JotCast | 9/27/22 Capitalist Times Live Chat

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9/27/22 Capitalist Times Live Chat

Roger Conrad

1:54

Hello everyone and thanks for joining us on the Capitalist Times September live webchat.

On the face of things, a lot has changed in the roughly one month or so since our last webchat. That starts with more than 10% declines in the S&P 500 and technology-heavy Nasdaq—which is down slightly more. And the selling has extended to sectors that have been outperforming this year like utilities and energy. Damage to the bond market continues to deepen, with the 10-year Treasury note yield now closing in on 4 percent, a level not approached since 2010.

It’s a scary time, and quite frankly the selling could go on for a while longer. But really, this is a continuation of what’s be

been happening since the S&P 500 peaked at the beginning of the year, as the stock market responds to Federal Reserve actions to tame inflation.

This isn’t the first bear market in stocks and it won’t be the last. But investors will do well to remember that whatever the downside, strong companies like those we’ve always featured in our advisories have always recovered from stock market setbacks. And deep selloffs like this one have always produced compelling opportunities to buy strong companies at what we call “dream buy” prices.

As always, this chat has no audio. Just type in your questions and we’ll answer you as quickly as we can concisely and comprehensively. We will send you a link to a transcript of the complete

Q&A after we sign off, which will be when we’ve answered all of the questions in the queue and from email received previously. Thanks again for tuning in today.

Let’s start with some emailed questions:

Q. Roger, I see that this weeks Barron’s had a very positive piece on APA Corp (NSDQ: APA). Any thoughts? How does it stack up against your selections? Thanks—Willy F.

A. Hi Willy. We’ve had a fairly consistent view on the former Apache over the past several years that energy investors are generally better off with more focused and less leveraged oil and gas producers.

1:55

We track the stock in our “Exploration and Production” coverage universe table on the EIA website, and currently rate it sell. The company scored some points with investors earlier this month by announcing an increase in its stock buybacks. And it’s now restored its dividend to the pre-pandemic rate of 25 cents a share. But the very factors cited in the Barron’s article as bullish—including the offshore South American project—seem to us more or less more of the same risk-taking that’s gotten this company in trouble in the past.

With so many far higher quality companies like Pioneer Natural Resources (NYSE: PXD) retreating to a buying range recently, there’s just no reason to buy a sub-investment grade company like Apache, which by the way has $124 million in bonds to roll over by January.

Q. With the Biden administration going "green," are we better off buying Canadian energy and pipeline stocks as an energy hedge?

These monthly chats are really well done. Sincerely--Don C.

A. Thanks Don. We do hold two Canadian midstream companies in the Model Portfolio, Pembina Pipeline (TSX: PPL, NYSE: PBA) and TC Energy (TSX: TRP, NYSE: TRP). And after this latest selloff, both are trading well under our highest recommended entry points, and not too much above our Dream Buy prices as well. It’s worth noting that both stocks have taken on some additional water in US dollar terms from the decline in the Canadian dollar to about 71 cents—and we believe that also represents an opportunity, as the loonie is likely to bounce back when the energy upcycle resumes.

On the other hand, we would not give up on US midstream companies simply because of Biden Administration policies. As we’ve pointed out, companies like Enterprise Products Partners (NYSE: EPD), Energy Transfer (NYSE ET) and others have now fully adapted to an environment of subdued production volumes by streamlining businesses and cutting costs

1:56

and debt. As a result, dividends are rising again—even though volumes have lagged well behind levels at similar stages of previous cycles. And you’re not going to find such high yields that are so well protected in any other sector.

As far as policy goes, Senator Joe Manchin’s energy permitting reform bill has been inserted into must-pass Senate legislation to keep the government operating. That doesn’t guarantee passage. But if it does make it through, it would be a major boost for pipeline projects by providing a great deal of certainty to planning that doesn’t exist now. Bottom line, don’t give up on US midstream.

