JotCast | 12/28/23 Capitalist Times Live Chat

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12/28/23 Capitalist Times Live Chat

Roger Conrad

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Welcome to our final Capitalist Times live webchat for 2023! We hope everyone is enjoying their holiday season so far, and we’re looking forward to fielding your questions and comments today.

As always, there is no audio. Just type in your questions and we’ll get to them as soon as we can comprehensively and concisely. We will send you a link to the transcript of the complete Q&A after we sign off. That will likely be tomorrow morning, as these things tend to go on for a while.

Per usual, we’ll start with answers to questions we received prior to the chat:

Q. I have been an investor in MLPs for many years. I like MLPs for the tax treatment of payouts, and hold them in taxable accounts. But in 2023, two of my larger holdings – MMP and CEQP – were bought out. I sold MMP before the OKE deal closed which caused a tax problem; and I took the ET shares in the CEQP deal, which has left me with a larger position in ET than is desirable. (I will sell some ET in Jan.) I also own CQP, EPD, MPLX, and PAA, (in addition to non-MLPs KMI, HESM, and WMB held in a ROTH account.)

I want to add another MLP or else I will increase the size of some current holdings. The only MLP with a decent yield (i.e. >7.0%) that seems "OK to buy" is WES. So what do you think about WES: [1] the ability of its management to execute, [2] the 'safety' of its payout -(coverage is only 1%)-

and [3] prospects for payout increases in the future. Is WES risky?

A. Hi Mack

Thanks for writing. We currently rate Western Midstream Partners a buy at 25 or less, and have for some time. The dividend appears to be secure and likely to be increased at a low to mid-single digit percentage rate the next few years. The primary business is still serving the drilling operations of the former Anadarko, which is now part of Occidental Petroleum (NYSE: OXY). That company looks more and more like a mature operator in the Permian Basin, which we believe is maturing rapidly in terms of reserves and future production. That basically means we expect steady throughputs. And Western's ability to prosper in the future will depend mainly on efficiency--controlling operating and debt costs, adding to assets incrementally where returns are assured etc.--as well as the health of Occidental.

We would also expect to see Western involved in M&A. So far, that's been as an acquirer, with the company closing the purchase of

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gathering and processing facilities in the Powder River Basin from a private capital firm in October. But at 48.79% owned by its largest customer Occidental, there's always the possibility of a buy-in, given the potential savings. And it's always possible Occidental will sell its interest to pay down more debt.

Currently, Western is a bit above our target buy price. And we'd wait for a dip to add to positions. And as long term bets on the energy up-cycle, we prefer the midstream companies in the EIA Model portfolio.

Q. Dear Folks, I would value your opinion about Vermillion (VET), which trades at roughly a 50% discount to your buy-under price.The European Union recently let the windfall profit tax expire, which apparently had depressed the stock's value.. VET also recently raised its dividend by 20%

% and released guidance for production and cash flow. I like the European diversity that the company brings to the table, but is that truly valuable at this time? Similarly, is the company's focus on natural gas production also a plus? Many thanks for your thoughts. May it be a good year for you and yours. Best regards, Jeffrey H.

A. Hi Jeffrey. Thank you for the well wishes, and we hope the same for you.

Our view is that Vermilion is deeply undervalued, especially given that we're still in the early stages of an energy upcycle. There's no more sure outward sign of inner grace if you will at a company than a big dividend increase. The payout is still less than half what it was pre-pandemic.

And the dividend was discontinued entirely for two years--so it's not surprising investors are still wary. But the painful adjustments made in 2020-21 are paying off with a much more sustainable balance sheet, CAPEX plans and payout policy. And I think the stock will be trading at a much higher price in the next couple years.

The EU decision to suspend the windfall profits tax after this year is a plus. But its actual impact on Vermilion's bottom line has been somewhat overstated I believe. Rather, profitability is going to depend squarely on realized selling prices for oil and gas in Europe as well as North America, with natural gas likely to be the more important commodity. And management has indicated cost control and returning capital to shareholders will be major priorities. The big test over the next 12 months will be meeting

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meeting the company's forecast for "a significant increase in 2024 free cash flow." Management has put significant price hedges in place to achieve a target 40% boost, and will also be helped by the completion of several projects to boost efficiency. The wildcard is a potential recession and a further drop in oil and gas prices. But that possibility appears to be well priced into the stock--which we continue to like for more aggressive investors.

