Magnifi Communities

Cheryl Pate is one of the managers of the Angel Oak Financial Strategies Income Term Trust (FINS), one of the closed-end funds we own in my Underground Income Service. Normally we would not share this information with everyone, but after giving paid members a first look, we decided her message was too important not to share with everyone.

Given that all the negativity surrounding bank stocks right now is making it difficult for investors to make clear decisions, I thought it was important to see the industry through the eyes of someone who views the industry from a credit as well as an equity perspective.

Cheryl shares my view that most of what we saw in March was a couple of one-off events related to specific developments at Silicon Valley Bank and Silvergate Capital. These developments had very little to do with most community banks across the United States.

Cheryl also points out that there are many bullish events that come out of the volatility that should lead to accelerated M&A activity in the second half of 2023.

This video presents you with information that outlines two massive investment opportunities. One is from the community bank industry in general, and the other is in the fund Cheryl and her team manage. With a 15% discount to net asset value and a yield over 9%, the Angel Oak Financial Strategies Income Term Trust (FINS) offers an extraordinary opportunity for huge long-term total returns. Cheryl also talks about developments in the market for community bank debt that make this fund a must-own for most investors.
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The pandemic certainly turned the semiconductor industry on its head.

Despite record production of semiconductors, shortages everywhere led to months-long waiting lists for many consumer products. To meet consumer demand, semiconductor makers ramped up supply even more.

But then inflation arrived and decided to stay awhile. Central banks responded by raising rates, and economies slowed. The appetite for items like consumer electronics waned, leaving inventories stuffed full of chips.

The ramifications were felt all along the semiconductor supply chain.

For example, when Apple (AAPL) reduced orders of memory chips last year, supplier Micron Technology (MU) saw its sales collapse. To preserve cash flow, Micron chose to cut capital spending by 40% in 2023.

That, of course, means it will need less equipment from its supplier Lam Research (LRCX). Lam now expects the wafer front-end market—which relates to the first process in chip fabrication—to shrink around 30% in 2023, to $70 billion. As a natural consequence, Lam’s share price is down by a third since the start of 2022. That makes it an interesting stock to buy now. Let me explain.

Lam Research: Profitable and Cheap

Lam Research sells the equipment used to make semiconductor wafers. This includes the deposition machines that deposit layers of metal, the etch machines that selectively remove some of those layers, and the cleaning machines that take away unwanted particles between stages. Aside from Micron, Lam’s customers include these other semiconductor titans: Samsung, SK Hynix, Intel (INTC), and Taiwan Semiconductor (TSM).

Historically, Lam has focused mostly on the memory market. Last year, 50% of its sales came from either NAND or DRAM memory chip manufacturers. Memory chips exposure to demand in consumer electronics makes demand for them highly cyclical.

Less than a fifth of LAM’s sales came from logic chips, where, thanks to cloud computing exposure, demand is more consistent and expected to grow quite rapidly amid rising artificial intelligence investments.

This cyclicality in Lam’s business largely explains why it trades at a steep discount to other chip equipment manufacturers. For example, ASML (ASML), which sells the photolithography machines needed to produce the most advanced logic chips, trades on a forward price to earnings ratio of 31, versus less than 15 for Lam’s shares.

In addition to the cyclicality of consumer electronics demand, the company is facing another problem.

Last year, the U.S. imposed strict sanctions against Chinese semiconductor manufacturers, barring companies from selling chip designs and manufacturing equipment to Chinese businesses. Lam predicted these restrictions would result in a $2 billion to $2.5 billion hit to sales. That led to Wall Street analysts cutting their 2023 earnings forecast by 13%.

Despite all of this, Lam’s leadership position in a consolidated sector allows it to be highly profitable. In recent years, its operating margin has exceeded 25%; it hit 31.1% in the year to June 2022. This enabled Lam to generate a five-year average return on equity of over 50%.

Lam also generates a good free cash flow yield of 5%, well ahead of ASML and equal to its close rival, Applied Materials (AMAT). In the last two years, the company spent $1.1 billion on capital expenditure, but still managed to generate $5.5 billion in free cash flow.

Lam’s Bright Future

Lam’s management is wisely using some of that capital expenditure to move away from its reliance on the memory chip market. Some of these investments include atomic layer deposition and selective etch technologies.

The company is already the market leader in dry etch, and a prominent player in the deposition segment of the wafer fab equipment industry. The combination of these two is critical during the chip making process, along with photolithography (which produces the mask that exposes areas for materials to be deposited or removed).

