In this issue, I identify the bluest of blue chip energy infrastructure stocks at a dirt cheap price with a 6% yield. Business is booming and it is only a matter of time until the market starts rewarding the stock.
Cabot Dividend Investor 219
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Cash in on the American Energy Revolution
Do you ever get the feeling that the media focuses only on the bad news? Frankly, since discovering binge watching on Netflix and Amazon, I don’t even watch the news anymore. You have to look beyond the toxic politics, sex scandals and stormy weather to realize that good things are actually happening in the background.
One positive story that never gets any attention is the American energy boom. In just a few years this country has gone from a state of hopeless dependency on foreign energy to the world’s largest producer of both oil and natural gas. It is a global economic phenomenon of staggering proportions that will materially affect the economic well-being of the country for many decades to come. Who knew?
As an investor, you need to know this story.
In 2007, our energy situation was dire. Domestic oil production fell to a modern low and we were importing about two thirds of our oil needs. Hundreds of billions of dollars were being sent overseas every year. Oil legend T Boone Pickens stated at the time that if such dependency continued it would effect the greatest transfer of wealth in human history.
Then, technology saved the day. New technologies in horizontal drilling and hydraulic fracturing (fracking) made it possible to access previously irretrievable oil and gas trapped in the massive quantities of shale rock formations across the country. With the newfound bounty, a 2010 Congressional Research Service study estimated America’s fossil fuel resources to be larger than any other country’s on earth, eclipsing those of Saudi Arabia, China and Canada – combined.
US energy production exploded into the stratosphere. Oil production more than doubled from under 6 million barrels per day to a recent 12 Mbpd pace, an all time record. The country is now world’s largest producer of oil, eclipsing Russia and Saudi Arabia, and is a net exporter of oil. It’s also the world’s largest natural gas producer. And production of both oil and gas is expected to continue soaring in the years ahead.
If you’re old enough to remember the 1973 Arab Oil Embargo and the ensuing gas lines and price hikes, you can appreciate the magnitude of this feat. Take that OPEC.
You would think that with the energy revolution taking place, American energy stocks would be through the roof. But they’re not. They’re actually cheap. The additional American supply on the world market combined with the global economic slowdown caused an oil price crash between 2014 and 2016. It wreaked havoc in the industry and most stocks have still not recovered.
That means we get another bite of the apple, the American energy renaissance part two. The industry has stabilized and been reborn as the new global powerhouse.
In this issue I will highlight a company that is the bluest of blue chip American energy infrastructure companies. The stock is ridiculously cheap but has started to move up lately. Business is booming and earnings growth will likely accelerate in the years ahead. Meanwhile, the stock is still 30% below the 2014 high and it’s paying a fat 6% yield. This stock is poised to be one of the best income investments in a decade.
[highlight_box]What To Do Now: After falling about 20% from the 52-week high in December, the market has come roaring back. It’s up about 19% from the December lows and over 11% so far this year. In fact, the S&P 500 is now just 5% below the all time highs. What a difference a couple of months can make.
What changed? Nothing changed. I’m not aware of any major problem the market was worried about that has been resolved. Investors just had a mood swing. Recent market action does reveal one thing though. In the 10th year of a bull market investors are starting to get nervous.
The market isn’t that cheap anymore. Cyclical companies sold off the worst and had the strongest bounce back. A lot of the more defensive stocks, including several in this portfolio, have been terrific over the past year but are a little pricey at current levels. It’s hard to trust the market enough to buy the cyclical companies, and defensive stocks are too expensive.
Right now, I think certain value stocks are the best way to play it. The recent portfolio additions of Altria (MO) and AbbVie (ABBV) fit the bill. These are great companies that are cheap for reasons specific to each company. There are good reasons to believe the stocks will perform well going forward and, in the meantime, they pay great dividends.
Great companies and great prices are a timeless winning strategy. They should perform regardless of whether the overall market goes up or down in the near term. This month’s “featured buy” also qualifies as a great value play.[/highlight_box]
Featured Buy
Enterprise Product Partners (EPD)
Commodity prices are unpredictable and all this extra oil and gas will likely hold prices down. However, certain energy companies aren’t levered to price of oil and gas but rather collect a fee for the storage and transportation of these commodities. These midstream companies make money on the fact that there is a lot of oil and gas sloshing around the country, and business and future prospects have never been better.
Enterprise is one of the largest midstream energy companies in the country, with a vast portfolio of service assets connected to the heart of American energy production. It has $36 billion in annual revenues from an unparalleled reach in the industry that is connected to every major U.S. shale basin and 90% of American refiners east of the Rockies, and offers export facilities as well in the Gulf of Mexico.
