JotCast | 5/30/24 Capitalist Times Live Chat

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5/30/24 Capitalist Times Live Chat

Roger Conrad

1:51

Hello everyone and welcome to our May live webchat for Capitalist Times members. We really appreciate your business and look for to addressing your questions today as quickly, comprehensively and concisely as we can. As always there is no audio. Just type in your questions and we'll get to them as fast as we can. We will be sending you a link to the complete transcript of the Q&A, probably tomorrow morning. And it will also be posted on the EIA and CUI websites.

Let's get started with some answers to pre-chat questions.

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Q. Glad to read that the latest issue of CUI agrees with the point I've made for 2 successive Chats-the utes have caught a tailwind in the last few weeks. I still believe that some of the tailwind consists of the cognoscenti both realizing and acting on a very basic fundamental-where is the power going to come from to juice AI? Plus, as you have noted, looks like the utes have outdistanced some of the megatechs and taken a leadership position for now. My question-do you think this move in the utes has staying power?

NEE may prove to be your call of the year-powered from the mid $40s (where it was when you stood tall for it) to over $70 in just about 3 months. NEP is basing well and beginning its move into the $30s. Congrats.

A. Thank you James. I think the utilities' move should have staying power, though how much near-term probably depends on the overall stock as much as anything else. Since you wrote, for example, there was a slight shift back to Big Tech. And while the move out of utilities

hasn't been nearly as dramatic as from other dividend stocks--the AI connection being one reason--some sector stocks have cooled off in the past week or so. I note that NextEra Energy is not one of them. And NextEra Energy Partners appears to have blown past where it was when JP Morgan triggered some selling last week.

The real appeal to me of the utility group, however, is longer-term. They're sticking to investment plans when few thought they could in the face of higher for longer interest rates. And though they've come well off the October 2023 lows, the better companies are still fairly cheap in terms of yield plus dividend growth. Thanks for the question.

Q. Hi Roger. I was on the golf course and did not get back in time ask my question in the chat. If you have time could you tell me why UTG has not made much of a move upward during this bull market in utilities.

I've been retired for quite some time and live off interest and dividends. Its always paid, but I would have thought there should have been some price appreciation. Thanks—Jeff

A. Hi Jeff. The Reaves Utility Income (NYSE: UTG) closed-end fund has returned about 12% over the last 12 months and roughly 6.5% year to date. That compares with 5.9% year to date for the DJUA, which is up 7% for the last 12 months. Bottom line the fund has actually outperformed the sector with less volatility.

However, one reason I prefer buying individual stocks to funds--even if there's a strong long-term track record for the manager--is that you always know what you own. The most you get with a fund is basically a snapshot of what the portfolio is on the day they file a quarterly or annual report. I can say with a reasonable degree of assurance that if we could look at the current portfolio of Reaves, we'd find it very diversified and balanced.

1:53

And based on the most recent available information, there were a fair number of telecoms, which have generally not been faring as well as electrics recently.

That would explain the near term underperformance of the fund, which unlike most closed end funds actually trades at a premium to net asset value as opposed to a steep discount. That's a very good sign investors view Reaves with confidence, especially since the fund does make use of leverage (19.84%), which many investors look askance on. The other thing about Reaves as opposed to the DJUA or any other utility index is the bulk of its return comes from its yield--which at this point is quite high at 8% plus. The benefit of that is you get your return in cash on a regular basis. But a high payout will also tend to keep a lid on closed end funds' net asset value, which will also limit upside.

If I'm right that utilities are moving into a period of outperformance,

I think this fund will appreciate considerably in value despite the big payout--both in NAV and by going to a bigger premium to NAV. But in terms of capital gains, you're almost surely going to get more from individual stocks.

Q. I’m a long time reader and wondering what your thoughts are on the source and timing of disruptions to electricity utilities. I have read one musing about large number of connected solar houses providing excess generated power to local businesses. Or an SMR financed by a dedicated user to supply a data center, etc. Others? And how will they affect the revenue streams and growth of present utilities. Not necessarily a Chat question but rather a topic for a future monthly report.--Ed M.