Lam provides customers with some of the most advanced tools in these niche segments. And its leadership position creates scale advantages that fuel its research and development spending at levels only Applied Materials and Tokyo Electron (TOELY) can match.

We cannot overlook the fact that there is a major tailwind blowing in Lam’s favor. This comes in the form of the U.S. government’s efforts to boost domestic chip manufacturing. Last year’s Chips and Science Act includes $39 billion in manufacturing incentives for chip makers. This has produced results, with commitments from Intel, Samsung, and TSM to invest over $100 billion between them in the U.S. over the coming years.

So, while Lam may lose much of its Chinese business, the increase in investment into the U.S. from these companies will likely make up for it.

Keep in mind, too, that other nations are not sitting by idly; in fact, some are also offering incentives to chip companies to build semiconductor manufacturing capacity. For instance, in South Korea, Samsung has been offered incentives to invest $230 billion in a new memory chip manufacturing facility over the next 20 years.

So, while the near-term outlook is murky, Lam’s future as a leading equipment manufacturer in a heavily-subsidized industry looks bright. Its relationships with all the top chip makers in the world, combined with historically strong levels of capex spending in the industry, leaves Lam Research with a quasi-monopolistic position in its niche.

That should help it to continue to generate strong profit margins and consistent cash flows. LRCX is a buy in the $480 to $520 range.
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In these uncertain times for investors, energy midstream stocks offer an island of stability. This sector provides an attractive combination of current yield and dividend growth. However, midstream companies divide into two distinct categories, and the differences are important.

Energy midstream covers the movement and storage of energy commodities from the upstream drillers to the downstream refining, manufacturing, and utility companies. This graphic from the Alerian Midstream Energy Index fact sheet shows the services the companies included in the index offer.

Before the 2015-2016 energy sector crash, the majority of midstream companies were organized as master limited partnerships (MLPs). The crash forced massive restructuring, and many companies converted to corporations. Currently, the midstream sector includes some companies organized as corporations and others that have retained their MLP business structure.

If you invest in an MLP, you buy limited partner units. As a limited partner, you will receive a Schedule K-1 to use when reporting your taxes. The distributions (dividends) paid by an MLP are classified as return of capital and are not taxable income. Any tax consequences come from the K-1, and generally, MLP income will not be taxed.

Midstream MLP units should not be owned in a qualified retirement plan such as an IRA or Roth IRA, as they can cause severe negative tax consequences. The reason is too long to go into here. Just don’t do it.

Midstream corporate shares are just like owning shares of any other publicly traded company. You receive a Form 1099 for reporting dividend income, which will be qualified dividends. You can own these shares in a retirement plan without any negative consequences.

The differences between the two midstream business types have led to an interesting divergence in dividend yields. To illustrate, let’s compare three large midstream corporations to three similar MLPs. I want to look at current yields and dividend growth for the last two years.

Midstream Corporation:

Kinder Morgan, Inc. (KMI): Current yield: 6.27%; two-year dividend growth: 5.7%

ONEOK, Inc. (OKE): Current yield: 5.72%; dividend growth: 2.1%

The Williams Companies (WMB): Current yield: 5.94%; dividend growth: 9.1%

Master Limited Partnerships:

Enterprise Product Partners LP (EPD): Current yield: 7.26%; two-year dividend growth: 8.9%

Energy Transfer LP (ET): Current yield: 9.45%; dividend growth: 100%

Plains All American Pipeline LP (PAA): Current yield: 8.17%; dividend growth: 95.5%

You can see that MLPs sport higher yields to go along with the tax-advantaged income. The MLPs have also been more aggressive with dividend growth coming out of the pandemic. Going forward, I expect the midstream corporations to grow dividends at a mid-single-digit annual rate and the MLPs to grow theirs in the high single digits.

Outside of the IRA problem, MLPs currently provide much better investment potential. If you want to own them in an IRA, look at an MLP-focused ETF. The Alerian MLP ETF (AMLP) tracks the index with the same name. The InfraCap MLP ETF (AMZA) is an actively managed fund.

Unique in the space is Plains GP Holdings LP (PAGP). Each PAGP share is backed by one PAA unit and pays identical distributions. However, if you invest in PAGP, you get a Form 1099 for tax reporting, not a K-1—the market prices PAGP to yield about 0.3% less than PAA.
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