Magnifi Communities

The Invesco QQQ ETF (QQQ) is a wildly popular ETF that tracks the Nasdaq-100. It’s a tech-heavy index that has been in a sideways pattern for much of the last year. When a stock is moving sideways, a covered call can be a good way to optimize returns while holding the shares. In this case,

Despite the volatility caused by two banks collapsing over the weekend, the broader market is still overvalued, so I have been avoiding that for the most part.

Instead, I’ve been looking at special situations. And for this week’s Hidden Profit Report, I’ve uncovered two situations that have the potential to deliver strong returns no matter what the market does.

And, best of all, both companies involved in these trades are ones you will be okay with owning for the long term if the short-term scenario does not play out as hoped…

The first special situation for this week is First Horizon Corp. (FHN).

About a year ago, Toronto-Dominion Bank (TD), also known as TD Bank Group, made a $25-per-share offer to buy First Horizon.

The offer makes much sense. First Horizon has a very attractive franchise with operations in 12 southern states, including Florida and Texas, two of the most attractive markets in the United States. The bank has 444 branches across the region with close to $80 billion in assets, plus plenty of capital. And the loan portfolio is in fantastic shape.

At $25 per share, TD Bank is paying 2.4 times the book value and 16 times the earnings for the First Horizon franchise.

Under the decidedly bank-unfriendly Biden Administration, regulators are still dragging their heels long after the deal should have closed. In the first week of March, TD announced that it was unlikely to receive approval to close the deal before the May 27 merger deadline.

There are two possible outcomes. First, TD Bank says it is committed to closing the deal. The deal could still close, and we can get paid $25 a share.

Given the massive volatility we have seen as a result of Silicon Valley Bancshares (SIVB), Silvergate (SI), and Signature Bank (SBNY) collapses, the deal closing looks unlikely at this point.

First Horizon has a strong balance sheet and can easily expand into some of the most attractive banking markets in the United States. It is also possible that the very attractive Southern franchise of the bank would attract another buyer.

Although the stock has sold off in the past few days, First Horizon has almost nothing in common with the failed banks:

It has no exposure to venture capital or cryptocurrency

Only 13% of its assets are invested in securities

And it has an enormous geographic edge over the bank the regulators closed

Every bank in the country has noticed the strong population and business relocation trend towards the South, and they would all love to be here. The risk-reward of buying First Horizon at current prices is attractive.

Heads, the deal closes, and we lock up a solid risk-arbitrage profit of over 60%.

Tails, and thanks to the market’s sudden distaste for bank stocks, we own one of the best Southeastern bank franchises at bargain prices that should trade at several times the current battered price in a few years.

The other special situation worth a look this week is Atlantica Sustainable Infrastructure plc (AY). The UK-based company has seen its stock price fall by over 20% over the past years. While it has recovered slightly in 2023, the board has still decided to review its strategic alternatives – usually code for: “We might just sell the company and move on with our lives.”

Atlantica owns a global portfolio of power generation companies, most of which produce renewable energy. 73% of its global production capacity is solar.

Atlantica is also investing in battery storage projects that will benefit from the global green energy trend.

The company has a strong balance sheet and plenty of cash on hand.

If Atlantica’s board sells the company entirely, it will be at a price much higher than the current level. If they sell off their natural gas or water assets and reinvest the proceeds in more renewable energy projects, that should also boost the stock price.

Using the proceeds to buy back stock would also turbo-charge the stock price.

But, if the board decides to do nothing, you would still own a world-class collection of energy and water assets that are producing a yield of over 6%.

The stock is trading at just 6.5 times free cash flow right now, so the assets are undervalued and should eventually trade much higher than the current price, even without a strategic transaction.

It has been hard to find interesting special situations of late. Both of these have the potential for short-term gains, with the most significant risk being that you end up owning high-quality businesses at bargain prices that should give you outsized long-term gains.

As earnings season winds down, a review of the stocks recommended through my newsletters that my subscribers received a lot of excellent dividend news. Dividend growth generates annual total returns that work through the market cycles—no timing required.

A couple of recent examples illustrate my point – and show how you can get in on this great strategy, too…

A dividend growth strategy involves buying shares of stocks where the company regularly—usually annually—increases the dividends it pays to shareholders. If you calculate the average annual total returns of dividend growth stocks, you will find that over the long term, you get a compound annual growth rate that comes very close to the average dividend yield plus the average dividend growth.

Dividend increases can also help a stock price in the shorter term. Last week we saw a dramatic example.

On Tuesday, March 7, the Dow Jones Industrial Average closed down 575 points, and the S&P 500 dropped by 1.5% for the day. That day, Dick’s Sporting Goods (DKS) gained over 11%. Dick’s released fourth-quarter earnings showing excellent results. A significant factor for the share performance was the fact that the company more than doubled the quarterly dividend going from $0.4875 per share to $1.00. The boost also doubled the yield to 3.0%.

Before the big increase this year, the DKS dividend had been growing by more than 20% per year. Investors have seen a 380% total return over the last five years. I suspect the growing dividends had something to do with those great returns.

