JotCast | 2/28/23 Capitalist Times Live Chat

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2/28/23 Capitalist Times Live Chat

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Roger Conrad

2:02

Greetings everyone and welcome to our CT live webchat for February. We're looking forward to a lively session today and appreciate your participation. As always, there is no audio and we will send a link to the complete transcript of all of the Q&A after we conclude, which will be after everything in the queue and what we receive beforehand has been answered.

Hans

2:11

Elliott With the ups and downs in the oil and gas, what is your overall outlook for this year. Thanks

Elliott Gue

2:11

Thanks for the question. Generally, I think natural gas prices are too low. While short-term weather related issues could keep rallies limited near-term, prices under $3/MMBtu to $3.50/MMBtu are unsustainable longer term given growing demand and the need to incentive additional volumes from fields like the Haynesville. Oil prices my view remains largely unchanged -- I think downside risk below $65 to $70 WTI is limited and prices will need to average in the $80-$90/bbl range long-term. The probability of an upside spike in the next 12 months to $100/bbl exceeds that of a major decline (say to the low $60's).

Robert

2:23

Given that I'm closely watching the short term down trend of PXD, any thoughts as to when PXD and the oil & gas sector may form a solid support . . . whether before or after the Congressional ceiling tug-of-war or more towards the last quarter of 2023 ?

Elliott Gue

2:23

PXD got hit late last week not due so much to company-specific news but due to rumors they were looking to acquire Range Resources (they later denied that). The oil-focused producers have been caught in a bit of a tug-of-war since last summer with the demand outlook bearish (recession ahead) and the supply outlook bullish (falling OPEC spare capacity, disciplined shale production downside risks to supply from Russia and end of SPR sales). Ultimately, I'd expect this tug-of-war to resolve to the upside for names like PXD. In terms of timing, I think the oil market will look tighter in H2 2023 vs. H1 2023 mainly due to the normal seasonality of demand -- demand takes off in the northern hemisphere in Q2/Q3 and with OPEC keeping production flattish, the global oil market should swing into deficit/undersupply. The biggest downside risk to energy remains something we've written about a lot since late last year -- if there is a recession and leg lower in the broader market as we expect, I'd be shocked if energy

Elliott Gue

2:23

did not see some selling pressure in sympathy with stocks.

Robert

2:26

By the way, I am somewhat uncertain as to who may have been dealt the better hand; you and Elliot having Sherry on your team or subscribers such as myself having good, consistent info provided by you and Elliot.

Elliott Gue

2:26

Thank you for the kind comment. We feel very lucky to have Sherry with us here at CapTimes -- she's been an integral part of the team from the very beginning and I've had the pleasure of working with her for 20+ years now.

Dan

2:31

Hi Roger,
With respect to Dominion Energy earnings report, I was surprised by their $1.5 Billion impairment (3.2% of market cap.) charge on unregulated solar assets. Are there other utilities that are exposed to the same impairment situation as Dominion was? Thanks for your thoughts.

Roger Conrad

2:31

Hi Dan. In my view, Dominion's writeoff against its contracted solar energy generation assets is a first step to selling them. During the call, management seems to indicate it had achieved what it wanted to in terms of developing expertise for regulated utility deployment. And Duke Energy is taking a $1.3 bil charge for selling its renewables portfolio--primarily because IRS rules require clawback of ITC (investment tax credits) taken when solar etc is sold within 5 years. On the plus side, American Electric Power (NYSE: AEP) last week announced a better than expected price for the sale of its renewables portfolio to a private capital consortium--so Dominion might wind up with a better price. But loss of ITCs with asset sales is what triggers these writeoffs. As for who else is vulnerable to the same, it would be any company with unregulated assets selling within 5 years of taking ITCs. That would potentially include a number of companies like Avangrid and Southern, but again only if they sold assets.

Guest

2:40

Hi Roger. May we please get your thoughts on BKH's latest quarter? The stock sold off and it now yields north of 4%. A buying opportunity at these levels? Thanks.

Roger Conrad

2:40

I commented on Black Hills' earnings extensively in the February Conrad's Utility Investor Utility Report Card comments. The big issue was management reduced the company's projected long-term growth rate to 4 to 6% annually from 5 to 7%--the main reason being the need to self-fund more utility CAPEX by issuing stock, in light of rate pushback from regulators following large recent pass throughs of natural gas costs and higher interest rates. Also the company appears to have shelved plans to sell minority ownership in certain natural gas utilities. These would have funded a sizable portion of CAPEX with minimal earnings impact, but apparently the company did not get the selling prices it wanted. That in my view is a good decision. And after the drop in price, I think the stock is a buy for those not already overloaded on it.

Jack A.

