downward pressure on rates will be removed.
Plus, there is still persistent inflation. Of course, the current thinking is that this inflation won’t last long. But it is still another force that should put upward pressure on rates in the near term.
In short, I believe interest rates have fallen too far and are likely to trend higher in the months ahead. This will benefit these two current portfolio positions.
A Better Company Now
FSK is a BDC with ties to the parent company KKR & Co. (KKR) from which it can leverage the pseudo-drop-down opportunities. The key dates are the inception date in 2008, the IPO date in 2014 and the purchase of a similar company, FSKR, in June of this year. FSKR was actually a slightly larger company that more than doubles the size of FSK.
Scale matters in private equity. BDCs are still a relatively obscure sector, but the biggest ones tend to get a lot more investor attention. Doubling the size increases stock liquidity and institutional demand. It also further diversifies the portfolio and lowers the financing costs. FSKR is also underleveraged with a lot of dry powder for new business going forward.
The portfolio size is now $147 billion and includes 195 companies in 23 different industries. The largest holding in terms of industry are Software and Services (15.8%), Capital Goods (13.6%), Credit Opportunities Partners (9.5%) and Healthcare Equipment and Services (8.9%). Credit Opportunities is a joint venture between FSK and the South Carolina Retirement System Group Trust (SCRS) with a similarly diversified portfolio.
The types of loans are solid with 70% of the portfolio in senior secured loans, backed by hard assets, and with 88% of the portfolio in floating rate loans. The floating rates not only protect the company from rising rates but puts them in a position to benefit as interest rates likely trend higher.
The Dividend
The main reason to buy FSK is the high income it provides. BDCs are tax-advantaged securities. Because they provide a desirable function, funding the growth of rising companies, they pay no tax at the corporate level. BDCs typically pay higher dividends because money normally lost to taxes is paid out to shareholders.
The stock currently pays a massive 11.5% yield. It pays a quarterly dividend which was just raised to $0.65, which annualizes to $2.60. The dividend should be safe as it is well covered with interest income and has stronger coverage than the average of its peers.
The merged company also has a policy to pay out a minimum 9% of NAV (net asset value), which it currently sells below. But with accretion from the merger, rising interest rates, and an improving business environment, FSK could be in a position to increase the dividend and/or pay out special dividends.
There are still distortions left over from the pandemic. A sky-high yield like this isn’t easy to find in normal times. The company is improved from the recent acquisition and the business environment should be very favorable for BDCs going forward.
FS KKR Capital Corp. (FSK)
Security type: Business Development Company (BDC)
Industry: Diversified
Price: 22.50
52-week range: 14.22 - 23.44
Yield: 11.5%
Profile: FS KKR is the second largest publicly traded BDC that specialized in high interest secured loans to middle market U.S. companies.
Positives
- The recent acquisition doubles the size and makes the stock more liquid and desirable to investors.
- It’s the right time in the economic cycle for smaller companies and BDCs.
- The massive 11.5% yield should be maintainable.
Risks
- The stock will not hold up well in an economic downturn.
- BDCs have a poor track record of performance.
Sell KKR December 17 $75 calls at $3.50 or better
Expiration date: December 17
Strike price: $75
Call price: $3.50
KKR & Co. Inc. (KKR)
The stock just had a great run. After pulling back on fears of contagion from Chinese real estate company Evergrande’s default, KKR has soared more than 25% in just the last few weeks. As contagion fears waned, the stock made up for lost time. It’s also up over 85% YTD and may be on the high side of the range. It’s a good time to lock in a high income and possibly a big total return after the stock has had a surge.
Here are the three scenarios.
- The stock closes above the $75 strike price at expiration
Call premium: $3.50
Dividend: $0.145
Appreciation: $10.48 ($75.00 strike price minus $64.52 purchase price)
Total: $14.25 (total return will be 21.9% in less than four months)
- The stock price closes below our $75 strike price.
Call premium: $3.50
Dividends: $0.145
Total: $3.65 (total income return of 5.6% in less than four months)
- The stock price declines.
The decline will be offset by the $3.65 in income. Of course, the stock price may still be above the original $64.52 per share purchase price.