In February, the Federal Agricultural Mortgage Corp (AGM) increased its dividend by 16%, going from $0.95 to $1.10 per share. Through most of the first quarter, when the broader market was up about 4%, AGM appreciated by 26%. The AGM dividend average growth for the last decade was 20% per year, meaning investors in the stock enjoyed a 400% total return for the ten years.

I hope boards of directors realize that few things help a share price more than meaningful dividend increases. Share buybacks are a hot topic these days, but I think returning cash to shareholders as growing dividends produces better returns for those investors.

I employ a dividend growth-focused strategy with my Monthly Dividend Multiplier service. I provide a model portfolio and track the returns. The portfolio consistently outperforms the S&P 500.
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Everyone pretty much agrees that we will—eventually, at least—transition from a fossil fuel-powered economy to one powered by less polluting energy sources.

However, as this energy transition gains speed, the risk of chaos emanating from it is rising. Here’s why…

Today, investment in new oil and gas supply is well below what it was a decade ago. And investment in clean energy, though accelerating, is not increasing as quickly as it needs to.

Fast forward to a few years in the future and that could translate to a very large mismatch between ever-rising energy demand and energy supplies. The end result would be a replay of what we saw in the aftermath of Russia’s invasion of Ukraine, with energy prices rising rapidly, forcing governments to help their citizens heat their homes and fuel their vehicles—but magnified by several times.

As investors, here’s how we position ourselves for this possibility…

Oil Companies Are Not Investing Enough

A great article from the Financial Times’ Energy Source newsletter explained that one main reason for this is simply that oil and gas companies are just not investing as much as needed into increasing future production.

Despite record profits last year, oil and gas companies globally invested about $310 billion into capital spending. This was far lower than the $477 billion they invested in 2014. The rest of their profits went toward share buybacks, dividends, and paying down debt. If oil and gas companies had invested the same percentage of profits into finding more oil and gas as they did 10 years ago, the oil and gas firms could have invested an estimated nearly $600 billion.

There are a couple of reasons they did not. First, after many years of poor returns—especially in the shale sector—investors want to see their money coming back. But more importantly, the energy market is responding to policy efforts to cut down on future demand for fossil fuels.

Luisa Palacios is the co-author of a new research paper, entitled Investing in Oil and Gas Transition Assets en Route to Net Zero, from Columbia University’s Center on Global Energy Policy. She told the Financial Times: “What we’re looking at is an energy transition not where demand adjusts first—but an energy transition where supply adjusts first.”

So, while fossil fuel energy supplies are being adjusted downward—even as demand rises—we will need a bigger contribution from clean energy sources. However, investments there have not risen fast enough. They currently sit at a ratio of 1.5:1 compared to fossil fuels. Estimates are that this needs to increase to 9:1 by 2030 if net zero goals are to be achieved.

This all adds to a real mess on our hands in the near future with regard to energy as the transition happens…and it also leads to the companies that produce fossil fuels making a lot of money.

Energy Transition Winner

My favorite companies in this area continue to be the European oil companies, which are trading at much lower valuations than their American counterparts.

For example, Exxon and Chevron are valued at about six times their cash flow. That compares with about three times for Shell. And U.S. oil firms have a price-to-earnings ratio of around 8, while European oil stocks have a P/E of around 4! The reason for the lower valuations is ironic. Investors are rating these companies lower because they are slowly transitioning away from fossil fuels to clean energy.

Among the European majors, an interesting company is Norway’s Equinor ASA (EQNR), which produces more than two million barrels a day of oil and its equivalent, split evenly between oil and gas. Two-thirds of its output comes from its prolific Norwegian offshore fields.

European natural gas accounts for about a third of its total output, and most of it is sold on the spot market, benefiting from any spike higher in prices. But, unlike some of its European peers, Equinor plans to grow oil and gas production through 2026, at about a 2% compound annual growth rate.

The company made a record-adjusted pre-tax profit of $75 billion last year, thanks to all-time high natural gas prices. This helped it emerge as one of the biggest winners of the energy crisis, as Norway replaced Russia as Europe’s largest supplier of natural gas.

The $75 billion annual pre-tax earnings smashed the group’s previous record of $36.2 billion in 2008 when oil prices reached record highs of more than $140 a barrel. Adjusted earnings for the year after tax were $22.7 billion, up from just $10 billion in 2021.

Another company characteristic that I love is that Equinor has no net debt, giving it one of the best

balance sheets among the major energy companies and leaving lots of room for dividend growth (current yield 8.26%).

Speaking of payouts to shareholders…the company said it would increase returns to shareholders to an expected $17 billion this year, citing its strong earnings, outlook, and balance sheet.

Equinor increased its cash dividend to $0.30 a share for the last three months of the year, from $0.20 a share in the third quarter, a 50% increase! It will also introduce an “extraordinary cash dividend” of $0.60 in 2023, and plans to buy back $6 billion of shares in 2023.

The proposed $17 billion of payouts this year is equivalent to around 18% of the company’s total market capitalization.

Like other oil stocks, Equinor’s stock has been under pressure and is down 4.25% this year to date. That gives us a nice entry point, at anywhere in the $29 to $33 range.
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