Investors Alley

For months, the share prices of most stocks have been in the doldrums or worse. Large-cap tech stocks have been the exception, posting nice gains so far this year.

Let’s check how a couple of covered call ETFs have performed compared to the most popular tech stock ETF.

It’s my favorite way of investing in tech…

The Invesco QQQ Trust ETF (QQQ) tracks the Nasdaq 100 stock index—the 100 largest companies that trade on the exchange. The portfolio is the who’s who of large-cap tech companies. Here are the top ten holdings.

Microsoft Corp. (MSFT)

Apple Inc. (AAPL)

Amazon.com Inc. (AMZN)

NVIDIA Corp. (NVDA)

Meta Platforms Inc. (META), a/k/a Facebook

Alphabet Inc. Class A (GOOGL), a/k/a Google

Alphabet Inc. Class C (GOOG), also a/k/a Google

Tesla Inc. (TSLA)

PepsiCo Inc. (PEP)

Broadcom Inc. (AVGO)

As of May 17, QQQ has gained 25.2% this year to date. For comparison, the S&P 500 has gained 8.75%, with almost all of those gains coming in January. QQQ has climbed steadily higher every month.

Covered call ETFs use an option selling strategy to generate cash income with an underlying portfolio. Selling calls can generate excellent cash income, but it also puts a cap on potential capital gains.

Two option-selling ETFs use the QQQ or Nasdaq 100 as their underlying assets.

From one website: “The Global X Nasdaq 100 Covered Call ETF (QYLD) follows a ‘covered call’ or ‘buy-write, strategy, in which the Fund buys the stocks in the Nasdaq 100 Index and ‘writes’ or ‘sells’ corresponding call options on the same index.”

The JPMorgan Nasdaq Equity Premium Income ETF (JEPQ) throws in some active management. The fund strategy, taken from its website, says JEPQ:

Generates income through a combination of selling options and investing in U.S. large cap growth stocks, seeking to deliver a monthly income stream from associated option premiums and stock dividends

Seeks to deliver a significant portion of the returns associated with the Nasdaq 100 Index with less volatility

Constructs a long equity portfolio through a proprietary data science driven investment approach designed to drive portfolio allocations while maximizing risk-adjusted expected returns

Both funds pay monthly dividends. QYLD reports a current distribution yield of 11.63%. JEPQ quotes and SEC yield of 13.95%.

Let’s see how each has performed so far in 2023…

QYLD closed out 2022 at $15.91 per share. On May 17, it closed at $17.53. Dividends paid a total of $0.679 per share. A little math gives a year-to-date return of 14.44%.

JEPQ ended 2022 at $40.80. The May 17 close was at $46.51. Dividends paid total $1.81 per share. JEPQ has returned 18.43%.

The results show that a covered call strategy will likely lag a buy-and-hold strategy in an up market; however, in a flat-to-down market, the covered call ETFs should outperform.

JEPQ is a newer fund that launched in May 2022. In September, I recommended to my Dividend Hunter subscribers to sell QYLD and buy JEPQ. To see why, and what other income stocks I like, become a member today.
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U.S. natural gas pipeline giant ONEOK (OKE) is set to buy Magellan Midstream Partners (MMP), which owns a pipeline network that primarily transports crude oil and refined products for $18.8 billion.

This is going to be huge for investors…

Magellan shareholders will receive $25 cash and two-thirds of an ONEOK share for each unit of stock they hold, representing a 22% premium to the company’s closing price before the deal announcement.

A Look at the ONEOK-Magellan Midstream Deal

This proposed deal will create one of the biggest oil and gas infrastructure companies in North America—a company with an enterprise value of $60 billion and a sprawling 25,000-mile network of pipelines stretching from North Dakota to Texas.

Pierce Norton, CEO of ONEOK, described the transaction as “transformational,” adding:

The combination of ONEOK and Magellan will create a diversified North American midstream infrastructure company with predominately fee-based earnings, a strong balance sheet and significant financial flexibility focused on delivering essential energy products and services to our customers and continued strong returns to investors.

Norton is right. And so is my colleague, Tim Plaehn, who loves the deal.

But don’t tell that to Wall Street, which hated the deal so much that ONEOK’s stock plunged 10% after the announcement.

Wall Street seems to be questioning the commercial logic from ONEOK in stepping out of its core natural gas transportation business to buy Magellan’s crude and refined fuels pipelines. Analysts think the businesses are so different that ONEOK management will not be able to handle it.

