JotCast | July 2023 Capitalist Times Live Chat

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July 2023 Capitalist Times Live Chat

Roger Conrad

1:50

Hello and welcome to our Capitalist Times webchat for July! Thank you for joining us with your comments and questions. As always, there is no audio for this chat. 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 a transcript of the complete Q&A session sometime after we sign off, which will be when there are no more questions left in the queue or from emails we received prior to the chat.

Per usual I’m going to start by posting some of those. Thanks again for participating today.

Q. Roger. What’s not to like at about AT&T and Verizon after Q2 earnings? Seems like strong cash flow, good EPS, a safe high dividend yield and a low valuation. What is it that the market doesn’t like that has driven the valuations of both so low? You still a fan?--Rick P.

A. Hi Rick. Dividend stocks in general have lagged the S&P 500 by a wide margin this year. But I think investors who might buy these stocks are also very likely still wary of these companies’ debt, which they took on recently to build 5G networks and lay fiber broadband. AT&T’s dividend cut when it spun out Warner—and even more so the dividend cuts/suspensions at other telecoms like Lumen Technologies (NYSE: LUMN)—have shaken the faith in remaining sector dividends regardless of the numbers.

1:51

There are lingering rumors that Amazon.com might enter the wireless business, resulting in customer losses and further depressed margins. And lastly there’s this lead cables issue, which WSJ basically alleges is a ticking time bomb for telecom balance sheets.

My view is all of these concerns an then some are reflected in AT&T’s current valuation of 6.1 times expected next 12 months earnings and Verizon at 7.4 times. Moreover, Q2 earnings and especially free cash flows support both companies’ dividends and balance sheets, which continue to benefit from steady debt reduction.

Amazon may decided to offer wireless service through its Prime brand, possibly as rumored by acquiring DISH Network (NSDQ: DISH).

But on the other hand, doing so would either require a huge outlay of cash to buy into a business with highly uncertain returns—or else reselling service through an MVNO agreement that would leave its margins at the mercy of the network owner, most likely Verizon. Finally, as I’ve noted recently to Conrad’s Utility Investor readers, the worst case for the lead cables issue now doesn’t appear to be anywhere close to the magnitude initially alleged by WSJ.

CUI readers can expect a full analysis of the telecom sector in the August issue, along with my top recommendations from its battered leaders. And my view from current prices is bullish now with two caveats—first we want to keep up with earnings to be sure businesses are still moving in the right direction, and second we need to be patient if we’re going to bet on recovery. It will happen so long as these companies maintain dividends and systematically reduce debt without shedding revenue.

1:52

But there’s no way to really predict when the shift in investor sentiment is going to make that happen.

Q. Mr. Conrad: I have read your comments about Verizon Communications (NYSE: VZ) and AT&T Inc (NYSE: T) and am very much appreciative of your newsletter. Very well researched and presented, as usual. However - As I view these 2 companies (I sold out of Verizon about 2 weeks prior to your newsletter), I see something else. I don't believe the public feels either company has any future growth plans. They are both companies providing infrastructure for communications, and smaller companies keep coming along with novel products that keep taking a chunk out of Verizon and ATT. So they appear to me (an unskilled analyst to be sure), to be just existing in the market while innovators keep taking a piece of their revenue and customer base. Yes, they have 5G - but that

improvement seems almost transparent to all but the most intense user of their system. So these two companies in my view are just sitting ducks in the market with complacent management running the organization like a utility. Would be interested in your thoughts on this.—Neal G.

A. Hi Neal. Thanks for those kind words. In the previous question I addressed what I believe to be the most immediate questions for AT&T and Verizon. Yours is a question about more existential challenges, which companies in pretty much every industry—even 120-year-old essential services like US telecoms—eventually have to face.

I think it’s pretty clear that these companies so far have not been able to monetize their investment in 5G networks the way they did 4G in the previous decade. If you look at what 5G is capable of providing—and what 6G et al will be—it’s easy to see how engineers would fall in love with it. And there’s a clear precedent to how 5G can eventually benefit telecoms, mainly the accelerating revenue growth of

1:53

Chinese telecoms over the past year as capabilities of Huawei-built 5G networks spawn new applications.

That hasn’t happened yet for AT&T, Verizon or even T-Mobile US yet I think for several reasons. The political decision to ban Huawei equipment and services from US communications networks essentially shut off the US Big 3 from the world’s best technology. Some had to switch suppliers midstream through the deployment effort, which delayed operability and increased cost/debt. Second, while networks have been catching up on technology, the delays and higher cost have really muddled the marketing message, discouraging development of applications that could have sold consumers and businesses much faster on 5G capabilities and why it’s worth paying more for. And third, households and businesses are in a cost-cutting mode due to inflation pressures and higher interest rates, which has made them even less inclined to pay more for 5G.

