JotCast | 5/14/20 Conrad's Utility Investor Live Chat

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5/14/20 Conrad's Utility Investor Live Chat

Roger Conrad

1:58

Good afternoon everyone, and welcome to the Conrad’s Utility Investor live chat for May 2020. I hope this day finds everyone happy, healthy and ready to share your investment questions and comments.

As always, there is no audio for this chat. Just type in your questions and comments, and I’ll get to them as concisely, comprehensively and quickly as I can.

Also per usual, I intent to keep the chat open so long as there’s anything in the queue, or remaining from the emails we received prior to it. And we’ll be sending a link to a complete transcript of the entire Q&A available shortly after I sign off, which will also be posted on the CUI website.

1:59

By way of an opening comment, I hope everyone by this time has had time to look over the May issue. More than anything else, it addresses our first big data dump on how companies have been affected by what I call COVID-19 fallout. That’s Q1 earnings numbers and especially the updates on guidance from management.

As we’ve seen, not even utilities and essential service company earnings are wholly immune from the economy’s rapid slide. And judging from today’s worse than expected initial jobless claims, we haven’t seen the last of the bad news.

As for utilities and essential services stocks, that big rally we saw off the March lows basically ran out of gas in mid-April. In fact, since then there’s been a general retreat, with utilities underperforming a broad stock market that’s turned to tech.

Ironically, I feel about as good as I possibly can right now about prospects for the 38 companies in our model Conservative Holdings, Aggressive Holdings and Top 10 DRIPs. Not only are dividends holding so far but even the most cyclical have been able to issue meaningful guidance for 2020, at a time when no one really knows the eventual damage COVID-19 fallout will do.

As I wrote in the May issue, I continue to believe a retest of the March lows is more likely than a “V” shape recovery for the stock market. As a long term investor focused on income, that worries me a lot less—now that our recommendations have demonstrated resiliency in their first brush with this economic and health crisis.

My approach remains using the market drops we see to accumulate our stocks, especially when they hit their designated “Dream Buy” prices. I list these in a table in the Portfolio section of every issue. I also won’t hesitate to jettison any company when the underlying business does appear to be cracking under the pressure.

As is my usual practice, I’m going to start the chat by posting answers to questions received prior to the chat. Thanks for joining us!

2:00

Q. Good afternoon Roger. I have two questions. First, what is your outlook for Energy Transfer (NYSE: ET) maintaining its distribution and increasing its stock price? My second question is about investing in general. I like your three-part strategy for utility stocks but wonder about your concentration on utility stocks. Have you concluded utility stocks alone over the best opportunities for returns that individuals need not deal with other industry stock categories, fixed income, or other asset classes? Are you advocating an individual have an investment portfolio based solely on utility companies?
Thank you for all the helpful information you provide.—Alan E.

A. I think Energy Transfer management has made it clear they intend to maintain their dividend if at all possible. But if they do wind up trimming, it will be because it was necessary to keep their BBB- investment grade credit rating. S&P has revised the company’s outlook to negative from stable, citing risk debt leverage will remain high due to weak

business conditions and CAPEX needed to complete large projects this year.

Q1 earnings came out just after the May CUI issue went to post, so results and guidance are not reflected in the Utility Report Card comments. But what we did see was I think very encouraging, including 1.72 times distribution coverage with $594 million in excess cash flow to deploy for CAPEX. And that number would have actually been $213 million higher stripping out a negative inventory adjustment. Debt to EBITDA was 4.12 times, in line with management’s target of 4 to 4.5 times.

During the earnings call, management stated its view that so far as Energy Transfer was concerned “things have bottomed out.” We’ll see if that’s true going forward in this very challenged environment for energy—which combines a supply glut with unprecedented sudden demand destruction.

This company has a lot of moving parts. But on the other hand, these results do prove the resilience of the large, diversified midstream business model. We continue to rate Energy Transfer a buy for more aggressive income investors so long as it trades under 15. By the way, I think a distribution cut is already well priced in at a yield of 17.5 percent, which should limit downside risk if there is one.

2:01

I very much appreciate your second question. I do believe that utilities and essential services stocks have investment characteristics that make them uniquely suited for income investors—one being that no regulated utility has ever gone out of business, another being consistent yield and reliable revenue. Also, the coverage universe I track can actually be subdivided into multiple sub-sectors. That’s historically provided balance, with some more cyclical than others. And of course, performance of this approach has been consistent and solid since I started applying it in the late 1980s.