A. Hi Ed. Actually I think this is a great chat question. People have been talking about "disruption" of the utility business as long as I've been advising on sector investing--and owned these stocks personally.

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That started with "cogeneration" of the 1980s, when industrial companies were supposedly going to leave the system en masse to self generate their electricity. The next was the deregulation of the 1990s that was supposed to bankrupt the sector with "stranded costs," as states deregulated generation and natural gas plants owned by Enron undercut all the nuclear and coal plants. As it turned out, Enron imploded and companies were only hurt to the extent they tried to copy its business plan.

About a decade ago, the talk was that utilities would be pushed into a "death spiral" by rooftop solar--as people put solar on their roof, the remaining customers would have to carry more system costs, incentivizing them to put up solar and so on. But as it's turned out, it's the rooftop companies that have been in a death spiral, while utilities have adapted distributed energy to their systems--cutting costs and in some cases actively participating in the business.

Each time, utilities have adapted and in fact

increased their dominance in the power sector. The industry landscape is a little different, in that quasi-utilities like Brookfield Renewable (NYSE: BEP) and Clearway Energy (NYSE: CWEN) are also competing for business--with some utilities also operating unregulated contracted generation businesses like NextEra Energy and AES Corp. But this is still a game where access to capital and economics of scale are essential to long-term success. And utilities' monopoly on T&D--and in 36 states generation as well--continue to keep them on top of the game.

Q. Dear Mr. Conrad. Do you have any thoughts on USAC? Can they sustain their payouts? What would be 'buy under' price? Per what you have in the EIA MLPs and Midstream coverage universe, it’s is a hold, no 'buy under' price given, and looks like has a lot of debt. Still, it’s a rare services play with yield and financials seem to be improving per what I see. It looked too good to be true, so curious what would be 'buy under' price.

Thanks in advance for thoughts—Cliff W.

A. Hi Cliff. USAC had a nice Q1, including record asset utilization, a 17.9% boost in EBITDA, 38.3% increased distributable cash flow and DCF dividend coverage of 1.41 times, up from 1.21X a year ago. Horsepower utilization of 94.8% was up from 92.6%, which indicates the company is still not having trouble getting business despite very weak natural gas prices.

The real question I've always had with the dividend is if Energy Transfer LP--the general partner--ultimately intends to roll up the company in a takeover that would allow it to hold in more of the cash. I think the possibility of some kind of deal has kept USAC shares selling at a discount. And it's noteworthy the dividend is the same as it was back in August 2015. That's basically why we have the stock as a hold in the MLPs and Midstream coverage universe. But barring a takeover by ET--which would probably be at some premium and in stock--I think the dividend is a good bet to hold.

1:55

We don’t have an official buy price for USAC at this time and really prefer the midstreams in the Model Portfolio. But we would probably take a look on a dip to the high teens.

Q. Hi Roger and Elliott: I own NFE, WDS and VET. Any updates on them? Regards—Kerry T.

A. Hi Kerry. We continue to cover all three stocks in Energy and Income Advisor--New Fortress in our MLPs and Midstream table and Woodside and Vermilion in Canada and Australia.

All three stocks are rated buy at this time, NFE at 35 or lower, Woodside up to 25 and Vermilion at 25 or lower. New Fortress had basically in line Q1 results and maintained its 10 cents per share dividend. The company also commissioned a floating LNG asset with first full cargo expected to lift earnings starting in June. Woodside's oil and gas production results were also pretty much in line, though year-over-year comparisons suffered from lower gas prices. But the company is on track for first oil at its Sangomar project mid-year and it secured a $1 bil loan from

Japan to fund the Scarborough LNG project. Vermilion generated $1.49 per share of free cash flow, enabling the company to reach its debt reduction target despite the negative impact of weaker oil and gas prices. Bottom line: All three are healthy as businesses and we expect them to do well as the energy cycle continues to unfold.

Q. Thanks for taking my question. On pipeline stocks like OKE, ENB or PBA, is there a tax benefit in the dividends paid in any of the three stocks?—Monroe J.

A. Hi Monroe. Thanks for your question. These companies' dividends are occasionally partly a return of capital, reflecting the tax advantages of the energy business. But for the most part, they just pay qualified dividends for tax purposes. The dividends are also reported on a Form 1099, so there's no K-1 to file. Pembina and Enbridge are both Canadian stocks, so there's 15% withholding tax from dividends.