2:42

Hi Elliot
I'm trying to understand how BOIL works. How is its price determined?. There is such a large fluctuation in its price, that it seems to me that buying it and holding on to it for a spike (perhaps even for up to 3 years) could result in a very significant profit if you expect more LNG export facilities to come on line in the United States by 2025. And by that time, there will be more import LNG facilities in Europe as well. What is correct or incorrect with my thinking?
Thanks

Elliott Gue

2:42

BOIL is an exchange-traded fund that tracks the Bloomberg Natural Gas Subindex -- it's designed to rise in value by 2% for every 1% DAILY rise in the price of the underlying Bloomberg Index. There are two issues with BOIL -- the futures roll and compounding error. The futures roll issue is that because the Bloomberg Subindex tracks a commodity, the index rolls its exposure from one mix of futures contracts to another based on a preset roll schedule. Prices are very different between contract months. So, if you're following the front-month futures contract, which most people do, then changes in the price of BOIL won't necessarily reflect changes in the front-month over time because BOIL has limited exposure to that contract. Also note that while the front-month futures contract for gas is at $2.73 right now, the December 2023 contract sells for $4.04/MMBtu, so the market is expecting natgas prices to rise just as we are -- there will be some issues with rolling contracts over the balance of 2023 given

Elliott Gue

2:42

contango in the futures curve. The second issue -- compounding error -- arises because BOIL tracks DAILY changes in the gas subindex. That means that over longer holding periods of several weeks or months, BOIL will not necessarily track gas prices well. I explain the maths behind this issue (for the UCO oil ETF) in a post over on my Substack https://freemarketspeculator.substack.com/p/proshares-ultra-bloomberg-... but the issue for BOIL/natgas is even bigger than for UCO/Oil. The bottom line is that you could be 100% right about the price of gas over the next 3 years (I think you are) and still lose money in BOIL. If you want to speculate on the longer term price recovery for gas, I'd much rather own a gas producer like CHK than a leveraged gas ETF like BOIL.

Jack A.

2:49

Hi Elliot:
Some more questions if I may:
Do you see much upside potential in the value of the exploration and production oil companies over the next couple of years? Do you think a better bet over the next two years is the oil service companies such as SLB? What about the refiners, relative to the E&P companies and the service companies, where do you see the greatest return at current prices over the next couple of years? I guess I'm concerned that if oil prices don't rise that much, and not much is invested in new oil production, there may not be much upward movement in the value of the E & P companies....
Thanks

Elliott Gue

2:49

I see significant upside potential for oil E&Ps over the intermediate to longer term because I believe that 1. oil prices will average higher than the current quote over 3 to 5 years and 2. many of the E&Ps still don't fully price in the free cash flow generation capacity even at strip prices (average futures prices over the next 24 to 36 months). My view over the intermediate to longer term is that oil prices will need to rise far enough over the next 2 to 3 years to incentive new volumes outside OPEC -- investment in new oil production capacity over the past 8 years has been inadequate, which is a major driver of commodity price inflation right now. Near term, we did pare exposure top some of the oil-focused E&Ps late last year and I think it's fair to say we see more near term upside in the services group, including names like SLB and BKR. We also like the refiners, like VLO, which I think have yet to price in a likely secular rise in refining margins. I'd also highlight the has E&Ps as an opportunity as

Elliott Gue

2:49

the best names like CHK have significant hedges to guard against the near-term weakness in price; yet, they can profit from likely longer term strength in gas prices once weather-related concerns fade.

Guest

2:54

Hello. Thanks for holding these chats frequently. Do you have an opinion on Allete (ALE)? The bill themselves as a leader in clean energy, esepcially for their size.

Roger Conrad

2:54

They had a big miss in 2022 earnings--posting $3.38 per share after a Q3 update stipulated a range of $3.60 to $3.90 per share. The main reasons were a loss taken on a now completed wind facility and the need to refund $12 mil after tax to Minnesota customers--after regulators disallowed a portion of interim rates the utility had been collecting. Also, weather hurt Q4 results, which were -23.7% lower than a year ago. Management did affirm the previous long-term guidance of 5-7% for earnings growth and raised the dividend 4% for 2023. And the Minnesota rate case though disappointing still has a decent 9.65% return on equity, with regulators still supportive of CAPEX plans. I think the stock is still a bit pricey but a buy under 60.

Alex M

3:00

Hi Roger. It's been a tough ride for Dominion. Zero capital gains over the last 10 years (same share price in 2013) coupled with a dividend cut... even though it's a regulated utility. Is the thesis broken here?