Bigger isn’t always better. But in this case it is. The business of perpetuating and enabling massive U.S. production of fossil fuels can have political backlash these days. Regulatory scrutiny is always an issue for these companies. But that fact gives Enterprise even more of an advantage. Adding additional capacity to existing pipeline systems gets easier approval and is far cheaper than creating brand new systems. The regulatory scrutiny has the effect of hurting the competition and making Enterprise more of a monopoly.
Enterprise has its hands on just about every facet of the fossil fuel chain. The company operates in four segments: natural gas liquid (NGL) pipelines and services, crude oil pipelines and services, natural gas piping and storage and petro chemical and refined product servicing. But the largest segment by far, accounting for most of revenues, is the NGL segment.
NGL exportation is the fastest growing area in the industry as this country has more natural gas than it can use. The country has only very recently developed the ability to export natural gas to other parts of the world where it fetches a much higher price. NGL exports are exploding and enterprise is in the middle of it (more on that in a later section of the issue).
In addition to being in a great part of an industry that is thriving, there are several other things I like about the stock right now.
Value
Historically, EPD stock has been a fantastic performer. In the twenty plus years the stock has traded (since 7/7/1998), it has returned over 1800% (with dividends reinvested) compared to a return of 243% for the S&P 500 over the same time frame. But the stellar performance has ceased of late. EPD returned only about 11% over the past five years, compared to a 67% return for the overall market over the same period. In 2018 the stock returned less than 4%.
But that’s because the industry has suffered as I mentioned above. Enterprise earnings have consistently risen over the past five years. In fact distributable cash flow grew 33% last year alone while the stock floundered. The stock now trades at just about 10 times distributable cash flow compared to its mid teens historical average.
The only thing I don’t like about value stocks is that they can remain good values for a long time. But things might be changing for EPD. The stock is up over 15% already this year. Word seems to be getting out. Of the 27 analysts who cover the stock, 26 rate it a “buy’ or a “strong buy”.
The Dividend
As a Master Limited Partnership (MLP), EPD pays no income tax at the corporate level provided the bulk of earnings are paid out to unit holders in the form of distributions. With the ability to pay out money normally lost to taxes, EPD and other MLPs tend to pay a higher income than most regular dividend stocks. EPD currently yields a superb 6.15%.
You might think that yield is too high to maintain, but this payout is as solid as it gets. It’s well supported by distributable cash flow with 1.5 times coverage in 2018 and 1.7 times in the last quarter. That’s astronomical coverage for an MLP. And it is well supported as Enterprise gets 85% of that cash flow from long-term contracts.
The high level of distribution coverage enables Enterprise to self-fund much of its expansion projects while most MLPs have to borrow money or issue more stock to raise money. As a result, EPD has a relatively low level of debt and investment grade credit ratings.
Growth
Every business has to grow. It can be tough for MLPs to consistently grow because of the difficulty funding. EPD’s self-funding advantage gives it a huge leg up. It’s able to grow the business at significantly lower cost than the competition. And growth opportunities in the form of new pipelines and storage facilities are abundant in this energy boom.
Enterprise has $2.1 billion in recently completed growth projects coming on line this year and another $6 billion in the next couple of years. Analysts are expecting 12% annual earnings growth over the next five years but it may be even higher.
This is a top-notch well-run player in one of the very best income sectors of the market during a time of unprecedented opportunity. The timing might be just right.
Enterprise Product Partners (EPD)
Enterprise Product Partners (EPD)
Security type: Master Limited Partnership (MLP)
Industry: Energy (Midstream)
Price: $26.26
52-week range: $23.59 - $29.51
Yield: 6.4%
Profile: Enterprise is one the largest midstream energy MLPs in the country with a vast portfolio of service assets connected to the heart of American energy production.
Positives
• As U.S. energy production continues to accelerate there should be strong demand for EPD’s services.
• The stock sells at a historically cheap valuation with a big 6.15% yield that is rock solid.
• An enormous amount of new projects coming online should give earnings a sizable boost in the quarters and years ahead.
Risks
• The energy market is unpredictable and a steep fall in the price of energy commodities will hurt performance.
• The NGL market is still unproven and EPD has large exposure.
Portfolio at a Glance
Portfolio Updates
High Yield Tier
The investments in our High Yield tier have been chosen for their high current payouts. These ?investments will often be riskier or have less capital appreciation potential than those in our other ?two tiers, but they’re appropriate for investors who want to generate maximum income from their? portfolios right now.