Portfolio Updates and Income Calendar
Portfolio Updates
| CIA STOCK PORTFOLIO | |||||||
| Open Recommendations | Ticker Symbol | Entry Date | Entry Price | Price on 10/25/21 | Buy at or Under Price | Yield | Total Return |
| AGNC Investment Corp. | AGNC | 1/13/2021 | 15.52 | 16.54 | 17.00 | 8.71% | 13.68% |
| Enterprise Product Partners | EPD | 3/17/2021 | 23.21 | 24.56 | 25.00 | 7.37% | 10.35% |
| U.S. Bancorp | USB | 3/24/21 | 53.47 | 62.52 | 57.00 | 3.04% | 19.58% |
| Qualcomm Inc. | QCOM | 5/5/21 | 134.65 | 131.93 | 140.00 | 2.07% | -1.06% |
| ONEOK, Inc. | OKE | 5/26/21 | 52.51 | 65.87 | 60.00 | 5.77% | 27.70% |
| One Liberty Properties, inc. | OLP | 7/28/21 | 30.37 | 31.88 | 33.00 | 5.68% | 6.50% |
| KKR & Co., Inc. | KKR | 8/25/21 | 64.52 | 74.86 | 70.00 | 0.79% | 16.03% |
| Xcel Energy Inc. | XEL | 10/12/21 | 63.00 | 64.66 | 67.00 | 2.83% | 2.63% |
| FS KKR Capital Corp. | FSK | 10/27/21 | 22.50 | 24.00 | 11.49% | ||
| EXISTING CALL TRADES | |||||||
| Open Recommendations | Ticker Symbol | Intial Action | Entry Date | Entry Price | Price on 10/25/21 | Sell To Price or Better | Total Return |
| USB Nov 19 $60 call | USB211119C00060000 | Sell | 9/24/21 | 2.30 | 3.05 | 2.30 | 4.30% |
| OKE Nov 26 $65 call | OKE211126C00065000 | Sell | 10/20/21 | 2.25 | 1.92 | 2.25 | 4.28% |
| KKR Dec 17 $75 call | KKR211217C00080000 | Sell | 3.50 | 3.50 | 5.42% | ||
| SOLD STOCKS | |||||||
| Security | Ticker Symbol | Action | Entry Date | Entry Price | Sale Date | Sale Price | Total Return |
| Innovative Industrial Props. | IIPR | Called | 6/2/20 | 87.82 | 9/18/20 | 100.00 | 15.08% |
| Qualcomm | QCOM | Called | 6/24/20 | 89.14 | 9/18/20 | 95.00 | 7.30% |
| U.S. Bancorp | USB | Called | 7/22/20 | 36.26 | 9/18/20 | 38.00 | 3.42% |
| Brookfield Infras. Ptnrs. | BIP | Called | 6/24/20 | 41.92 | 10/16/20 | 45.00 | 8.49% |
| Starbucks Corp. | SBUX | Called | 8/26/20 | 82.41 | 10/16/20 | 88.00 | 6.18% |
| Visa Corporation | V | Called | 9/22/20 | 200.56 | 11/20/20 | 200.00 | 0.00% |
| AbbVie Inc. | ABBV | Called | 6/2/20 | 91.04 | 12/31/20 | 100.00 | 12.43% |
| Enterprise Prod. Prtnrs. | EPD | Called | 6/24/20 | 18.14 | 1/15/21 | 20.00 | 15.16% |
| Altria Group | MO | Called | 6/2/20 | 39.66 | 1/15/21 | 40.00 | 7.31% |
| U.S. Bancorp | USB | Called | 11/25/20 | 44.68 | 1/15/21 | 45.00 | 1.66% |
| B&G Foods Inc, | BGS | Called | 10/28/20 | 26.79 | 2/19/21 | 28.00 | 4.42% |
| Valero Energy Inc. | VLO | Called | 8/26/20 | 53.70 | 3/26/21 | 60.00 | 11.73% |
| Chevron Corp. | CVX | Called | 12/23/20 | 85.69 | 4/1/21 | 96.00 | 12.95% |
| KKR & Co. | KKR | Called | 3/24/21 | 47.98 | 6/18/21 | 55.00 | 14.92% |
| Digital Realty Trust | DLR | Called | 1/27/21 | 149.17 | 7/16/21 | 155.00 | 5.50% |
| NextEra Energy, Inc. | NEE | Called | 2/24/21 | 73.76 | 9/17/21 | 80.00 | 10.00% |
| Brookfield Infras. Ptnrs. | BIP | Called | 1/13/21 | 50.63 | 10/15/21 | 55.00 | 11.65% |
| EXPIRED OPTIONS | |||||||
| Security | In/out money | Sell Date | Sell Price | Exp. Date | $ Return | Total % Return | |
| IIPR Jul 17 $95 call | out-of-money | 6/3/20 | 3.00 | 7/17/20 | 3.00 | 3.40% | |
| MO Jul 31 $42 call | out-of-money | 6/17/20 | 1.60 | 7/31/20 | 1.60 | 4.03% | |
| ABBV Sep 18 $100 call | out-of-money | 7/15/20 | 4.60 | 9/18/20 | 4.60 | 5.05% | |