In a recent article about the merger, Tim wrote: “In its current form, ONEOK is a very well-managed energy midstream company. The shares yield about 6.5%, and earnings and cashflow will increase for 4% to 6% dividend growth.” Tim went on to quote a few highlights from ONEOK’s press release about the Magellan acquisition:

The transaction is expected to be earnings per share accretive beginning in 2024, with an accretion of 3% to 7% per year for 2025 through 2027.

Free cashflow (different from EPS) accretion is expected to average more than 20% from 2024 through 2027.

Free cashflow after dividends and growth capital investments will increase by about $1.0 billion yearly in the first four years after the merger.

“Bottom line,” Tim concluded, “The combined company will generate tremendous and growing free cashflow. That should lead to strong dividend growth. ONEOK has a history of dividend growth. The current rate is 28% higher than the dividend declared after the company rolled up its controlled MLP in 2017.”

I believe Magellan Midstream’s focus on crude oil and refined product logistics is a complement to ONEOK’s natural gas and natural gas liquids (NGL) franchises.

This will turn out to be a big benefit in the event that NGL pricing (which has been on the decline lately) continues to drop due to robust NGL production. Magellan’s other liquids-focused assets will pick up the slack. Keep in mind that NGLs typically make up 55% to 60% of ONEOK’s annual EBITDA.

And even if you ignore this deal, ONEOK has great growth prospects, thanks to its plans in Mexico.

The company has filed for approval for a new pipeline to connect ONEOK pipes (Roadrunner pipeline) at the U.S. and Mexican border, where a final investment decision is expected this year. Mexican gas demand growth has long been an attractive area. ONEOK’s peer TC Energy (TRP) has projected its Mexican earnings to double over the next few years.

And at its core, both ONEOK and Magellan Midstream are still energy pipeline businesses. And both companies own increasingly rare assets. Let me explain…

The Future of the Pipeline Business

For pipeline builders, the shale era brought a wealth of opportunities. As gushers of oil and natural gas suddenly erupted in places such as North Dakota and Pennsylvania, the need for a vast expansion of the plumbing that moves fuel around the country was obvious. That’s what led to a decade-plus-long boom that produced thousands of miles of new pipelines.

The shale growth story is not over in the U.S. oil and gas patch, but it is slowing. And for certain, the associated pipeline building boom has pretty much run its course. An increasingly inhospitable regulatory environment has delayed or canceled a number of major projects.

These circumstances make acquisitions one of few remaining paths to growth. ONEOK management understands the current reality—and it is correctly looking at its future prospects, considering the energy transition.

ONEOK is starting to look for new growth opportunities in moving around low-carbon fuels, such as hydrogen and biofuels or transporting carbon dioxide from carbon capture and storage projects…even though none of those businesses currently exists in scale. In discussing the Magellan deal, ONEOK’s CEO, Pierce Norton, told analysts that the new company’s larger size would make it better prepared for the big changes coming “down the pipe,” adding: “Scale does matter going into the future, especially going into wherever energy is going.”

Norton continued: “As far as hydrogen and…renewable fuels, those kind of things that can move through these [pipelines]. The future is going to determine that. It’s going to be determined by what the customers are desiring and the cost. But having these two companies combine sets us up for that opportunity.”

I agree with Tim Plaehn’s assessment…there will likely be high single-digit to double-digit dividend increases starting next year for the combined companies. If you buy shares of OKE now, you will be happy with the investment for the next decade. Buy it under $62 a share.
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Last week, when ONEOK Inc. (OKE) announced it would acquire Magellan Midstream Partners LP (MMP) in a $18.8 billion deal, the market disliked the news and the stock dropped by 10%.

The market is wrong about this tie-up.

I can prove it with one word…

ONEOK is an energy infrastructure company focused on natural gas and natural gas liquids. The company provides gathering, processing, and transporting services. Magellan Midstream Partners owns a pipeline network that primarily transports crude oil and refined products. There is little or no overlap between the services provided by the two companies. The combined company will offer a much broader range of services than either would as a standalone. Also, ONEOK is organized as a corporation, and Magellan is a master limited partnership.

The deal, which was announced Sunday night, is a cash and stock transaction, with Magellan unit holders receiving $25.00 per unit in cash plus 0.6670 shares of OKE. The implied value as of May 12 was $67.50 per MMP unit. The MLP closed that Friday at $55.41.

ONEOK is on the list of recommended investments for my Dividend Hunter service, and I was pleased to get the press release announcing the deal. However, the market was not of the same mindset. OKE closed on May 12 at $63.72, and at the close on Tuesday, May 16, the stock price was at $56.58, giving an 11% decline over the two days. I suspect the amount of OKE shares given per MMP unit may be adjusted.