HOLD – Community Health Trust (CHCT 34 – yield 4.7%) – This little healthcare REIT has been gangbusters. Since its IPO in May of 2015 it has returned double that of the overall market. In the past year it returned 52% compared to 3.8% for the S&P 500 and 35% for Morningstar’s REIT group. REITs have been hot and this is one of the better ones with its small size and higher growth. But don’t forget, REITs are a defensive sector and when a REIT flies like this one has it usually comes back down to earth. It may go higher but I don’t want to add to the position at the 52-week high after a great year.
HOLD – General Motors (GM 40 – yield 3.8%) – High quality vehicles, great management a solid balance sheet and a great plan for the future? What have they done with the old GM? I like everything about this company except for the fact that we are in the late stage of the economic cycle and the trade stuff. But GM is not as economically sensitive as it once was. Cost cuts and efficiencies have enabled GM to lower the North American break-even point to about 10 million to 11 million of industry sales. But it might not even get to that point in the next recession. Sales only sank to about 9 million industry sales in the last recession. In the meantime, the stock continues to behave well.
HOLD – STAG Industrial (STAG 28 – yield 5.1%) – STAG is a great smaller REIT in a lucrative space. It leases to single tenants in the industrial and light manufacturing space, like warehouses and discount centers. They aren’t sexy properties but they require little maintenance and are cash machines. The stock has been a spectacular performer. I like everything about STAG except the price. I downgraded it from “BUY” to “HOLD” last week as it approached some technical resistance near the 52-week high. It actually pulled back a little this week. I will keep it at HOLD until it breaks through current resistance.
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
BUY – AbbVie (ABBV 80 – yield 5.4%) – This is in my opinion one of the very best dividend stocks in the healthcare sector. It yields a stellar 5.3% at the current low price and the dividend will grow as it has increased 168% since 2013. The stock is nearly 35% below the 52-week high after a rare bad spell. As I’ve mentioned, there is more overseas completion for its blockbuster Humira drug. The threat is overblown as AbbVie has a fantastic array of newer drugs to pick up the slack as well as one of the best pipelines of new drugs in the industry.
The healthcare sector has underperformed the overall market so far this year. One reason is that the sector held up much better than most during the selloff but there is a new risk shaping up. The government is making more noise about capping drug prices. I don’t think they’ll do anything anytime soon because they can’t even pass a budget. But I’ll keep an eye on things. Meanwhile, the stock has stabilized and should be a longer-term winner.
BUY – Altria (MO 52 – yield 6.2%) – This stock has stabilized and has been moving higher. It’s up over 6% in the past week. There continues to be good news surrounding its recent investment in marijuana producer Cronos (CRON) and purchase of e-cigarette maker JUUL. Marijuana stocks are on fire as optimism for growth in the industry is hitting a fever pitch. Cronos earlier announced a fourfold increase in year-over-year sales and the stock is up 130% in the last three months. Wells Fargo (WFC) issued a report that stated JUUL sales should more than compensate Altria for any slippage in tobacco volume. Then last Friday a Bloomberg report stated that management at JUUL expects revenues at the company to soar 161% in 2019. The market has been skeptical about Altria’s recent stakes in these companies, but early indications are looking good.
HOLD – American Express (AXP 107 – yield 1.3%) – Everything is going great right now for the credit card giant. It had a great 2018. And the business seems to be firing on all cylinders. The stock is also a favorite of Warren Buffett. AXP is cheaper than rivals Visa (V) and MasterCard (MA) but I worry about the slowing global economy. The stock really took it on the chin when the global economy tanked a few years ago. The stock has been solid lately but I’m keeping a sharp eye out for any trouble.
HOLD – CME Group (CME 180 – yield 1.6%) – The company operates exchanges that trade derivatives, and volatile markets are great for business. Fourth quarter earnings were announced a few weeks ago and, after the volatile quarter, they were great. Revenues were up 37% and earnings soared 58% from last year’s fourth quarter. After a great run in the stock I took half off the table earlier this month. I still like the company, and analysts estimate profit growth will be in the mid teens for 2019, but the stock is pricey here. I’ll hold it for now but will likely sell the rest if there are signs of weakness.
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
BUY- Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 1.9%)
BUY – Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.4%)
It’s nice to have something in the portfolio that isn’t vulnerable to a market downturn. These funds fit the bill. Bonds are still generally low paying and risky as interest rates may rise. But these short-term funds eliminate interest rate risk and provide a decent yield.
HOLD – Consolidated Edison (ED 82 – yield 3.5%) – This is a safe and solid utility with a decent yield that should be rock solid. While the performance has been uninspiring there seems to be little downside at this point and a solid yield. ED reported earnings last week that came in a penny over consensus estimates. The market liked it as the stock was up 4% on the week. That’s a strong move for this stock.