| IIPR Sep 18 $100 call | in-the-money | 7/22/20 | 5.00 | 9/18/20 | 5.00 | 5.69% | |
| QCOM Sep 18 $95 call | in-the-money | 6/24/20 | 4.30 | 9/18/20 | 4.30 | 4.82% | |
| USB Sep 18 $37.50 call | in-the-money | 7/22/20 | 2.00 | 9/18/20 | 2.00 | 5.52% | |
| BIP Oct 16 $45 call | in-the-money | 9/2/20 | 1.95 | 10/16/20 | 1.95 | 4.65% | |
| SBUX Oct 16 $87.50 call | in-the-money | 10/16/20 | 3.30 | 10/16/20 | 3.30 | 4.00% | |
| V Nov 20 $200 call | in-the-money | 9/22/20 | 10.00 | 11/20/20 | 10.00 | 4.99% | |
| ABBV Dec 31 $100 call | in-the-money | 11/18/20 | 3.30 | 12/31/20 | 3.30 | 3.62% | |
| EPD Jan 15 $20 call | in-the-money | 11/23/20 | 0.80 | 1/15/21 | 0.80 | 4.41% | |
| MO Jan 15 $40 call | in-the-money | 11/25/20 | 1.90 | 1/15/21 | 1.90 | 4.79% | |
| USB Jan 15 $45 call | in-the-money | 11/25/20 | 2.00 | 1/15/21 | 2.00 | 4.48% | |
| BGS Feb 19 $27.50 call | in-the-money | 12/11/20 | 2.40 | 2/19/21 | 2.40 | 8.96% | |
| VLO Mar 26 $60 call | in-the-money | 2/10/21 | 6.50 | 3/26/21 | 6.50 | 12.10% | |
| CVX Apr 1 $95.50 call | in-the-money | 2/19/21 | 4.30 | 4/1/21 | 4.30 | 5.02% | |
| AGNC Jun 18 $17 call | out-of-money | 4/13/21 | 0.50 | 6/18/21 | 0.50 | 3.21% | |
| KKR Jun 18 $55 call | in-the-money | 4/28/21 | 3.00 | 6/18/21 | 3.00 | 6.25% | |
| USB Jun 16 $57.50 call | out-of-money | 4/28/21 | 2.80 | 6/18/21 | 2.80 | 5.24% | |
| DLR Jul 16 $155 call | in-the-money | 6/16/21 | 8.00 | 7/16/21 | 8.00 | 5.36% | |
| AGNC Aug 20 $17 call | out-of-money | 6/23/21 | $0.50 | 8/20/21 | $0.50 | 3.00% | |
| OKE Aug 20 $57.50 call | out-of-money | 6/23/21 | $3.50 | 8/20/21 | $3.50 | 6.67% | |
| NEE Sep 17 $80 call | in-the-money | 8/11/21 | $3.50 | 9/17/21 | $3.50 | 4.75% | |
| BIP Oct 15 $55 call | in-the-money | 9/1/2021 | $2.00 | 10/15/21 | $2.00 | 3.95% | |
AGNC Investment Corp. (AGNC)
Yield 8.7%
It sure took a while. But AGNC is finally coming around again. This yield-sensitive mortgage REIT has been floundering since making a 52-week high in June. It fell primarily because the yield curve flattened as the long interest rates plunged. But interest rates have reversed course and are likely headed higher for the foreseeable future. The stock did nothing until October. It’s been trending consistently higher all month. BUY
Enterprise Product Partners (EPD)
Yield 7.4%
The midstream energy partnership in on fire for a stodgy mover. It’s up about 15% in the past month. It has been a sharply higher trend for EPD. The energy sector is killing it. EPD still sells below the 52-week high, the pre-pandemic high and the all-time high. It should have a ways to go as the energy sector shows no weakness and business conditions for the company should be booming. BUY
KKR & Co., Inc. (KKR)
Yield 0.8%
This alternative investment asset manager stock is absolutely on fire. It’s up over 25% in just the last three weeks. Business is booming and the stock had been red hot. But the rally stopped and the stock pulled back after the Chinese real estate problems and fears of contagion. But those fears have subsided for now. KKR has made up for lost time. We’ll see how much more this surge has. BUY
One Liberty Properties, Inc. (OLP)
Yield 5.7%