You can essentially recoup this as a credit on your US taxes if you hold them in a taxable account.

Q. I listened to a podcast about oil and gas and Gabriele Sobara recommended a few names you don’t cover in E&I and would like your thoughts: CIVI, CTRA, SM and GPOR. Thanks for doing these chats.—Donna R.

A. You’re welcome Donna. Thanks for writing and for bringing these names to our attention. Civitas Resources (NYSE: CIVI) is a small oil and gas producer focused on the DJ Basin in Colorado as well as the Permian Basin. The company has been growing its output pretty consistently with acquisitions and is likely to continue to do so. It pays a dividend that's part "base" and part variable, the amount depending on realized selling prices for its oil and gas. The company has been buying back stock and I think is almost certainly on several companies' lists for a possible takeover with a market cap of $7 bil or so.

Coterra Energy is in our EIA coverage universe as a buy at 22 or lower. It also pays a

1:56

variable dividend and at a $20 bil market cap is also a possible takeover target. Production is strong, with management raising guidance for oil by 2.5% earlier this month for 2024.

SM Energy is smaller and its oil and gas production is more dispersed among regions. It's more oil weighted (44% of production). We would see it as a potential takeover target as well. The dividend is a bit lower but well covered as management focuses on debt reduction. Gulfport Energy pays no dividend and is focused on paying down debt and buying back stock. Management is taking a very conservative line on drilling this year, given the weak price environment.

Generally speaking, we prefer the producers in our Model Portfolio.

Q. Hi Roger. With the announcement regarding AY it appears we have a take under on our hands. It would seem that renewable energy assets are not so valuable after all. Looking back a few years AY was in the 40’s what happened?

I would appreciate your comments of where we go from here regarding AY, AQN, and AQNU. Kind regards--Jim C

A. Hi Jim. Thank you for your questions. You inspired me to post an Income Insights on this deal, as well as several others.

Atlantica shares have had their share of ups and downs since the IPO in mid-2014. Within a year, the MLP boom crashed, which also took down yieldcos. And then its sponsor/parent Abengoa SA--the global engineering firm--went bankrupt, which triggered a number of cross defaults on project level debt and forced the company to hold in cash, rather than pay it out in dividends. The dividend was cut from 43 cents in December 2015 to zero for the next nine months, before management partially restored it in September 2016 (29 cents), December (16.3 cents) and March 2017 (25 cents). At that point, Abengoa sold its ownership to Algonquin Power & Utilities and the dividend began ratcheting up again, hitting the current rate in September 2022.

The stock hit a low of around $11 in early 2016 but recovered to trade in a band around $20 until early 2019--when like every other company connected to renewable energy, it went on a tear--hitting a high near $50 just after Biden's inauguration. And following that, it basically sank along with other renewable energy stocks, hitting a low point in the high to mid-teens before takeover rumors began.

As I said in the update Tuesday, I think Algonquin as a 42% plus owner is a highly motivated seller because of its need to cut debt. I think the new private capital buyers see the value in Atlantica, are patient and expect to be able to grow the long-term contracted assets base substantially in the next few years. I think over the next 2-3 years, Atlantica would have been worth a lot more staying independent, and I confess to being disappointed by the selling price. But on the other hand, what we have now is basically the equivalent of a very short-term bond yielding more than 8%. That's our return for holding on

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if this deal closes, as appears likely. It's also possible (though not likely in my view) that the offer will get a sweetener. And if the deal fails (also unlikely), the stock will likely temporarily revisit the high teens but ultimately go higher. That's why I intend to stay with Atlantica. As for Algonquin, this is a necessary step for its eventual recovery and I still intend to take the AQN common shares when the preferred converts next month.

Q. Roger. Thanks for the opportunity to ask these questions. I read these live chats in totality and they are very helpful. First question: what are the top three to five utilities that will profit from the upcoming surge in need for electric power due to EVs, AI, etc.? Second question: which electricity generation stocks are the likely acquisition targets by the large tech players (similar to Delta purchasing a refinery) or others who will require a proprietary supply of electricity? Thanks—Gary S.