Q. Dear Rodger,

In your recent story (as captioned above) you note the following.

NextEra the parent took a $900 impairment charge against the value of its stake in Partners, reflecting the massive decline in that stock’s price. But

But Partners itself again affirmed it won’t need new growth equity until 2027, as it will boost cash flow by repowering 740 MW of wind facilities the parent jointly owns rather than drop downs. The company also reiterated its forecast for an end-2023 run-rate of $700 to $820 million distributable cash flow, which even at the low end is 2.2 times dividends. The above referenced 2.2x distribution coverage is not accurate. How did you arrive at a 2.2x DCF/Distributions coverage? Respectfully Yours--Christopher S.

A. Hi Christopher. Happy Holidays.

The DCF coverage is based on the $700 to $820 mil run rate for 2023 distributable cash flow, and the roughly 94 mil shares of NEP outstanding, which makes for $7.45 per share DCF at the low end of the range—compared to the current (recently raised) annualized dividend rate of $3.47 per share.

The current level of skepticism about the dividend at a yield of 11% plus

relates to what happens in 2027–when NEP will either have to raise new capital on economic terms or sell assets. My reason for betting on a recovery is I think it’s likely they’ll be able to not only refinance debt but to resume drop down acquisitions from parent NextEra Energy. In fact, they did issue $750 mil in debt earlier this month at elevated but workable interest rates. I’m keeping the buy target at 30 until there’s more progress on the recovery.

Q. Hi Roger
When did you downgrade NEP? My notes show your last recommendation was <$80 in August 2023, but now, without comment, you're showing <$30. Best wishes for a Merry Christmas and a healthy, happy New Year to you and your family. --Mr G

A. Hi Michael

Sorry my advice for NextEra Energy Partners was unclear. I still like the

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company and believe in its eventual recovery. I think bears are making a mistake projecting NEP will not be able to issue reasonably priced capital before 2027. In fact, earlier this month they were able to sell $750 mil of bonds at a reasonable interest rate. I also believe bears are underestimating the support of parent NextEra Energy for the yieldco model as a means of raising capital to fund it’s extremely aggressive renewable energy expansion—just as they did in the previous decade when NEP due to adverse market conditions was temporarily put out of action as a funding source.

I reduced the highest recommended entry point, however, because NEP is at this time not able to do drop downs. And that’s likely to limit upside in the stock—you should be able to get all you want at 30 or less in coming weeks. I will raise the buy price as recovery continues. Hope this answers your questions. Enjoy the holiday.

Q. Roger and Elliot.
Enjoy and follow your work. Appreciate the quality of the fundamental work your

do. Quick question for the REIT Service: Do you still maintain KREF as a SELL? Any changes in the company or environment that are significant regarding its status as an investment - with a focus on 3-5 years of steady income?--Ron M.

A. Hi Ron

Happy holidays. Thank you for those comments. I hope you've received the December REIT Sheet, which we posted Thursday. It includes my coverage universe table, which does continue to track prospects of KKR Real Estate Finance Trust. My view on the financial REITs in general is the rally we've seen the past couple months is premature. The big question is how much the economy slows and undermines credit, particularly for already troubled office property loans that KREF has. Also, the assumption a lot of people have made is that lower interest rates will help financial REITs across the board. And that might not be the case for REITs that hold a lot of variable rate loans, such as KREF.

My advice on this REIT has been hold for quite a while, largely because a

double-digit percentage yield does price in risk of a cut. Management has been very adept in the past responding to shifting environments. And having KKR as an ultimate backstop is pretty good assurance. But I would still be cautious with KREF and with very few exceptions all financial REITs. Dividend coverage for KREF is still very tight--Q3 payout ratio was 91.5% or 172% including a big writeoff. They also collected just 96% of interest payments due during the quarter, so there could be more writedowns ahead if the US economy does keep slowing.