As I read the press release and reviewed the presentation slides, one word shows the power of this deal for OKE investors: “accretive,” meaning “adding to.”

In its current form, ONEOK is a very well-managed energy midstream company. The shares yield about 6.5%, and earnings and cashflow will increase for 4% to 6% dividend growth. The press release notes these benefits of the Magellan acquisition:

The transaction is expected to be earnings per share accretive beginning in 2024, with an accretion of 3% to 7% per year for 2025 through 2027.

Free cashflow (different from EPS) accretion is expected to average more than 20% from 2024 through 2027.

Free cashflow after dividends and growth capital investments will increase by about $1.0 billion yearly in the first four years after the merger.

Bottom line: The combined company will generate tremendous and growing free cashflow. That should lead to strong dividend growth. ONEOK has a history of dividend growth. The current rate is 28% higher than the dividend declared after the company rolled up its controlled MLP in 2017.

I will be looking for high single-digit to double-digit dividend increases starting next year. If you buy shares of OKE now, you will be happy with the investment for the next decade.
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When markets are disrupted, good companies get taken down along with the ones that are facing problems.

The banking sector “crisis” pulled down the share prices of companies across the financial sector. Finance REITs were included, and this group faces continued challenges due to potential commercial mortgage challenges.

Recently the CEO of a favorite finance REIT made it clear that shares of his company are significantly undervalued…

Arbor Realty Trust (ABR) is a commercial finance REIT. The company focuses on financing solutions for multi-family and single-family rental properties. During the bank/financial stock selloff that started in March, the Arbor Realty Trust share price declined by one-third.

On May 5, Arbor released its 2023 first-quarter results. During the management conference call with Wall Street analysts, Arbor CEO Ivan Kaufman explained why he thinks the market is wrong about the ABR stock price. Here are some of the high points, quoted from the earnings call transcript:

After coming off our best year as a public company in 2022, we’ve had a tremendous start to 2023 with another exemplary quarter as our diverse business model continues to offer many significant advantages over everyone else in our peer group, with a premium operating platform with multiple products that generate many countercyclical income streams, allowing us to consistently produce earnings that are well in excess our dividend. This has allowed us to increase our dividend another 5% or $0.02 a share to $0.43, reflecting our 11th increase in the last 13 quarters, or 40% growth over that time period, all while maintaining the lowest payout ratio in the industry, which was 68% for the first quarter.…

Additionally, and very significantly, we’ve grown book value per share by 45% over the last three years from just under $9.00 a share to almost $13.00 a share, even with 11 dividend increases during that period.…Yet we still trade at similar dividend yields and price-to-book values as the rest of the space despite our unquestionable outperformance, which is why we strongly believe we are completely undervalued and there has never been a better time to make a significant investment.

ABR shares currently trade at about $12.20. That number is down 30% from the 52-week high of $17.43. Over the last year, the company increased the dividend from $0.37 to $0.42, including a two-cent raise announced with the earnings release. ABR currently yields almost 14%.

Historically, this well-run, strong-growth finance REIT has been priced to yield around 8%. To return to that yield, the share price would need to climb to $21. That’s assuming no further dividend increases, which is highly unlikely.

When a sector or the whole market gets hammered by the investing public, stock market disruptions take down the share prices of good companies along with those that trigger a selloff. If you understand that great companies will take advantage and thrive, you can back up the truck and load up on shares. Arbor Realty Trust is arguably the best of the commercial finance REITs, and I expect the company to take advantage of the current commercial mortgage stresses and be able to accelerate its growth.

I agree with CEO Kaufman. Back up the truck for ABR.

The stock market seems focused on only two types of stocks: technology companies involved with AI, and regional banks—which are going through a crisis.

Investors are ignoring the rest of the stock market, which is just drifting. But that should not stop you from picking out a few investing gems from the large body of adrift stocks.

Let’s look at one particular opportunity in the infrastructure sector…

Every four years, the American Society of Civil Engineers’ (ASCE) Report Card for America’s Infrastructure grades the condition of U.S. infrastructure in the familiar form of a school report card, assigning letter grades based on the overall physical condition of the infrastructure and needed investments for improvement.

The last overall grade, in 2021, was a poor C-minus, so it should not come as a great shock that at least $2.6 trillion needs to be spent to replace unsafe bridges, old dams and potholed roads if the country’s infrastructure is to be brought up to a better grade.

As the United States goes through a program of upgrading its crumbling infrastructure over the next decade, there will be a structural demand story for basic materials.