As a result, the Big 3 have been reduced to competing for customers so they

can pay down the debt taken on to build networks. That doesn’t mean all this capability won’t be used—in fact, the continuing explosion of data processing and storage augmented by artificial intelligence ensures a lot more will be needed. But in the meantime, industry margins continue to erode. And that includes AT&T, Verizon and T-Mobile US—though ongoing damage is far worse at their remaining rivals.

It’s interesting your perception is that these companies’ rivals are innovators and the Big 3—or at least AT&T and Verizon—are “sitting ducks” losing business to them. I think that may be a common view. But the reality is companies like Lumen, DISH Networks et al are basically vanishing before our eyes, undercut by the Big 3’s vastly superior network services now offered at cut rates to customers. Even the cable television companies are losing core customers at accelerating rates, with revenue becoming increasingly dependent on wireless networks they rent from Verizon.

It’s fair to ask how this all ends. My

view is communications is an essential services industry that’s always favored greater scale. And it’s been rapidly consolidating in terms of players and market power pretty much since the late 1990s, following Baby Bell deregulation that was supposed to launch hundreds of competitors.

I used to cover nearly 70 US telecom sector companies in the 1990s. Now there’s less than a half dozen that really matter in terms of revenue and market share, two of which are AT&T and Verizon. And as customer additions in Q2 indicate, they’re still adding market share though probably not at the rate T-Mobile is—even as companies like Lumen are in a race to cut debt faster than revenue is shrinking.

1:54

I think this consolidation is going to continue, with takeovers or bankruptcies the most likely outcome for smaller communications companies. And as that happens, I think 5G will eventually reward the investment of the remaining players. That in turn will shift investors’ perception of these stocks, though there’s no way to say when. But in the meantime, it’s hard to beat the dividends, which in Verizon’s case continue to rise every year.

Q. Hi Elliott. Last I heard, there is still some impediment to completing the Mountain Valley pipeline......How is Energy Transfer Partners (NYSE: ET) affected by whether this pipeline is operational?...... Despite analysts' optimistic price forecast, ET seems to be stuck in a narrow

range........... What are your thoughts about when its price can go above 14? It's much lower than it was before it cut its dividend, which has now returned to previous level? Thanks--Jack A.

A. Hi Jack. Since your question pertains to midstream, I’ll answer. Energy Transfer Partners is not a partner in the Mountain Valley Pipeline. The lead developer there is Equitrans Midstream (NYSE: ETRN) and major partners include NextEra Energy (NYSE: NEE), Consolidated Edison (NYSE: ED), Altagas (TSX: ALA, OTC: ATGFF) and RGC Resources (NSDQ: RGCO).

The pipeline would also connect Appalachian natural gas to markets of high demand in Virginia and North Carolina, which are not core operating areas for ET.

1:55

So whether it opens or not will not have a meaningful impact on the partnership’s cash flow either, though I guess you could say any event that delays new transportation capacity coming on stream drives up the value of existing pipelines anywhere in the US. .

As for the Mountain Valley Pipeline project itself, the deal reached as part of raising the federal debt ceiling specifically prohibits federally granted permits from being litigated in the courts, so long as developers like Equitrans are in compliance. Nonetheless, the US Court of Appeals for the Fourth Circuit did just that, ruling against the project. That ruling will almost certainly be overturned on appeal to the US Supreme Court. But it nonetheless compels the developers to suspend work until that happens,

which probably means the earliest MVP can come on line is sometime next year. And that may be too late to prevent a dividend cut at Equitrans.

Again, that won’t have any impact on Energy Transfer. As to why shares are still trading in the low teens, I have a couple of comments. First, they are back roughly where they were prior to the pandemic and somewhat higher than immediately prior to the dividend cut announcement in late 2020. They are well below the mid-30s range where they traded at the peak of previous energy up-cycle in 2014-15. But that level was reached only after a six-year plus rally from the late 2008 lows. This recovery only began in late 2020. And the history of previous energy up-cycles is midstream stocks are always the last to peak

1:56

Our view is ET will eventually trade at least in the upper 30s during this cycle. It’s a larger and stronger company that it was during the previous energy upcycle for one thing. But in any case, we get a yield well north of 9 percent that’s still growing while we wait for the appreciation.