Q. Hi Roger:
The markets, especially early on, didn't seem to take well to the Pembina purchase from Enbridge. Do you share their views? Thanks—Jerry F.

A. Hi Jerry. Happy Holidays.

I actually think this transaction is a win-win for both companies. Enbridge gets reasonable cost financing for its acquisition of Dominion Energy natural gas utilities, which means that much less new debt or equity needed.

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Pembina gets quality contracted assets that mesh well with the rest of the business. And the deal is expected to be immediately accretive to distributable cash flow.

Generally speaking, stocks of acquiring companies get sold when deals are announced. But in any case, whatever trepidation anyone had about this deal seems to have worn off. I still like Pembina as a buy up to 38.

Q. Hi Roger,
I am considering whether to sell this stock for tax loss this year and really cannot wait until the chat. it seems that there are better options at this point
Thank you—Marianna K.

A. Hi Marianna

I am not recommending selling AGL Energy at this time. I think the company has turned the corner--earnings and dividends are on track for a big

rise this year. And it now has a clear plan for investment in Australia's energy transition that should keep profits rising going forward. I think the presence of activist investors is now a strong positive. And the company seems to be on the same page with the country's regulators on both the federal and state level.

The stock has not returned to where it was a few years ago. So it may make sense to take a tax loss, with the intent to either buy back later or to purchase something else, depending on your circumstances. But I'm still positive on AGL. Best and Happy Holidays

Q. Like your bond and convertible recommendations in your latest issue--Like to buy KMI and NEP say $10000-15000. Have accounts with Fidelity and Schwab and cant do it !! disappointing
However in real terms the bonds YTM of about 5.5-6.0% compared to 2yr treasury at say 4.6% is only about an extra $100-150 per yr so not much lost.

One final point--any suggestion how to buy these bonds ?? Thanks Richard G.

A.Hi Richard. Unfortunately, bonds are not as liquid and therefore easy to buy as common stocks. That’s why my standing advice—including in the December issue of Conrad’s Utility Investor—is to (1)work with a broker who is familiar with bonds, saving on the commission will more times than not cost you far more with a higher bid/ask spread or just not being able to buy, and failing that (2)enter buy limit orders and be prepared to wait.

As you point out, the yield difference with the 10-year Treasury bond (now 3.84%) is only a 1-1.5 percentage points or so less than the bonds I’m recommending. But that does add up over the holding period.

Q. i HAVE A QUESTION FOR ROGER I'D LIKE INCLUDED IN THE UPCOMING LIVE CHAT,

I OWN UTG BUT NOTICE THAT THE PORTION OF ITS DIVIDEND PAID WITH CAPITAL GAINS HAS RISEN STEADILY AND NOW

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DWARFS THE DIVIDEND PORTION. DOESN'T SEEM LIKE THIS IS SUSTAINABLE AT THE CURRENT PAYMENT LEVEL? YOUR THOUGHTS PLEASE.--JOHN T.

A. Hi John. Happy holidays.

Closed end funds like Reaves have enormous latitude over how they cover cash dividends. But that said, what they pay is entirely at management’s discretion—and because you as an investor never really know what’s inside (except when they publish SEC reports ), they’re pretty much always a black box.

That’s why I always prefer to own a portfolio of individual stocks to even the best CEFs. But that said, Reaves has a very long term record of being able to raise dividends regardless of the market conditions. And the utilities

utilities and essential services stocks they specialize in are raising dividends about as robustly and reliably as they ever have.

There is a non zero chance UTG cuts its payout in the next 12 months—cap gains in the utilities sector were tough to come by in 2023, as they were in 2022. But this is a quality fund that historically hasn’t taken many chances with investors money. So I’m still comfortable recommending it, though I prefer individual stocks.

Q. Hi Roger, Barbara and I would like to wish your family and you a very Happy Holiday Season and a Merry Christmas. Your call on WP Carey (NYSE: WPC) was spot on... You estimated .857 qtr, came in at .86. Amazing...Best—Robert P.