That said, I think the recommendations in CUI are best used in combination with best in class dividend paying stocks from a range of industries. That’s why we launched CUI Plus as a companion service about a year and a half ago. It’s a managed portfolio, meaning we address how many shares to buy as well as what, why, where and how. And in an extremely volatile stock market, we’ve outperformed the S&P and by a wide margin the

the DVY (iShares Select Dividend ETF) used in many income strategies.

If you’re interested, we offer a trial subscription and of course our forever guarantee—you’ll never pay more than what you paid originally so long as you keep your subscription current.

Q. Cher RC. It's always seemed to me that "dividends" paid as additional shares in a company don't amount to anything. All stockholders own the same fraction of the company as they did before receiving the "dividend." Am I correct on the point? That doesn’t change if there's also a cash dividend per share. Then there'll be an advantage to holding those additional shares the next time there's a cash dividend. But if a company can afford that, then why wouldn't they simply raise the dividend per share -- instead of doing this additional-shares-as-dividends dodge? Cheers—Paul N.

A. There are several schools of thought on that actually. By distributing stock rather than cash, for example, one could argue that management can invest the money to increase earnings power and assets. That in turn could increase the value of the company per share by a greater amount than investors would realize by taking cash now.

There aren’t so many examples of stock dividends paid by utilities at this point. But I think the 3 percent stock dividend paid by upstate New York bank Arrow Financial (NSDQ: AROW) has been a strong positive for investors over the years, even as the company has lifted the cash portion of its payout consistently.

Where I take a stock dividend as a sign of weakness is when a company that’s been paying cash suddenly makes a switch. In the case of Telefonica (Spain: TEF, NYSE: TEF) I noted in the May Endangered List, I think offering “scrip” is clearly an attempt to hold in cash at a time when overseas cash flow is at rising risk and leverage is again putting the investment grade credit rating at risk.

It’s not so much that the idea of stock dividends is bad. It’s that Telefonica as a company is weakening and its shares are at elevated risk of going lower. And the dilution from having more shares outstanding from a stock dividend does increase the risk of a deeper cut down the road

2:02

Q. Two questions: Is Consolidated Edison’s (NYSE: ED) Quality Grade an "A" or a "B"? ED is listed on the April and May Utility Report Card as a "B" but the inset note describes ED as having maintained its "A" rating. Secondly, if Con Ed’s dividends are threatened will the company appear on the Endangered Dividend List?—Steve B

A. First off, apologies to everyone for the discrepancy, and thanks Steve for pointing it out. We’re a small shop and we present a great deal of data in this advisory, so we very much appreciate when readers point out anything that is confusing.

In the case of Con Ed, as my Utility Report Card comments also point out, there was much to be impressed about in the Q1 earnings report and guidance update from management. The most important is how well the rate mechanisms that decouple revenue from electricity demand are holding up. In fact, aside from higher bad debt expense, the only shortfall this company is seeing from COVID-19 fallout is from steam sales, a direct result of less comm

commercial activity in New York City.

Con Ed gets a B rather than an A rating for one reason: Its resilience depends 100 percent on the continued support of New York regulators. That’s been generally solid so far during this crisis, but it is a unique pressure point that investors need to take note of.

At this point, it’s a little worrisome that officials are so far delaying action on ultimate recovery of bad debt and recovery fees. They obviously have bigger fish to fry given the situation in the state, and particularly New York City. But this is something I’m keeping an eye on obviously.

2:03

As for the Endangered Dividends List, there’s no reason to include Con Ed on it at this time. Were I to see support from the state soften—and I am on high alert for that particular risk—I would quickly become more cautious. But at this point, I rate this stock a hold, with a possible upgrade to buy should it drop meaningfully from here.

Q. Do you have any thoughts on the planned telecom mega merger of O2 and Virgin Media?—Bill F.

A. I think it could be positive for both parents—Liberty for Virgin and Telefonica for Q2. Joining forces in the UK does offer considerable opportunities for cost reduction, especially with 5G technology starting to roll out. The big question will be whether UK regulators will require something major in return for allowing this to happen, considering their opposition to Telefonica’s earlier attempt to sell O2 to a unit of Hutchison. But if this happens, it would clearly come at a good time for Telefonica, which as I noted answering an earlier question is cash strapped once again.