HOLD – Ecolab (ECL 168 – yield 1.1%) – The company reported fourth quarter earnings last week that were in line with Wall Street estimates. The market liked it as the stock moved 2.34% higher on the day. The stock continues to outperform the market in good times and bad. It’s a little pricey here at the 52-week high but it still has strong momentum.
HOLD – Hormel Foods (HRL 43 – yield 2.0%) – Hormel also reported earnings last week that slightly beat Wall Street expectations. The performance has been solid in the down market as well as the recent uptrend. The only thing holding me back from raising it to a buy is the price, which is not far from the yearly high. I will continue to hold it for now because it isn’t clear yet if we are in another leg of a bull market or a bear market rally.
HOLD – Invesco Preferred ETF (PGX 14 – yield 5.8%) – This is a great place to diversify away from stocks and bonds and get a high yield in a portfolio of preferred stocks. The performance has been solid since the December lows. I will continue to hold it unless there are clear signs of weakness.
HOLD – McCormick & Co (MKC 133 - yield 1.7%) – This company is the world’s leading spice and seasoning player with a whopping 20% market share of an $11 billion annual global market. It’s four times larger than its nearest competitor. After a blowout 2018, returning 39%, the market treated the slight earnings miss in late January harshly. But the stock has since surged about 10%. It looks like it’s found its footing again and it’s cheaper than most of the other defensive positions.
BUY – NextEra Energy (NEE 188 – yield 2.4%) – This is a great stock with good momentum that continues to rise. It’s also near the 52-week high. As investors have gained a new appreciation for safe dividend paying stocks they continue to trend higher. But this stock is special. It offers the safe and predictable earnings of a traditional utility along with the stronger growth of an alternative energy company. The valuation is getting a little stretched but I won’t fight the tape for now.
BUY – UnitedHealth Group (UNH 252 – yield 1.4%) – The health insurer had a down week, but after a great year in 2018 and the strong bounce from the December lows it probably needs a breather. This is a great stock in an expanding industry and this is a rare company that is both defensive and offers growth. It’s still reasonably priced and a great fit for today’s market.
HOLD – Xcel Energy (XEL 54 – yield 2.6%) – This is a good strong utility with stability and strong growth. Being a leader in alternative energy, it will benefit from the increasing visibility of the industry. I honestly find the stock a little too pricey here. I’ve been tempted to sell the remaining 2/3 of the position, but that’s hard to do as the stock continues to outperform the index as well as the overall market. The company recently increased the quarterly dividend 6.6%.
Last price as of mid-day on February 27, 2019
Dividend 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 Dividend Investor for an explanation of how dates estimated.
A Further Word on the Energy Boom
As I talk about how great all this oil and gas production is, you may have a concern. Aren’t fossil fuels (oil, natural gas, coal) going out of style? Isn’t alternative energy the wave of the future? Plus, a couple of months ago I recommended a cigarette company. Does this guy think it’s the 1950s?
The world runs on energy. It’s what keeps the lights on and runs the economy. Without it, we’d be back in the Stone Age. It’s great to talk about wind and solar power, and hopefully someday those or other sources of clean energy can replace fossil fuels. But, believe me, it ain’t happening anytime soon. These sources of clean energy are still a long way from replacing the pulmonary system of civilization.
Not only are oil and gas abundant fuel sources but they also bring jobs, government revenues, security and manufacturing advantages that are crucial. The U.S. currently gets about 83% of its energy from fossil fuels, according to the US Energy Information Administration (EIA). The world is forecast to generate at least 80% of energy needs from fossil fuels until at least 2035.
But climate consciousness may have a strong effect on the type of fossil fuel used. Natural gas is by far the cleanest burning fossil fuel and is the fastest growing fossil fuel source worldwide. The fact is that this country has much more natural gas than it can currently use.
As natural gas production exploded in the early part of this decade, the country had a huge oversupply. The price of natural gas plunged on the oversupply from $14 per BTU several times last decade to $2 per BTU by 2012. The price is currently just $2.74. But other countries are desperate for the stuff. And in Europe and Asia the price per BTU is often three or four times what it is here. Why not sell it to them?
We can sell it to Mexico and Canada. But you can’t pipe the stuff across the ocean. In order to sell it overseas it has to be converted to liquid form—liquid natural gas (LNG), put onto tankers and shipped. The problem is that our country had no such export facilities because we were net importers of gas before the boom. And it takes time to whip up massive fractionalization and export facilities.
The first one started to come on line in the US in 2015. But more continue to follow. Natural gas exportation is absolutely exploding and we’re just getting started. This is a huge growth area in the US energy industry that few people are aware of. This month’s featured buy is heavily involved in facilitating the export of LNG.
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Your next issue will be published March 27, 2019
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