A. Thanks Robert, and all the best to you both this holiday season. I wish I

I could take credit for being prescient. But all I really did was use the math management had parsed out on several occasions after announcing the spinoff.

Though Carey had been moving away from office properties for some time, the announcement it would essentially spin off most of that business as Net Lease Office Property (NYSE: NLP) did surprise a lot of people. And I think it actually undermined a fair amount of institutional support for WPC. But being up front then on what they were doing with the dividend and following through on it has apparently restored much of that lost faith, judging by the rebound in the stock.

At this point, WPC is much more focused and able to grow faster. And I think NLOP is going to reward those who hold onto it with considerable cash dividends as well, with the 34 cents per share to shareholders of record

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December 18 the first installment.

Q. Roger. In your opinion, is T, HASI, NEP, and ET worthy of additional investment at this time ?--JOHN R.

A. Hi John

Happy holidays. NextEra Energy Partners and AT&T are a bit above my highest recommended entry points. I'm likely to raise those in the New Year as these companies report Q4 numbers and NEP especially continues its recovery. But at this point, I would consider both stocks holds unless they come off to 30 and 16, respectively.

On the other hand, both Energy Transfer LP and Hannon Armstrong are still at good entry points. Note that Hannon now has a formal plan to convert to a C-Corp from a REIT. Management expects no material impact on operations

or dividend policy, though ultimately it anticipates easier access to low cost capital.

Q. Hi Roger,
As a long-time subscriber to your utility publications I have absorbed your thinking that the most important factor in company success is regulator relations. Some time soon could you address in Conrad's Utility Investor the trend toward performance-based regulation and performance incentive mechanisms? Both sound like bad news for income investors. Thank you,--Teresa P.

A. Hi Teresa

Thanks for writing. I actually view incentive based regulation as a major positive for companies, as they allow shareholders to get a piece of cost savings measures that are really the heart of most capital spending we're seeing. In fact, pretty much everywhere we've seen this kind of regulation adopted, it's been at the behest of utilities. Per your request, I identify performance regulation in the ratings analysis I'll be doing for the January issue. But at this point, I don't view this as a risk, but in fact a way

companies can further ensure the safety of their dividends and ability to grow.

Q. Roger, I know you and Elliot have been expecting a recession soon. Do you both still feel caution is warranted and recession is likely? What would ease your concerns? Also, what are your expectations for better prices for natural gas? Do LNG exports still look promising? Thanks so much for your guidance.—Willy

A. Hi Willy

Recession is a very slippery word, especially as we move into a presidential election year. But generally speaking, we believe there are signs the economy is contracting--especially in certain key sectors as the result of higher borrowing costs. That definitely comes out in Q3 results for US and Canadian real estate investment trusts as well as guidance, which I presented in the latest REIT Sheet. And REITs as landlords literally have connections

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with every corner of the economy. We also saw it in the Q3 results of utilities, particularly in tapering industrial sales growth and in some areas outright contraction.

Bottom line--we're hoping for a soft landing. But now that the Wall Street consensus is basically taking one for granted, we're especially wary of what might happen to the stock market if the economy disappoints--even if policymakers don't call it an official recession. That's one reason we're sticking with large amounts of cash in model portfolios of our services going into the start of the year--the still high yields on money market funds being the other. We are also still mostly weighted to stocks, though on the value side and not the Big Tech 7 that have been the market leaders this year.

Fred

2:00

Hi Guys,Has anything changed over the past few weeks re PXD/Exxon deal and your suggestion to hold my PXD shres?

Roger Conrad

2:00

Hi Fred. There's no change in our Pioneer recommendation at this time. Even if the ExxonMobil merger should fail, we'd still want to own this company and its prime Permian Basin acreage. But despite the FTC request for more information, we see limited grounds for a successful court challenge. The dollars are large but as Exxon's CEO has pointed out, the combined companies have less than 15% of total Permian Basin production and less than 5% of total US output. We think it's likely the FTC will try to impose some conditions. But at the end of the day, this merger has a very high likelihood of going through.