The big potential loser here if this does go through is BT, which would face a much larger competitor in every aspect of UK communications. If the new Virgin/O2 elected to focus on margin improvement initially, BT could see less near-term pressure from competition on earnings. But not paying a dividend, there’s little reason for anyone to stick around this stock.

Q. Hello Roger. I’m a long time subscriber and reader. Thank you for all you do. So I decided to be extra smart in March and sold everything at the bottom to generate a large Capital loss. My plan was to wait the required 31 days and buy everything back at a lower price. Mr. Market totally fooled me and everything came roaring back. Most issues after 31 days were at generally the price they were before the selloff started.

So here I am with all my cash and not a clue what to do going forward. I would love to buy back my usual core of NEE, D, SO, and DUK. They seem too expensive, but keep going up. What to do? I’m waiting, thinking there will be a second selloff, but starting to doubt that will happen. Sincerely—Bill G.

2:04

A. First off, thanks for being a long-time customer. We truly appreciate it. As I wrote in the May CUI and expressed again in the opening comments, I continue to believe it’s far more likely stocks’ move since late March is a bear market rally, rather than the start of a “V” shape recovery. That’s not a universal view obviously. But I think given the earnings and especially the guidance from companies we’ve seen, many investors right now are doing more hoping than honest analysis.

That’s by the way been the case at some point in every bear market I’ve lived through since I came into this business in the mid-1980s. There’s always been a time when people thought the storm had passed but were really in its eye. At some point all the optimism vanished and there was at least one retest of the lows

For a short time in late March, the vast majority of our Portfolio holdings actually traded at “Dream Buy” prices, including several that were actually at profit taking levels just a few weeks before. My feeling is before a new bull market begins, at least some of those stocks will be back at Dream Prices.

On the other hand, I can guarantee that it will be incredibly difficult emotionally for anyone to buy at that point. In fact, everyone’s instinct will once again be to sell and go away until there’s an all-clear sign.

That’s why I strongly recommend a more systematic approach to investing. Rather than trying to time the ups and downs to make big bets, start making a series of smaller ones—when stocks you want to own long-term trade at attractive prices. You can place “buy limit” orders at levels you’d want to buy in.

They won’t be executed unless those prices are reached, so you’ll have to be patient. But your orders will be filled unemotionally when prices drop enough—and you won’t have to be on hand to make the trade.

Q. I have scoured you archives unsuccessfully looking for guidance on calculating cost when selling all or part of one of the DRIPS you recommend. Is there anything I’m overlooking?--Richard D

A. Thanks for pointing this out. I don’t have anything to point you to on the CUI site at the moment. But this is a very good suggestion.

Having done this myself on occasion, you do have control over which shares you sell, therefore the cost basis of what you sell. Keeping your own record of prices and dates on reinvestment is preferable. But if you haven’t been doing that, the companies themselves can provide all of the needed information. Some like Dominion Energy have websites with a wide range of functions.

2:05

Once you have the data, you can decide what shares you want to sell and calculate their average cost basis. Look for us to have more on DRIP mechanics in the near future.

Q. Hello, Roger. We are following, and appreciating more than ever, your advice during the current extreme challenges. We have accumulated quite a bit of uncommitted cash, and are waiting for the time to put it to best use. With safety and liquidity being top concerns, do you have any ideas as to the best place to "store" these funds? Right now, we have some in Treasury MMA's and high-quality diverse mid-term Muni funds, but do you think an ETF of TIPs would make any sense? Your thoughts would be very much appreciated.—Lou E.

A. As I wrote in the May issue of CUI, my top choice for a parking place for cash is still the Vanguard Intermediate Term Tax Exempt Fund (OTC: VWITX), though with the caveat that the combination of weakening state and local government budgets and overheated election year rhetoric could trigger some volatility in coming months.

The fund has nearly 10.000 individual bonds—the vast majority rated at least A and maturing in 5-7 years. That protects against both credit risk and interest rate volatility. The fund has very low expenses, a high tax advantaged yield and a history of steadiness as well.

If a potential near-term decline of 5 percent or so in NAV is a real concern, I would recommend the Vanguard Federal Money Market (VMFXX) as an alternative. Only bankruptcies at federal agencies would threaten this fund’s $1 NAV. The yield is only about half a percent. But it would fully withstand another hit to the broad stock market. And it’s easier to tap a money fund when you want to buy stocks at low prices.