Roger Conrad

3:00

Hi Alex. I think Dominion is pretty attractive here--as you've pointed out the stock is at a low point, actually the lowest relative valuation vs the utility sector in decades. That's understandable, given the elevated uncertainty from the strategic review and pending changes in Virginia regulation. And there are changes coming, including almost certainly asset sales. But the key factor now is Virginia legislation negotiated over the past year or more by the company, customer groups, the legislature and Gov Youngkin is now ready to sign--and it provides a pretty clear path toward the company being able to deliver on utility CAPEX and eventually top tier sector growth. I'll have more in the March issue on the deal. But I think this is the wrong time to give up on the company, despite recent performance.

JT

3:08

I read a report that stated more people are paying cash for houses. How does this affect mortgage REITs like KREF?

Roger Conrad

3:08

Hi JT. Good question. KKR Real Estate's primary exposure in the residential lending space is for financing multi-family properties (45% overall portfolio as of end Q4), basically large apartment complexes. So to the extent that people pay cash for houses rather than take out mortgages, it should not have a direct impact on its earnings. In fact, you could argue I think rightly that fewer people borrowing to buy homes is bullish for apartment lending--which would be bullish for REITs like Mid-America Apartment (NYSE: MAA) and others we track in the REIT Sheet. As for traditional mortgage REITs, less liquidity would be another blow to companies already taking a big hit from rising interest rates and are increasingly vulnerable to credit concerns as well. That's why I'm pretty much universally bearish on the group--and I think we're going to see more M-REITs cut dividends as BRMK and MFA already have.

Guest

3:19

Hi Roger: Can you tell us some more about CHK? Is it aggressive or conservative? I believe you have written that the dividend is variable. Is there a guaranteed base amount and the rest varies on the company's profitability? I am trying to figure out its risk and volatility compared to the conservative high dividend holdings I have such as MMP, EPD and MPLX. Can you please help us with some guidance? Thanks. Barry.

Roger Conrad

3:19

Hi Barry. Chesapeake Energy is definitely one of our more aggressive recommendations. Mainly, as a producer of oil and gas, earnings follow energy prices, and management has linked the dividend paid each quarter to earnings. We think that will be a huge advantage the next few years as the energy up-cycle moves higher. But as we wrote in the feature article of the current issue of EIA "Don't Sweat Energy's Pullback, Take Advantage of It," a variable dividend will go up and down depending on where energy prices are in a given quarter. CHK pays a base dividend of 55 cents per share. But because of a big Q4 drop in gas, the variable portion of the payout is 74 cents for a total of $1.29 in March. That compares to $2.61 variable in the December payment for a total of $3.16. In contrast, Enterprise, Magellan and MPLX operate assets under contract, so earnings and dividends are considerably steadier.

Guest

3:26

Hi Elliott, can you give us your current thoughts on ARKK fundamentally and technically? Technology and growth have outperformed recently leading some to think the market has bottomed.

Elliott Gue

3:26

ARKK declined 81% from its February 12, 2021 peak to a low on 12/28/2022. After a decline of that duration and magnitude, it's not a huge surprise to me that you'd see an oversold bounce. Generally, bear market rallies are driven by positioning and sentiment -- when investors get too bearish on the overall market, speculators get too short stocks and/or long-only investors hold too much cash, there's risk of a countertrend rally. This is something I've been tracking in my Creating Wealth service for some time now, as well as over on my Substack, The Free Market Speculator. It's hard to measure sentiment quantitatively; however, we can see it in the CFTC futures positioning data and the monthly BofAML fund managers' survey. Generally, when you have a sentiment/positioning bear market rally the stocks that performed worst amid the sell-off will bounced the furthest -- I think that's what drive the big rally in ARKK to start the year. Also interesting to me is the "Dash for Trash" we saw at the beginning of

Elliott Gue

3:26

2023 -- in January the 20% of US traded stocks with the highest short interest jumped almost 12% compared to a 6.7% rise in the S&P 500. That suggests that a good bit of the upside was driven by short-covering rather than a change in outlook. Since ARKK contains some of the most heavily shorted stocks on the board, I suspect that flattered performance of the fund as well. Fundamentally, I think ARKK is in trouble -- it's basically a go-go growth fund in a market that's turning increasingly hostile to growth stocks. These stocks performed well mainly due to pull-forward of demand amid the coronavirus lockdowns coupled with zero/negative rates, low inflation and easy money. Both of those drivers are now turning bearish for ARKK. Technically, I wouldn't be surprised to see ARKK make some more "stabs" to the upside as it's still just consolidating above support in the high-$30s. I'd look for a break below $37 to confirm the next leg of the decline is underway.