Q. Elliott and Roger. I am a long-time subscriber to EIA and other pubs and thank you for the information and analysis you both provide in your Pubs and Chats. I’ve owned MLP’s and Pipeline C-Corps for many years and now

have overweight positions in several. My investments in descending dollar order are: Enlink Midstream (NYSE: ENLC), Energy Transfer (NYSE: ET), Enterprise Products Partners (NYSE: EPD), Magellan Midstream Partners (NYSE: MMP), ONEOK Inc (NYSE: OKE), Kinder Morgan (NYSE: KMI) and Williams Companies (NYSE: WMB). I have two primary questions: 1) Outlook and timing for oil and natural gas US prices and volumes, and 2) Severity and Timing of your expected recession and its effect on Pipeline stocks.

I am considering adding ET to my IRA accounts via buying LEAP Call Options expiring in 2024 and/or 2025, which are selling at reasonable low option premiums. Given its excess Free Cash Flow and Company statements regarding increasing cash Distributions. It seems to me to be greatly undervalued. Any thoughts regarding using Long Call Options to add MLP’s to IRA accounts? Thanks--Dick B.

A.Hi Dick. Thanks for your question. First, we remain somewhat lukewarm on EnLink Midstream. The company is still sub-investment

grade, which makes its $5.6 bil debt burden a bit of a worry as it’s also more than the stock’s $4 bil market capitalization. Management has been successful cutting costs and debt the past few years. But there’s pretty heavy exposure to places like Oklahoma and North Texas that are further behind in recovery than, for example, the Permian Basin. And this is a smaller midstream—we prefer to stick with the larger companies that make up the rest of your list.

In the upcoming issue of Energy and Income Advisor—which will post this week—we look at the macro picture in more detail for oil and gas prices, which includes the growing probability of a recession. Pipeline companies in my view well prepared to weather such an environment. First, they’re already well adapted to a low volumes environment. US producers could conceivably further reduce output depending on how weak the economy becomes. But more likely, they’re just going to keep output conservative, as they did last year precisely because they saw risk of a

1:57

big price decline. And midstream companies have also slashed debt and costs.

As stocks, midstream companies are going to respond in the near term to investor fears that this could be 2020 all over again. And we’ve already seen some severe selling, notably in ONEOK. But what’s important here is what happens at the business level. And if these pipeline companies can keep raising dividends, it’s not going to be too long before investors come back.

Regarding LEAPs, it’s an interesting strategy and prices have dropped along with these midstreams’ share prices. Obviously, when you attach an expiration date to your bet, you’ve got to get the timing right. So while I have a high level of confidence ET will trade north of $20 by the time the cycle peaks, I have considerably less on the question of whether it will be approaching that price in the next two years. This is a good subject for us to explore further in EIA, however.

Alex M

2:03

Hi Roger. It seems that AQN's recent price action has been worse than peers? Any particular reason why? And will the higher cost of equity hurt growth plans? Thanks.

Roger Conrad

2:03

Hi Alex. I think one reason Algonquin has underperformed is it's home market is the Toronto Stock Exchange, which means it's primarily priced in Canadian dollars. By contrast, the dividend is paid in US dollars, which matches up with the fact that 90-95% of cash flow is earned in this country in a typical quarter. The stock is also a part of the S&P/TSX, which has been heavily sold on concerns by traders about the Canadian dollar, which has fallen to about 71 US cents.

As far as the company itself, it's still negotiating with American Electric Power over the future of the Mitchell coal plant so it can close the acquisition of Kentucky Power. But this deal has been pre-financed, so there's no overhang of investors expecting an equity sale. It's possible acquisitions may slow going forward--though would be targets have become cheaper as well.

john.alexa@snet.net

2:08

Please provide an update on BSM. Thanks

Roger Conrad

2:08

Hi John. Black Stone Minerals is primarily a royalty company--what it pays in dividends depends largely on the volume of drilling on its lands (most by third parties) as well as the realized selling prices, with natural gas the most important. The dividend should be viewed as variable--it rose sharply this year, most recently with a 5% sequential boost for the August payment. I think it's likely the payout will be a bit lower when the November payment is declared because oil and gas prices have come down since the end of Q2. That's pretty much why I've held the highest recommended entry point at 14 for shares. But this is a solid little company operating in Texas that's set up to pay us more as the energy cycle unfolds. I like it for more aggressive investors interested in high income and who want to be on the long energy cycle. But again, the dividend is going to follow the price of oil and gas.