With infrastructure spending in the background, the intersection between the price of their products and the cost of their inputs is aligning to make it a very good time to be a company involved with construction supplies (aggregates, cement, etc.) in the U.S.

For instance, the average cost for U.S.-made cement hovered around $130 per metric ton in 2022. That is its highest average level for many years, and it has barely fallen—despite forecasts of lower demand from construction projects linked to the residential housing market.

Meanwhile, costs have started to fall for inputs like natural gas, which concrete firms use in large quantities in their production process. The Henry Hub spot price for natural gas has fallen to levels last seen in August 2020. This much lower natural gas price will benefit the concrete producers. The combination of falling input costs (apart from labor) and high prices will make it a very profitable year for the sector.

Vulcan Materials

Let me bring to your attention one company that will benefit from the large infrastructure projects because it can supply the needed materials in huge quantities: Vulcan Materials (VMC). Based in Birmingham, Alabama, Vulcan is a leading supplier of crushed aggregates and a producer of downstream basic materials like asphalt and concrete. It has 400 active aggregates facilities, 70 asphalt facilities and 240 concrete facilities across 22 states in the U.S., as well as in British Columbia, Canada.

Vulcan provides the basic materials for the infrastructure needed to maintain and expand the U.S. economy. Aggregates (Vulcan is the largest producer) are used in most types of construction and in the production of asphalt mix and ready-mixed concrete. Vulcan’s materials are used to build roads, tunnels, bridges, railroads, airports, hospitals, schools, and factories that are essential to the U.S. economy.

The company dominates construction materials markets in the southern U.S., but still continues to expand aggressively. For example, in 2021, Vulcan acquired U.S. Concrete for $1.29 billion. This acquisition gave it a greater foothold in metropolitan areas of Texas and complemented its existing facilities in the state, as well as in the prime markets of New York, New Jersey, and the aggregates segment in California.

Vulcan is benefiting from a growing volume of projects in the highways sector. Keep in mind that approximately half of the company’s sales of aggregates come from publicly funded projects.

The first of the projects funded by the U.S. government’s infrastructure plans started to come through last summer. According to official statistics, the number of highway projects starting in August 2022 was 14% higher year-on-year, reflecting both a return to pre-pandemic normality, as well as the higher levels of government funding. About 40% of the $850 billion in guaranteed funding from the U.S. Infrastructure and Jobs Act is focused on highways and bridge renewal.

Why Buy Vulcan Materials?

Vulcan Materials reported strong first-quarter results that included strong pricing gains and just a moderate pullback in shipments. Revenue increased 7% year over year, largely driven by robust growth in its aggregates business. Gross margin expanded 90 basis points year over year to 18.3%, as higher selling prices offset higher raw material costs.

On the last earnings call, management raised its full-year revenue and net earnings guidance, largely due to the strong performance and pricing gains in its aggregates business. Aggregates account for more than 70% of Vulcan’s consolidated revenue and an even larger portion of the company’s gross profit.

An increasingly industrial policy-driven U.S. economy is accelerating demand for construction materials. According to Census Bureau data, spending on factory construction hit an all-time high of $108 billion in 2022, as more and more companies reshored their production back to the U.S.

Infrastructure projects are resilient during economic downturns, as governments tend to fund projects through the cycle to support the economy and prevent job losses. Stable demand has supported consistent price increases through economic cycles and led to subsequent margin expansion for companies like Vulcan.

From 2007 to 2021, Vulcan’s price increases exceeded inflation in all but five years. During this period, the company’s price per ton grew over 90%, while inflation rose roughly 31%. Also, the company only recorded one year of price contraction during this 15-year period. This is evidence of the firm’s pricing power, even during times of softer demand

This suggests that investors should realize there will be an extended business cycle for materials suppliers, despite the slowing housing market.

VMC is a buy below $200 per share.
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While it’s interesting to see what options are trading in terms of absolute volume, it can also be useful to look at relative volume. For instance, Broadridge Financial (BR) traded over 125x its normal options volume one day last week. The banking software company typically only trades 40 contracts per today, so seeing a 2,000-lot

My talks with bankers and technology providers in Tampa last week emphasized how important deposits have become in the world of banking. Even the flashiest fintech companies were emphasizing how their products could help banks attract and retain deposits.

There was a lot of talk about how the industry is changing. Banking is now a digital industry, and firms that cannot keep up are going to have to consider selling out to a larger bank with greater technology capabilities.

While I was in Tampa, we also saw the recent bank rally begin to slow down somewhat.

Although clickbait hunters and instant experts may be selling, there are two groups of people who are getting very bullish on bank stocks.