A. Hi Gary. Thanks for writing.

This is pretty much what the feature article "Day of the Data Center" in the April Conrad's Utility Investor addressed. I highlighted the opportunity from data centers and then identified regulated and unregulated companies best positioned to take advantage. I really don't have much to add to that, other than to say that all of the utilities I highlighted posted strong Q1 results and updated guidance. And though most have gained some ground since--as the utilities/AI theme has started to get some play--all of the picks are still below my highest recommended entry points.

Anyone on this chat who isn’t a CUI member can get access to all of our issues by calling Sherry at 1-877-302-0749, 9-5 pm ET Monday through Friday to take advantage of one of our membership offers.

Q. Hi Roger - this week is bringing a lot of M&A news.

1. Is this series of buyouts (AGR, ALE, now AY) indicative of a market bet that this is the last opportunity to bargain shop before the fed (eventually, moment still indeterminant) lowers rates? 2. Who's next? 3. Is there any way this AY sale could fall through? I would hope so, because I don't think 22 is an attractive price and I would much rather hold my stock long term than cash out. (I would feel that way about 22 even if the market price this morning hadn't been well above 23.) 4. Separately, your take on yet another ET acquisition of midstream assets? 5. And even more separately, how do you feel about the rationale behind multi-national utilities? For examples, CA-US Emera and UK-US National Grid (NGG)? Is it more of an unnecessary headache dealing with quite different regulatory systems, managing assets that often have little to no geographic proximities or connectivities? Or is the straddling of national boundaries a strength for the ability to invest capital more flexibly as regulators allow better

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or worse returns? (And thoughts on the recent crash in NGG price? I'm assuming nationalization by a new Labour gov't is a big longshot...) 6. Thoughts about recent FERC transmission permitting reform? 7. Re: AES, it's good to see the price rebound to the low 20s. Part of the business mix is partial ownership in startups, Fluence being the first to be publicly traded and now looking to be on the verge of profitability. I've followed your general advice to avoid picking winners in energy tech, instead focusing on the adopters who can buy and deploy infrastructure with contracted returns, but I like owning AES as an opportunity to own selected tech opportunities through a value ute/power co. Are there signs or talk of any other AES-sponsored startups approaching public offerings? Uplight? 5B? Best regards—Dan N.

A. Hi Dan. Thanks for your questions. I hope you've had time to read the Income Insights I posted Tuesday "What to Make of Takeover Tuesday." I highlighted the Atlantica takeover offer, as well as

three other deals with significant developments in the Utility Report Card coverage universe.

In the Atlantica case, you had a very motivated seller--mainly Algonquin Power & Utilities with its 42.16% and need to cut debt as it transforms into a purely regulated utility. I think had Atlantica and Algonquin waited to sell, they would probably have received a higher price later this year than the $22 Energy Capital Partners is offering. With the Board and Algonquin approving the deal, I think a higher price for Atlantica is unlikely. If the offer should fail to win regulators' or shareholders' approval, I would expect Atlantica to dip back to the high teens initially, but ultimately move considerably higher as renewable energy stocks continue to rejoin the energy bull market. But the most likely outcome here is the merger goes through--and that means owning Atlantica at this price is equivalent to owning a very short-term bond with very little risk that's yielding around 8%. I intend to keep holding it.

1:59

As for who might be next in utility M&A, that will be the subject of the feature article for June in Conrad's Utility Investor. I have multiple ideas. But my underlying rule is always to only own takeover targets I'd want to own if there were no deal this year. US/Canada "multi-national" utilities I believe continue to be effective and I think we'll see more. And I will also address spinoffs, which I think also continue to offer considerable M&A upside--and there are some intriguing possibilities at AES for the future.

My Tuesday piece also included some thoughts on Energy Transfer's latest deal--which is bullish for distributable cash flow per share growth and therefore for the dividend and the stock. The appeal as is the case with all the midstream and in fact upstream deals we're seeing now for oil and gas is driving costs lower with the benefits of greater scale, It's a powerful trend that should have a long way to run.