Guest

2:12

AQN has an "ex-dividend date of 9/28/22". Does that mean that if I purchase sharers today I will receive dividends on those shares when paid on 10/14/22? Can I buy shares tomorrow on 9/28 and still receive their dividend on 10/14?

Roger Conrad

2:12

To receive the dividend Algonquin has scheduled for payment on October 14, you need to be a "shareholder of record" as of September 29. Anyone interested in receiving the October dividend, however, should probably purchase AQN as soon as possible, rather than waiting for the last minute--as trades can take a while to clear.

2:18

Do you have any advice on what to do with Store Capital? Also, what do you think of Iron Mountain?

Roger Conrad

2:18

Hi JT. Both of those are tracked in the REIT Sheet--the most recent issue posted Monday and includes the full data bank of 86 individual REITs. My current advice on Store Capital is basically hold for now. The REIT has agreed to be taken private by a Singapore sovereign wealth fund and real estate investment firm Oak Street for $32.25 per share. There's a "go shop" period ending Oct 15 in which Store can attempt to attract a higher bid, and the acquirers may bump it up a bit to win approvals. But equally, if this market environment continues to worsen, it's possible the deal may unravel, so conservative investors may want to lock in now. Deal failure likely takes shares to the low to mid-20s.

Iron Mountain is a buy up to 55. The dividend appears well covered and the remaining data center REITs are likely to be takeover targets.

2:26

Any thoughts why OKE has sold off greater than its peers?

Roger Conrad

2:26

ONEOK has historically been more volatile than for example Enterprise Products Partners, primarily because its business is more volume dependent. That's been good news this year. And in fact, Bakken well connections indicate the company could see strong volumes in second half 2022. This company has also aggressively attacked costs and debt the past few years, putting off dividend increases to hold in more cash for that purpose. But the Bakken is still perceived as being a more economically sensitive area for oil and gas production than the Permian--as is the MId-Continent region where this company also has a big presence. And though management presented a positive picture for the rest of the year at a conference earlier this month, the market is still going to treat the stock as being more sensitive to the economic cycle than the likes of Enterprise--which by the way has also sold off more than 10% this month.

Guest

2:35

Roger: You previously opined that ET will raise their dividend to $1.20 per share. How gradual or immediate would such increase occur? How likely is this prediction? Does the company make such claims/promises in their quarterly conference calls? As you previously pointed out at $1.20/share, the yield would be 10% at a share price of $12/share. Is this too good to be true???

Roger Conrad

2:35

Energy Transfer management has been very consistent this year about its target of restoring the full pre-pandemic quarterly dividend rate of 30.5 cents per share. The boost to 23 cents for payment last month marked the third consecutive quarterly boost, leaving the payout about 25% below. And the massive insider buying we've seen this year--including a $6.8 mil purchase by Chairman Kelcy Warren--is a pretty good sign management is confident it can do it.

A couple reasons why I think they'll do it: Energy Transfer is a major player in LNG exports, with a new 20-year supply agreement with Shell in Louisiana just the latest expansion in this area. It continues to find ways to grow and streamline its business, selling its 51% ownership stake in Canadian assets last month and acquiring the Woodford Express pipeline. And it continues to generate massive levels of free cash flow to pay down debt, in part from synergies from the Enable Midstream merger.

Bob B.

2:42

Hi Roger …..what caused all of the utilities to go down today ?

Roger Conrad

2:42

HI Bob. Utility stocks have actually been coming down pretty consistently since about mid-September. The averages are still running about 20 percentage points or so ahead of the S&P 500 this year so far--largely because those themes I've highlighted like reshoring of capital and manufacturing to the US, recession resilience, renewable energy spending and relatively low valuations. But it's clear that institutional money was maintaining investment in utilities to keep a toe in the market--and now that many are bailing from stocks in the face of Fed action, they're selling them too.

As far as strategy, the most important thing for investors is to keep a close eye on business strength of what you hold. The good news is nothing has changed on that score--this is still a sector that's in very good shape and there are no guidance changes with our holdings at this time. The opportunity we had to take money off the table earlier this month in stronger performers is no more. But we're holding what we have.