Q. What is your take on TC Energy’s (TSX: TRP, NYSE: TRP) sale of a 40 percent ownership interest in two US pipeline systems. I interpreted this as a positive, but Mr. Market felt differently, driving TRP down.—Joe W.

A. HI Joe. I think the sale is very much a net positive. It achieves TC Energy’s 2023 target of $5 billion plus in asset sales more than five months ahead of schedule.

Those are funds needed to complete the delayed Coastal GasLink Pipeline. And the sale shouldn't have a lot of impact on distributable cash flow or dividends. S&P affirmed the credit rating at the sale and TC has affirmed guidance as well.

I think the stock’s downside since the deal was announced is more explainable by other factors. One is the Columbia Gas Pipeline fire in Virginia that forced the company to shut down a part of the pipeline and declare a “force majeure.” That will no doubt be a topic when management reports Q2 results and guidance on July 28, and it’s obviously added to the uncertainty about the rest of the report.

It’s also worth pointing out that pipeline stocks in general slipped on the day of the announcement of the sale, part of a general weakness in dividend stocks. And remember that TRP shares are priced in Canadian dollars, so Fed policy for keeping interest rates higher for longer has hurt its US dollar price.

In any case, TC Energy is very cheap at this point. So barring some really bad news on the Coastal GasLink project tomorrow, I think we could get a bounce. But in any case, this is a high quality company in a sector that still has a great deal of upside to the energy upcycle. And that’s good reason to expect a solid rebound, if we’re patient now.

John R.

2:04

I inadvertantly overlooked your recommendation to sell KREF and still retain ownership. Do you still prefer selling KREF ?

Roger Conrad

2:04

Hi John. The stock is actually right around where I recommended moving on from it. Management has a strong track record of operating in a business with meaningful credit and interest rate risk, sustaining the current dividend the last five years being a pretty good example. I'm wary of it mainly because I don't think the other shoe has really dropped in the office property market. And their loans have not historically been on the high quality side of the market. They do have the backing of KKR, which is invaluable both for evaluating risk and raising capital. But Moody's cut in credit rating to Ba3 from Ba2 last month does I think illustrate the risk to KREF earnings if the economy slows meaningfully form here. It already looks like they may foreclose on a property owned by Goldman--and Q4 earnings barely covered the dividend again. All things considered, I think there are better places to invest in REITs.

Pete H.

2:10

I am wondering why EVRG rarely comes up in discussions and why it is not a candidate for the conservative or aggressive portfolios?

Is there an irrational fear by investors that the nationwide push for cleaner energy could particularly impact EVRG due to difficult Kansas and Missouri regulators preventing them from getting an adequate return on their renewable investments?

Also regarding EVRG being a potential takeover candidate, is it possible that given the difficult regulators, potential suitors are looking somewhere else for a more merger friendly environment.

Thanks in advance for your views on EVGR.

Roger Conrad

2:10

Hi Pete. I've actually owned Evergy Inc (NYSE: EVRG) personally for many years and it's been a steady performer over that time. I don't see much risk to company guidance for 5-7% annual earnings and dividend growth, driven by utility CAPEX and systematic reductions in operating and maintenance costs. They seem to be on good terms with regulators that have had contentious relations with other utilities (Missouri and Kansas). And they appear to have survived the well intentioned efforts from private capital concerns to boost shareholder value, which so often backfire in the utility space. The stock is trading at a good entry point ahead of Q2 earnings on August 4. I'm skeptical of EVRG being a merger candidate--Kansas and Missouri are not easy to win approvals from. But really the only reason I haven't added it so far is there have been equally high quality stocks trading more cheaply.

Jack A.

2:11

Hi Elliott:

Exxon recently bought an ESG company with its stock, and Exxon's shares took a hit with the purchase... What are your thoughts about the purchase, and where do you see the price of Exxon in 1 to 2 years?

Thanks

Elliott Gue

2:11

I think you mean Denbury? (DNR). If so, I don't think that is a particularly meaningful acquisition for XOM given that it was only a $4.5 billion deal and XOM has a market cap over $429 billion. I don't think it's had a dramatic impact on the stock either, since XOM is down about 0.3% since the deal was announced compared to a roughly 1% gain for CVX.

XOM will probably continue to invest a bit in alternative energy plays, but the amounts are low relative to its peers elsewhere around the world. And, the company invested more than its peers in traditional oil and gas development during the down cycle, so it has by far the best production growth prospects of any supermajor in my view.

I think the main fundamental driver of the stock for the next 1 to 2 years is likely to be the ramp up of its assets in Guyana, which seems to be going (if anything) ahead of schedule.