Finally, I think any reform that makes it easier for companies to build/upgrade transmission lines is positive for utilities. What FERC is doing, however, is very much a work in progress at this time.

Thanks for all your questions.

Q. FUN and SIX look like are going to merge making a huge company. Is this a investment opportunity in your opinion? Thanks. Monroe J.

A. Hi Monroe. Thanks for your question. I think there's pretty sound industrial logic behind a merger of Six Flags and Cedar Fair, as both would have better economics of scale and therefore a lot of opportunity to reduce costs. That fact appears to be recognized by credit raters--as the deeply junk ratings for both companies are on watch for upgrade. Clearly this is a very cyclical business--and inflation has demonstrably put pressure on visitor spending these parks depend on.

It's also unclear how much anti-trust scrutiny the FTC is going to put this deal through, given how large the new company will be vis a vis competitors--enterprise value roughly twice the next largest competitor in the Entertainment Facilities sector.

Given there are far bigger companies that also have a presence in the space like Comcast and Disney, it seems like a court challenge would have a difficult time. But they have asked for more information and we're still waiting on a ruling. SIX shareholders get 0.58 shares of the new company per one for FUN. That's a value of $25.41 per SIX share now, which is slightly less than the current price--indicating FUN is trading at a discount to deal value, so it's the better value now assuming this deal closes.

Q. I just saw that our local son has a start up while ringing the Nasdaq
bell. Sounds like a good idea and interesting investors. Would love your opinion. The symbol is AIRJ—Kid C.

A. Thanks for your question. Montana Technologies

Corporation has an interesting product. It is definitely still in startup mode, and eventual demand for atmospheric thermal energy and water harvesting is purely speculative at this time. The "business combination" announced earlier this month and the joint venture with GE Vernova are certainly promising, as is the earlier commercialization deal with Carrier. But at this point, the stock is still a ways from real earnings. One to keep an eye on--but it could just as easily go under $10 the next few days as the $50 hit back in March.

2:00

Ok that's all the pre-chat questions we have. Let's get started on the live ones.

Gina

2:00

Hi Elliott & Roger, hope you're both well. Thanks for all the insight you provide. Some questions on recommended names and one not on your list:

Roger Conrad

2:00

Thanks for joining us today Gina.

Gina

2:09

Hi again, sorry, hit enter too quickly.

Any idea why the big selloff in SUN after the NS acquisition? Is this unitholders exiting after the dividend? Or is something else going on?
Regarding CAPL, what's the biggest catalyst we should be watching to see if they recover in price after reactions to earnings?
Do you have any thoughts on WES? It has a high yield at 9.6%, is there a reason why you don't include it in your High Yield Energy Target List?

Thanks, appreciate your insight.

Roger Conrad

2:09

No problem. There's been a milder selloff in the broader-based Alerian MLP Index coinciding with Sunoco's post-NuStar close slide. And I think that's probably helped push the stock lower a little more than it would have from just NuStar holders selling and moving on. Also, SUN had been sliding since the merger won anti-trust clearance in early April.

As far as business fundamentals news, Q1 results at SUN were pretty solid, with the company raising 2024 EBITDA guidance to reflect the merger. SUN sold 9% more fuel gallons, which offset lower margins. And both Moody's and Fitch raised credit ratings.

The fact that ultimate GP Energy Transfer has a history of rolling up MLPs it controls could be weighing on SUN. But we would view this as an opportunity to buy below the highest recommended entry point of 60.

Roger Conrad

2:13

Addressing Gina's other questions. CrossAmerica I thought had pretty clear rationale for the Q1 earnings shortfall--mainly the timing of an expense that should result in substantial savings. I think the reaction in the share price is typical of a stock with sub-$1 bil market cap and just 1 analyst covering. But so long as the expense is not repeated and we see the benefit, I think shares will rebound. I would note, however, that CAPL had been trading well above our highest recommended entry point of 21--so another good example of why it pays to be patient building positions in energy stocks.

2:17

Finally, regarding Western Midstream, we still have it as a buy at 35 or lower--and it's slightly above that level now. The Meritage acquisition is already boosting results. And the recently raised dividend appears well covered for now. The fact that Occidental Petroleum owns almost 50% as the general partner is probably why we don't have a higher buy price--OXY has not been that interested in expanding and a sale of WES can't be ruled out as part of the debt reduction strategy. But a dip lower for WES would make it tempting to add to the High Yield Energy List.