Guest

2:47

Hi Elliot, IEF bonds have done poorly. Can you give us an update on your thoughts? It makes sense to me that yields would go higher, price lower, on bonds as the fed has telegraphed higher rates for some time. It seems that cash, specifically US dollars, is the best place to be. I don’t understand why investors would buy 10 year bonds (IEF) just because there is a recession coming. It would seem that this thesis would rely on the fed lowering interest rates and caving in to economic pressure versus fighting inflation, which I believe you have written is not the correct thing to do and unlikely to happen (i.e. fed pivot). Statements from Powell in the last 75 basis point increase seems to confirm this.

Elliott Gue

2:47

The Fed is likely to raise rates to around 4.25% to 4.5% by early next year and the plan is then to basically keep rates there for a time since monetary policy acts with a lag. The current 10-year rate is just shy of 4%, which means that you'd have a huge inversion if short-term rates were to get up to 4.5%, indicative of ultra-tight monetary policy. I don't expect a "pivot" near term because the economy and labor market are still holding up pretty well; however, it's another matter amid a deepening recession and another major leg lower for stocks likely by early 2023. Thus I do expect then to pause on hikes and, eventually, start cutting. I suspect the reason yields have continued to rise is that the market still hasn't priced in a deepening recession in early 2023, when it does I'd expect the 10 year to experience a sizable rally as investors run for the safety of Treasuries. It's taking longer for the 10-year to bottom than I'd expected, but it's going to be tough for yields to cross above 4% with the

Elliott Gue

2:47

US facing a likely recession. To hedge our exposure to IEF in the model portfolio I've also recommended a sizable position in SIJ, which is a short in high-yield bonds. To date, much of the gain in this ETF is down to rising rates across the board (Treasuries, investment grade and high yield), but as recession starts to become reality, HY should dramatically underperform as credit quality comes into question. Basically I see our bond exposure in the model -- short high yield, long Treasuries -- as a recession hedge with a yield kicker to go alongside our sizable allocations to inverse equity ETFs and a large chunk of cash.

Victor

2:47

The Fed has been very aggressive in raising rates to fight inflation. Apparently, they will push another .75% rate hike in November, before the midterm elections; which is uncommon. Aren’t they engineering a recession?

Roger Conrad

2:47

Hi Victor. We certainly believe the odds of the US economy entering a recession have grown considerably. And the Federal Reserve from its statements appears willing to accept the risk of one in order to bring down inflation. That's basically why the stock market is selling off, and why risk is high it will fall further.

The key right now is how well companies are prepared. We think the stocks we've been featuring are in far better shape to weather a downturn than they were for example going into early 2020. That's in part because the memory of that decline is so fresh and corporate America never really had time to come out of its defensive crouch. In fact, the rising levels of free cash flow we saw this year has largely been set to conservative ends--further insulating balance sheets, earnings and dividends.

Donna

2:56

You recently recommended NEE and now its at about 80. This was my trigger point....are you still a fan?

Roger Conrad

2:56

Hi Donna. I've had 80 as my highest recommended entry point for NextEra Energy for most of this year. The irony is this utility is simultaneously the strongest company in the US power sector, and has consistently been one of the best sector stocks to bet on short-term volatility. The 52-week high and low, for example, are roughly 94 and 67 respectively. And that's in the context of consistently meeting earnings and dividend growth targets, both at the Florida utility and deploying renewable energy/transmission etc elsewhere under contracts. I don't know how much lower the stock may go under 80 but I would consider 60 a dream buy price for NextEra.

BTW, NextEra stands to be a major winner if Senator Manchin's permit reform passes this week. It owns 30% of the Mountain Valley Pipeline, which would be revived by the bill if if becomes law.

Guest

3:02

Thanks for your ongoing advice and wisdom over the years. What is the reason, if any, for AQN's 20% selloff from $14.50/share 2 months ago to its current $11.65/share? Do you have any dream price for this company? Do you find it still to be a conservative purchase like EPD and MPLX are? (even though they different industries)

Roger Conrad

3:02

My Dream Price for Algonquin has actually been 12, so it's below that now. As I answered to a previous question, AQN's home market is Toronto, which means its NYSE-listed share price is affected by the US dollar/Canadian dollar exchange rate. That's dropped to about 71 cents, and exchange rate concerns have arguably driven down TSX indexes as well, resulting in further downside momentum.