We felt the stock got a little overcooked late last year and have not raised our buy target. But a buying opportunity is ahead and I

Elliott Gue

2:11

continue to think the stock has 50% of upside over the next two years in a world of $80+ dollar crude on average.

2:16

That hasn't happened yet -- in fact, US oil inventories are below the seasonal average, and gasoline/distillate stocks are tight. China and India have been gorging on Russian crude at discounted prices and, while the Chinese economy has some wobbles to be sure, apparent demand hit a record high in April.

Fred W

2:16

Hi Elliot and Roger,
It looks like China may be having more problems with their economy than most other market forecaster’s have thought.
Based on the current China outlook, are you still Bullish on our oil investments near term or do you foresee a slight pullback over the next few months due to China’s pending problems?

Also, would appreciate your latest thoughts on PXD? Is there still a possibility that one of the oil majors may make a play to acquire it?

Thanks for your excellent insights throughout the years that I have been a subscriber.

Elliott Gue

2:16

In out opinion, oil prices already reflect a substantial weakening in global demand and a recession. If you take OPEC/IEA forecasts at face value then the oil market is 2 to 3 million bbl/day undersupplied in the second half of this year; historically undersupply of that magnitude would send oil prices significantly higher.

Yet, for most of 2023, oil prices have been range-bounce, well off their 2022 peak levels. The only way that makes sense is if you expect a severe recession for the global economy that causes demand to fall by enough to forestall the expected tightening in balances in the the second half of the year.

Jeffrey H.

2:16

GREETING FOLKS, Thank you again for this opportunity. My question deals with TRP. The market has not been happy lately with this stock, which is quite a bit below your dream price. How do you view its recent asset sale and its prospects going forward? There was a time when you considered TRP to be a core conservative holding. Do you still? Many thanks

Roger Conrad

2:16

Hi Jeffrey. I answered an emailed question on this subject a bit earlier in the chat. In brief, I think the sale of a minority stake in those pipelines is a great move--it not only achieves TC Energy's asset disposal target for the year to cover the cost of the Coastal GasLink pipeline. But they now have a private capital partner who will invest in expanding the system--$1 bil already planned--which is vital to the LNG trade. TC releases results tomorrow. And management is going to update on the pipeline fire in Virginia as well as Coastal GasLink. But I think they're doing what they have to for meeting 3-5% annual dividend growth and keeping the their BBB+ credit rating. And I do still consider it to be a very high quality midstream stock that should be trading at a new all-time high by the time this energy upcycle runs its course.

Michael L.

2:21

Where do you guys see OXY in 12 months? I have it in an IRA and have doubled my money, thanks to you, but wondering if I should get out and move to one of the new gas plays or Hess?

Elliott Gue

2:21

We still like OXY longer term. That said, we don't see as much upside in the stock relative to some of our other recommendations, which is why we recommended booking some profits on it late last year and haven't raised our "buy under" price.

So, I would say that we still think it makes sense to have exposure to OXY, we did recommend selling part of our position to make room for recent recommendations including Hess (HES), basically an oil play partnered with Exxon, and EQT (EQT), arguably the lowest cost gas producer in the US. So, we certainly agree with a strategy of booking partial gains on a name like HES to make room for stocks that have more near-term upside potential.

Mike C.

2:24

Good afternoon everyone – thank you for holding these immensely helpful chats.

Roger, congratulations on CUI’s 10-year anniversary! Quality is still king, and that goes for your, Elliott’s, Sherry’s, and Yiannis’s work.

Questions for everyone:

Metals: thanks for the update on copper. What would you consider an attractive price for FCX? Is Alcoa still a buy up to 55? And…do you think there’s a reasonable play on lithium ahead, recognizing that there are a lot of complexities and changing dynamics in that market?

If oil spikes to over $90, what names do you think will have the greatest short-term leverage/reaction?

Roger Conrad

2:24

Hi Mike. Thank you for those kind words. Hard to believe CUI has now been around 10 years. I remember the dean of newsletters Dick Davis years ago telling me once that you've made it if you're still around 5 years in this industry. I think we'll be around many more. Glad you liked the metals report. As indicated there, we're very bullish long-term on Freeport, BHP and other metals stocks but pretty near term cautious mainly because of global economic concerns. I think you can buy BHP now. Freeport has historically been a winner if purchased in the low 30s--a bit of a drop from here. Long-term I think it and BHP will trade north of $100. Alcoa would be a hold at this point along with FCX. As for immediate leverage to a pop in oil prices, I think the producers we have in Energy and Income Advisor give you the best risk/reward for your money--though I will say we're somewhat more positive the rest of the year on natural gas.