Alex M

3:29

Hi Roger. Thoughts on EVRG at this price point? Thanks

Roger Conrad

3:29

Hi Alex. I think Evergy is at a good entry point now yielding well over 4% and selling for less than 16x expected next 12 months earnings. The company announced earnings last week that were far above the mid-point of the guidance range and affirmed its long-term guidance growth of 6-8% a year. But management also set a guidance range of $3.55 to $3.75 per share--with a mid-point actually slightly below 2022, which triggered some selling. My view is nothing here has changed. The company will face its first rate review in Kansas since the merger that formed the company in 2018, which means some uncertainty. And there's been an appeal of regulators' approval to securitize Winter Storm Uri (2021) in Missouri--which has delayed the bond issue in a rising interest rate environment and may ultimately increases costs. But otherwise, cost control and CAPEX appear on track as drivers of earnings and dividend growth. I think it's attractive.

guest

3:37

Please explain the pros and cons of the Southern Company financing 1.5 billion dollars of senior debt at a very favorable rate. How does the conversion factor play into any benefit for the shareholders?

Roger Conrad

3:37

The main benefit is this is low cost financing (coupon rate 3.875%), and the company has stated it intends to use it primarily to pay off variable rate debt--which has become more expensive over the past year. The issue converts to shares of common stock on December 15, 2025--so issuing these bonds is basically delayed equity issue, meaning there will be more shares outstanding after the conversion. We've already seen the stock react negatively to announcement to reflect the eventual dilution, though for all practical purposes there are far more important factors that will affect where earnings per share will be in December 2025--the main one being if the company can bring the two new nuclear reactors under construction at Vogtle site over the finish line. I have a good deal more on that issue in the Feb 22 Income Insights "Southern Company's Dream Deferred: Does Nuclear Have a Future?" I do think low cost financing now will benefit the company down the road and we'll see a much higher share price and payout.

Buddy

3:43

third try one sending this message. Are oil producers losing their drilling discipline? EOG recently reduced their variable dividend and significantly increased their capital expenditure program to support increased drilling in the Permian. Is this a new trend which won't be positive for the stability of crude prices? If you notice, the oil service stocks are acting much better than the oil producers.

Elliott Gue

3:43

Thanks for the question. EOG boosted their CAPEX spend mainly due to an increase in spending on facilities and infrastructure projects like pipelines -- in a normal year its 15% to 20% of the budget, in 2023 more like 20%. This mainly appears to be in support of a number of new plays they've unveiled in recent quarters like Dorado in South Texas Eagleford. This is characteristic of EOG, a company known for finding high return plays-within-plays capable of producing above-average returns even at low prices. The decline in the special cash payout is more a function of declining price realizations than their CAPEX budget -- this variable portion of the div. is designed to return excess capital to shareholders and will rise and fall with commodity prices. I don't think producers are generally losing discipline -- the message from the producers to date has been very conservative in terms of drilling activity. Gas producers -- CHK and SWN for example -- have been particularly aggressive in cutting rigs and guiding

Elliott Gue

3:43

for 2 to 3% declines in production volumes. Also, on the services side, the strength has mainly been in int'l/offshore names not US land -- look at names like PTEN and HP which have hefty North American (NAM) exposure and the stocks have taken hits. One thing I like to watch is the performance of HAL vs. SLB -- HAL has more of a NAM focus and it's down 7% this year vs. SLB +0.8%. Since last June SLB +52%, HAL up 17.3%. I see continued modest upside to US shale production and conservative drilling plans -- international spend is primarily to support long-cycle projects and OPEC spare capacity. Indeed, when the Saudis are spending big, for example, I see that as bullish oil intermediate to long-term -- after all, if Saudi is spending it's because they think we need more oil and they do have better visibility as to supply demand conditions than any single US or European producer (or the US government).

Buddy

3:43

EOG recently reduced their variable dividend and increased their capital expenditure program so they could increase their drilling in the Permian Basin. I this a new trend which will eventually lead to oversupply of crude. Drilling discipline has been a huge factor in stabilizing the price of crude in the 70s and 80s and I would hate to thing the prodiuce

EOP recently reduced their variable dividend and increased their capital spending program to support additional drilling in the Permian. Is this a new trend which could jeopardize the stability of crude oil pricing? If you notice, the oil service stocks are acting much better than the oil producers like EOG, CVX and XOM. Your comments please and thank you.

Elliott Gue

3:44

I think this question came through a few times -- that happens sometimes with this chat provider -- and I answered above. If I missed something in the question, let me know.

Mack P

3:49

Question about CEQP -- “Stock” price has declined significantly in last three months. Yield is not over 10% which is a red flag for me. In recent earnings report, earnings and c.f. were up, but so were operating expenses. Overall c.f. was up but c.f after distributions was down 23%. Does that mean the payout is at risk of being cut? I can live with declining price (to a point) and would even add if all else was OK. What is your latest view on CEQP. Thanks.

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