Amidst the red-hot energy sector and the technology rally, this diversified industrial REIT may seem like a boring stock to own. But it’s a distance runner, not a sprinter. It’s a defensive stock with a great yield. As the market normalizes and the recent outsized returns become much harder to get, defensive stocks should be popular again. OLP is also a more cyclical REIT that should get an extra benefit in the strong economy. BUY
ONEOK, Inc. (OKE)
Yield 5.7%
Just when it looked like the rally in this midstream energy stock might be running out of gas, it goes ahead and makes another new high. We’ll see how high this surge takes it. On the one hand, it just had a huge upside move and may be due for a consolidation. On the other hand, the stock is still below the pre-pandemic price with much higher earnings and a better energy market. HOLD
Qualcomm (QCOM)
Yield 2.1%
This 5G chipmaker stock continues to smell up the place. While the technology sector is rallying again, QCOM is just floating around the low point of its range like a piece of whale excrement. It’s likely because of the slowdown in China and the chip supply issues. But those things haven’t held back profits in recent quarters. Even if profits are impacted, it should only be temporary, and the boom times will last longer. Hopefully, next week’s earnings report can get the stock moving again. BUY
U.S. Bancorp (USB)
Yield 2.9%
There was a stumble. Everything was strong at the bank except net interest income margins because of lower rates. Rapidly rising long-term rates will fix that missing piece. But the stock sold off after the earnings report, despite beating consensus estimates on both revenue and earnings. Rising costs weren’t offset by higher interest margins as the last quarter only had a short time of higher rates. But that should get fixed next quarter and the stock has already made up the lost ground. HOLD
Xcel Energy Inc. (XEL)
Yield 2.9%
I like this alternative energy utility stock in both the short and long terms. This is a great way for conservative investors to play the huge growth in alternative energy. XEL had been a stellar performer until investors forgot about alternative energy in the pandemic recovery as other long-neglected sectors got hot. But it should be favored again when things normalize. In the short term, the stock was purchased near the bottom of the recent range. It should get a nice bounce even before it comes back into favor. BUY
Existing Call Trades
Sell USB November 19 $60 calls at $2.30 or better
The stock recovered from a recent minor stumble and is now at over 62 per share. As a result, the calls are price well above target at $3.05. I like the prospect for the stock over the next several quarters. Much of its fate over the next three weeks-plus until expiration will be determined by the market. If you’re bearish near term, these calls are still worth selling at the current level.
Sell OKE November 26 $65 calls at $2.25 or better
These new calls are in the money as well. After appearing to be topping out, the stock has moved to recent highs in the past couple of days. The strike price is currently about a dollar less than the current price but the calls still sell below the target price. OKE tends to consolidate after a surge and perhaps that’s what investors are anticipating.
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 November 24, 2021.