In today’s video, I show you who they are – and why they’re right…

One is Wall Street analysts.

The other is banking insiders. Officers and directors have their checkbooks out and are going on a buying spree.

I also take a quick look at the recent bank loan and deposit numbers from the federal reserve and what they mean for smaller banks like the one we prefer.

It is far better than the headlines are reporting.
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Once again, technology stocks are grabbing the financial headlines. They have powered most of the gains in the S&P 500 in 2023.

In fact, Apple and Microsoft alone now account for a record 13.5% of the index—the most ever for the top two stocks.

While it’s tempting to buy big tech right now, the safer investing route—and the one I prefer is sticking with—is consumer staples companies that have strong brands.

Consumer Goods Companies Bonanza

Consumer goods companies had a remarkably strong 2022, despite a sharp rise in raw material costs and stretched household budgets. In fact, consumers swallowed big price increases in 2022 without batting an eyelid.

Companies in the sector hiked prices by 10% on average in the fourth quarter of 2022, according to Bernstein analysis, with volumes a mere 2% lower—and that trend has continued into 2023.

Most food and beverage companies were able to pass along large price increases in the first quarter, with sales volumes only edging down.

Here are just a few examples cited by the Financial Times: At AB InBev, North American beer prices rose 5.6% while volumes fell slightly. Kraft has long struggled with sales volumes, and in the first quarter they fell 6%—but prices were up 13%, and margins are widening. And Kellogg’s, best known for cereal, had a 14% benefit to sales from its price mix. Its management said it has been surprised by price elasticity remaining well below historical levels.

The story seems to be the same almost everywhere in the consumer staples sector. Companies up and down the value chain are passing on big—sometimes very big—inflation-plus price increases, and consumers are willing to pay. There is precious little evidence of trading down to cheaper alternatives.

This is a testament to the power of brands. But only companies able to maintain the luster of their product names can pull this off consistently: consumers will pay more for trusted products, which then deliver higher profits to the brand owner, cushioning it against rising input costs. This contrasts with generic products, churned out in high volumes at low margins.

A brandholder has “pricing power”—a Holy Grail for most businesses. And, as long as a company can maintain the quality of its brands, it will retain pricing power. After all, quality never goes out of style.

Let’s now take a look at one such consumer brands powerhouse, PepsiCo (PEP).

Pepsi’s Pricing Power

PepsiCo, founded in 1898, produces and sells food, snacks, and beverages around the world. In addition to its eponymous soda, as well as other beverages including Mountain Dew, Gatorade, 7UP, Tropicana, and various bottled water products, the company also owns food brands including Lay’s, Ruffles, Doritos, Tostitos, Cheetos, Quaker Oatmeal, and Rice-A-Roni. And, PepsiCo also provides tea and coffee products through a joint venture with Starbucks and Unilever.

On average, 11 of the 15 top-selling products in convenience stores come from PepsiCo, and Lay’s is the world’s best-selling snack food brand, having expanded sales from just $100 million fifty years ago to $30 billion today. Overall, PepsiCo ranks first in the $200 billion global savory snacks market, controlling 22% of the market, per research firm Euromonitor.

Pepsi’s net sales should rise by about 6% in 2023 and 4% in 2024, driven by 8% organic revenue growth. In 2022, PEP’s net sales rose 8.7% due to organic revenue growth of 14.4%. Organic sales growth will be driven by price increases—the company’s effective net prices jumped 16% year-on-year in the first quarter of 2023.

I think that investors will continue to favor Pepsi given the company’s ability to raise its dividend and deliver strong growth.

PepsiCo is a defensive blue-chip name with a strong balance sheet and high degree of earnings stability. I like the power of its brands, such as Frito-Lay and Pepsi, in an inflationary environment. It gives the company the ability to successfully pass higher costs on to consumers in the form of price increases.

The company’s shares are included in the S&P Dividend Aristocrats group. In June 2022, PepsiCo raised its annualized dividend by 7% to $4.60 per share. The company also announced a 10% increase in its annualized dividend to $5.06 per share, starting with the June 2023 payment—the 51st straight year PepsiCo has increased the dividend.

Management continues to expect $7.7 billion in cash returns to shareholders, consisting of $6.7 billion in dividends and $1.0 billion in share buybacks.

Pepsi’s stock recently hit an all-time high, up 12.5% over the past year and 7.75% year-to-date. Its current yield is 2.62%, but based on its history, Pepsi will continue to raise its dividend on a steady basis every year. PEP is a buy below $200 per share.
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