2:22

Hi Elliott, why do you think SLB stock is tanking so badly compared to HAL and BKR? What is the market tell us with this action?

Elliott Gue

2:22

The market is definitely favoring the upstream and downstream names over services year-to-date. Energy stocks in the S&P 500 are up around 9-10%, while the Big 3 services names are all down in 2024.

Within services, SLB is the laggard YTD, down almost 12% compared to HAL down around 1% and BKR down 4%.

Two fundamental reasons.

First, SLB was outperforming until Saudi announced their decision not to proceed with a planned increase in oil production capacity by 2030. So, I suspect SLB's near-term underperformance is partly a function of concerns over the amplitude and duration of the international spending cycle (SLB is the leader there).

Secdond, that's been compounded by the market's general suspicion over acquisitions -- following SLB's CHK acquisition announced 04/02 SLB has underperformed its two main peers. Indeed, underperformance since 04/02 accounts for most of the YTD performance gap.

In my view these concerns are overblown. International spending remains healthy overqall, and Saudi is mainly

Elliott Gue

2:22

shifting spending from oil to domestic gas, which is basically a means to increase oil exports. As for the acquisition of CHK -- look at names like XOM and EQT that have announced deals in recent months, the initial reaction in negative but once the market digests the news, the stocks recovered. I's also note than over longer time frames, SLB outperforms -- the stock is outperforming over 24 and 36-month holding periods.

John C.

2:23

Hi roger
can you pls review the upcoming AQNU conversion. I am underwater significantly on this (and also my holding in AQN). Your advice? thanks

Roger Conrad

2:23

Hi John. As I noted in Tuesday's Income Insights "What to Make of Takeover Tuesday"--as well as in an earlier chat question--I intend to hold AQNU through the conversion into AQN shares--which will be a the maximum ratio of 3.333 shares. I think the Atlantica sale is a significant step forward for the company's ongoing financial recovery. The Liberty Utilities business is meeting guidance. And when the divestiture of AY and other contract renewable energy assets is complete, I think Algonquin very quickly becomes a takeover target--with former parent Emera a potential bidder. It looks like we'll have a profit on the AQNU from the initial entry point in December 2022 including the very generous cash flow from dividends. I had though we'd have a capital gain as well by the conversion. But this situation is still moving in the right direction and I intend to stick with it.

BKNC

2:30

There have been a few positions which have been down. I wanted to get your opinion on them as well as if it is time to start accumulating shares. BCE has been having trouble. It is the lowest it has been in 4 years. What do you feel about BCE, WPC, AGLXY and CVS?

Roger Conrad

2:30

I think you want to stay with all four companies. The US dollar prices of BCE Inc and AGL Energy have been weighted down by currency weakness (CAD and AUD). But it's fair to say all but AGL--which ironically just raised FY2024 guidance--have disappointed on the business front. BCE reduced its rate of dividend growth from mid to low single digit percentages for the next few years. WP Carey cut its dividend to spinoff its office properties. And CVS cut 2024 guidance on higher unreimbursed Medicare costs. That said, WPC is raising dividends again and doing deals to raise cash flow. BCE had very solid Q1 results. And CVS is still building a one-stop health franchise. I think we're at a low point for all four.

John K

2:38

Roger,

Now that Southern Company has demonstrated it can complete and bring into service its Vogel Units 3 and 4, do you foresee the possibility that Dominion Energy may contract with Southern Company to complete its two V.C. Summer AP-1000 units in Jenkinsville, SC? Otherwise, do you foresee the possibility that Dominion Energy may partner with Duke Energy to do likewise?

From recent articles, it appears that both Dominion Energy and Duke Energy are facing uphill challenges addressing the growing electricity demand needs of a growing residential population (demographic shift) and the demands of data centers as well as other commercial and industrial demand increases. Depending on how far into the project and in what condition the V.C. Summer nuclear units were in when the project was terminated, this may be a possible solution for both companies’ energy demand challenges. Thank you!

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