Jack A.

2:28

Hi Elliott:

Baker Hughes, which you have recommended, has done well. But it's near its high for the last five years; and I received notice this morning that its chief legal officer just sold about 12% of his holdings. Do you feel we should take some money off the table, or do you feel that Baker Hughes has further to run, and how much higher do you see it going?

Elliott Gue

2:28

Yes, we do think BKR has further to run. I like their business mix -- specifically, their exposure to the LNG business, which is set to take off starting late next year as new export capacity comes on stream in the US. Also, they do have a nice, historic expertise in offshore services, particularly drilling fluids, which are basically used when drilling deepwater offshore wells.

Generally, I think if you apply a mid-cycle multiple to BKR in the coming (likely extended) upcycle for energy, you can make a case for the stock to trade up to the $60 to $70 range in the next 1 to 2 years.

I don't worry too much about insider transactions unless there's a consistent pattern of selling. After all, people sell stock for a variety of reasons (such as making a down payment on a home) unrelated to their view of where the stock is headed. In this case, there have been several insider buyers in the last six months, so I just don't see the sort of consistent pattern of selling that sends up red flags.

Mike C.

2:31

Regarding MMP – and assuming the acquisition is completed – the acquisition will leave a distinct hole in my HY income sleeve (as well as a decent profit). Given that you have MMP rated conservative, and OKE rated aggressive, what would you recommend to fill a retirement-income HY sleeve position previously occupied by MMP? Does the acquisition skew OKE in a more conservative direction? Or would it make more sense to partition the position across EPD and MPLX, the other conservative holdings in your HY list? (I appreciate that this is a taxable event, regardless of what moves get made.)

As always, thanks for all of the great work!

Roger Conrad

2:31

Mike, I think by acquiring Magellan Midstream Partners--not in the bag yet--ONEOK will merit the Conservative designation, initially just by virtue of asset/geographic diversification and greater scale. And over time, the accelerated growth of free cash flow will enable much faster dividend growth and debt reduction as well. ONEOK has to date been more aggressive in my view because of its heavy concentration in the Mid-Continent and Bakken, as well as a focus on volume and commodity price sensitive operations. Magellan in contrast is mostly contract and take-or-pay. Bottom line--I'm leaning toward just keeping the ONEOK shares if this merger closes. I will point out that at least one major shareholder is voting against, on the grounds long-term investors could be hit with a substantial tax. And to be honest, I would have preferred a deal with another MLP. But I do think the OKE/MMP combination will be formidable, and the energy upcycle has a ways to run in our view.

Jack A.

2:35

Also, although I wrote my concern about natural gas prices in a previous question, this morning's inventory report shows a further increase and a fall in natural gas prices by about 5%. If you haven't answered this question already, what do you make of it? If we can't get natural gas prices to go up with record heat in a segment of the country, how much further can we expect natural gas prices to rise in the short term? I know we will have some new LNG export terminals coming on line at the end of 2024 to 2025, but how much of a slack do you expect these new terminals to take up, and how much of an increase in natural gas prices do you foresee with these new terminals? Also, how do these forecasts affect your natural gas recommended stocks such as Chesapeake Energy and EQT?

I know these are a lot of questions, but I was hoping for an increase in natural gas prices with the warmer weather, and surprised it hasn't happened.....

Thanks

Elliott Gue

2:35

This might be a little controversial but hot summer weather is probably the most overrated catalyst I can imagine for gas prices.

If you look at a chart of gas demand seasonally, you'll see that it's all about the winter months for the US -- gas demand in December is usually on the order of 30 to 40% higher than in July (the height of summer). Basically, what happens between roughly mid-December and mid February will have a strong influence on how gas trades through the year.

Front month futures have little or no impact on profits for a name like EQT or CHK. For example, today, the front-month is down big, but you look at the January 2024 futures and they're sitting at 3.76/MMBtu, down only 2% - 3% (which isn't much for the notoriously volatile gas market).

What that means to me is that the market is saying that the weather isn't likely to be hot enough for long enough this summer to eliminate the gas glut in storage by November. However, the market is also saying the implications of that aren't

Elliott Gue

2:36

particularly meaningful to prices in 2024 (even early 2024). By then, the bigger drivers will be 1. winter weather conditions and 2. the likelty ongoing fall in gas production due to the lagged impact of lower CAPEX this year.

Sandy W.

2:37

Good Morning

ABBV went below your revised 'buy below' price and immediately went above before I got the money out to buy it. Is it worth angsting about buying when the interest rates are up another notch and the share price is apparently recovering from the good news. So frustrating.

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