There is no reason to doubt this company will meet its 2022 guidance, however, or back up its well covered 6% plus dividend. The purchase of Kentucky Power is still pending negotiations over the future of a coal power plant. But it's also pre-financed, so current market turbulence will not affect the cost or ability to close. Shares could drop further. But I think this is a good opportunity for long-term investors who don't own AQN to pick some up.

Jimmy

3:07

Hi Elliot, SARK has performed poorly compared to inverse of ARKK. ARKK is close to the June lows while SARK is far from its June highs. Have you done or read any research to indicate if SARK has the same problems as the other leveraged ETFs that are notorious for losing investor money?

Elliott Gue

3:07

All inverse ETFs suffer from compounding error. This is a function of the fact the ETFs track daily changes in the underlying -- if ARKK is down 1%, SARK seeks to be down 1% in a given day. However, over longer holding periods, this can result in significant tracking error. Just consider an index that sells for $100 and produces the following series of price changes over 5 days: +10%,-5%,-10%,+25%,-10%. The index would close at $105.81 on day 5, up 5.81%. Now, consider an ETF that's designed to track the inverse of those same daily percentage changes over 5 days. On day 5, even though it absolutely tracks the underlying perfectly, it would be trading at $85.76, down 14%+. There are two key determinants -- the volatility of the underlying (in this case ARKK) and planned holding period. Specifically, the more volatile the underlying and the longer you hold the inverse ETF, the larger the tracking error might be. In this case, I last recommended SARK on July 19th. Since then ARKK is down about 17% and SARK is up

Elliott Gue

3:07

14%, so the tracking error has cost of 3% points or so over two (very volatile) months for the stock market. In my mind, as long as we don't hold it for longer than 6 to 9 months, the level of compounding tracking error is acceptable. Also, remember, than in fast-moving markets, the compounding error can actually work in our favor -- for example, I last recommended ARKK on December 6, 2022 and we held through to May. From December 6, 2021 to May 6, 2022 ARKK tumbled 51.5% and SARK soared 67.4%, positive +16% of compounding error. In my view, far too many investors avoid inverse ETFs because of compounding/tracking errors when they can be excellent hedges in markets like this. The trick is to understand the volatility and planned holding period and don't overstay your welcome in these ETFs.

Brian

3:07

Elliott, what are your thoughts on SLB stock price action and similar oil field services (HAL, BRK)? The later price action are just horrendous.

Elliott Gue

3:21

SLB is our top play in the oil services group as we think they're best placed fundamentally to benefit from increased global spending on exploration and development of new oil and gas plays. For example United Arab Emirates (UAE) recently announced a plan to accelerate planned capital spending to increase their capacity to produce oil/gas. This plays right into the hands of companies like SLB, which has experience in these geo-markets. The stock is down in line with the S&P 500 energy index over the past two months -- this is a function of broader market risks rather than anything specific to SLB. HAL/BKR both have more North American spending exposure and I think there's some disappointment on how little new CAPEX we're seeing out of US shale this year despite the big surge in prices. We don't recommend HAL at this time. Long-term perspective, we still like BKR due to its massive LNG business. last quarter they whiffed due toi the wind down of their Russian business, but they're selling it now and I think

Guest

3:08

With the collapse of the British currency and market, are there British utilities or exploration companies that you have a positive outlook on?

Roger Conrad

3:08

Thanks for that question. We have seen stocks like United Utilities and National Grid take on a lot of water this month. That's in part because their home market is London, which means the drop in the pound to $1.07 or so has had a direct negative impact on the US-listed ADRs of these companies. The one thing that makes me hesitate in really getting bullish on UK utilities--or energy companies for that matter--is the plunge in popularity of the current Conservative Party government. Labour recently was advocating for nationalization of utilities, momentum for which has picked up in the European Union. That's likely to be a popular line in the next election, given the massive run-up in customer bills in the UK. And the government is likely to try to strike when share prices are as low as possible. I still like Vodafone and it would definitely benefit from a UK recovery. But at this point, I want to look first at the US for utility and energy stocks.

Guest

3:16

Gents: MO has a wonderful yield of 9%. Why has the market continued to beat it up? Your other publication lists it as a buy. What do other people not see in it? For retirees needing income, it is a great stock. What am I missing? Thanks.

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