Kerry T

2:04

Hi Elliott:

Congrats on calling the year end rally. Seems like consensus is that the fed will cut rates and that cutting is a great thing for the stock
market. Previously, you've explained that when the fed cuts rates it's a sell signal. Still think we are headed for a recession and back down
to 3600 or lower for the S&P 500? Regards.

Elliott Gue

2:04

Thanks you. Yes, what's interesting is that since the end of October, US financial conditions have eased dramatically -- based on the Goldman Sachs US Financial conditions index, we've seen the fastest pace of easing since 2020-early 2021 and we're back to levels last seen in the middle of 2022. Part of that has been the big rally in bonds, some due to expectations for easing in 2024 and part of it is likely down to the surge in bank reserves at the Fed (high-powered money). So, this tidal wave of liquidity is what's driving the market higher and I think that remains a tailwind into early 2024. Longer term, however, the market is now looking for the fed to cut 7 times (175 basis points) by the end of January 2025. Historically cuts of that magnitude are unlikely absent a recession and generally when there's a recession the market falls even with the Fed cutting rates. I think we will see the market ultimately break the 2022 lows in the coming cycle.

Jeffrey H

2:05

Dear Folks, BCE is still below your dream price of $40. There has been news about regulatory issues and fiber -- I am not sure how that affects the company. I'd appreciate it if you would explain your position on BCE -- Do you consider it as solid a buy as Verizon? Many thanx.

Roger Conrad

2:05

Hi Jeffrey. I think BCE is pretty much an analogue of Verizon in Canada. Government regulators have enacted a new rule requiring fiber network sharing, and the company has said it will cut future CAPEX in response. But just a couple weeks later, the company was the big winner in a 5G wireless spectrum auction--both in terms of licenses acquired and the price paid for them. And the wireless business is far more important to the company at this point.

Would they prefer a Conservative Party government as their primary regulator in Ottawa? Almost certainly. But BCE also affirmed earnings guidance and 2024 looks like another steady year as well. I don't recommend really loading up on any one stock. But BCE is at a good place to build positions.

Barry B.

2:09

You mentioned in the last email that that Chesapeake had signed a contract with Japan to supply LNG at an index price. How much better is this price than the domestic price Chesapeake would receive normally? Keep up the good work, I look forward to a prosperous New Year with you!

Elliott Gue

2:09

CHK hasn't disclosed the exact terms of the deal for competitive reasons. However, the Japan-Korea Marker (JKM) benchmark for Asian LNG sells for around $11.75/MMBtu right now compared to January 2024 US NatGas futures at $2.56. Netherlands TTF benchmark (Europe) is around $10.81/MMBtu. So even though international gas prices are well off their 2022 peaks they're still far, far higher than in the US. Happy New Year and thanks for subscribing!

Dave T.

2:13

Hi Roger – wondered if you knew of any event or occurence that may have caused the recent drop in the Exelon (EXC) share price? Thanks for all you do.

Roger Conrad

2:13

Hi Dave. Exelon took a tough rate decision in Illinois, which is 27% of their rate base. Specifically, the Illinois Commission rejected their grid CAPEX plans for 2024-27 and has required them to file another one in mid-March that pays more attention to "customer affordability." They also granted an ROE of just 8.905%, which is well below the national average of around 9.5%. The upshot here is there's going to be protracted negotiation and very likely Exelon will be investing a lot less in Illinois. On the other hand, they did receive a much more amicable rate deal in Maryland--another key state they serve that also has a reputation for less than favorable regulation. In my view, any bad news is well priced in at this point for the stock. And I think there's a good chance for a better outcome in Illinois to lift the stock. Meantime, there's no change in my recommendation.

Alan R.

2:17

Hi Guys,

I am curious about your big picture thoughts on oil. A number of emerging economies are trying to expand their productions abilities and some have even decided to drop out of OPEC+. I expect that impact on supply will take some time, but could this be enough to throw the current tight supply-demand balance off?
Also curious is you have done any additional work on Kodiak KGS.
Thank you for your excellent work; have a happy and healthy and prosperous new year. Regards

Elliott Gue

2:17

I don't think countries leaving (or entering) OPEC+ will have any meaningful impact on supply. Angola, which announced it's leaving OPEC, has experienced a steady decline in production for 13 years now. At the peak in 2010, they produced almost 2 million bbl/day, today it's 1.14 million.

They have taken some steps to stabilize production losses and I think they hope to attract more investment in future to see some increase in output. So, they're trying to avoid having OPEC stick them with a low production quota. However, there's no big increase in supply coming in the next 3 to 5 years.

More broadly, you'll see some increase in output from Guyana in coming years and some probably from Brazil as well. However, I don't see much of significance from emerging markets -- certainly not enough to move the needle on the global supply-demand balance or even offset base declines from maturing fields.

Gary S.

2:18

Roger-
What is the margin of safety you use for your buy limit recommendations? Are the buy limits statistically based? Moving average based? Please explain. Thanks.

Roger Conrad

2:18

Hi Gary. It's really pretty simple from my end. The highest recommended entry points are based on a combination of sustainable growth at companies and share price valuations. What I'm looking for is a sum of dividend yield plus sustainable annual growth to be 10% or higher for the best in class, and progressively higher sums for stocks I deem of lower quality to rate buys. Quality grades are based on 5 criteria--I'll be highlighting them as they pertain to essential services stocks in the January issue of Conrad's Utility Investor. The idea is share prices for high yielding stocks over time follow dividend growth, which does bear out.

Eric D

2:23

Roger I have large positions in epd,et, and mplx. I want to add another mlp. What one mlp looks best for 2024. Best

Roger Conrad

2:23

Hi Eric. Per the Alert we sent out yesterday for Energy and Income Advisor readers, my top pick for midstream the next 12 months is the same as my pick for the last 12--that's Energy Transfer LP (NYSE: ET) as a buy at 15 or less. We're up close to 30% the last 12 months on top of a 55% gain in 2022. And I think as the dividend expands, the company makes more acquisitions and the energy cycle continues we're headed for a lot more--the stock is still barely one-third the previous cycle's high. As a complement to these, I would take a look at the other midstreams in our Model Portfolio--Plains GP (NYSE: PAGP) appears headed for similar gains as the cycle unfolds, if it's not acquired first. For something more aggressive, Equitrans Midstream (NYSE: ETRN) looks to me like a takeover target when the Mountain Valley Pipeline opens up early next year.

Lani

2:31

Hello Roger,

I’ve owned CDPYF since 2005 and RIOCF since 2016. Monthly distributions have always been recorded on my TDWaterhouse then TDAmeritrade statements and 1099s as qualified dividends. This has never been questioned by my CPA's tax preparers or the IRS. In the last couple months since Charles Schwab finally “killed” TDAmeritrade (which they purchased several years ago) Schwab has listed the distributions on their statements as non-qualified dividends. I've been challenging this to no avail, though it’s long been my understanding and from info. I can pull from the internet that Canadian REITS are not subject to the same ordinary income rates that apply to dividends received from U.S. REITs. I’m continuing to challenge Schwab.

Your thoughts? And if I’m correct, I hope any of your readers who own Canadian REITS and automatically became Schwab clients in September are checking their monthly statements carefully.

THANK YOU!

Roger Conrad

2:31

Hi Lani. Yes, like most of the surviving big "discount" brokerages, Schwab is laser-focused on profit margins--and aggregating assets like TDWaterhouse/Ameritrade's to gain scale is how they do it. I'm not surprised they're trying to take the very easiest way out regarding Canadian REIT dividends--which is basically nothing. And unfortunately, I think it's going to be very difficult to even get someone on the phone who has any authority or access to it in order to right things.

You are in the right on this. And the IRS has stated specifically that taxpayers should not count on brokerages to have accurate tax information but should file as they and their tax preparers believe correct--keeping backup available. The cleanest solution would be to transfer the account you hold these stocks in to interactivebrokers.com. But failing that, you should file with backup material the correct way.

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