Investors Alley

During the current period of intense market volatility, some investors have grown fearful. For these concerned investors, municipal bonds, aka “munis,” are worth a look. Munis are issued by state and local governments, and generally pay tax-exempt interest at the federal and potentially state levels.

Municipal bonds have played a vital role in building the framework of America’s modern infrastructure, and were a major source of financing for canals, roads, and railroads during the country’s westward expansion in the 1800s.

Today, the proceeds from municipal debt continue to fund a wide range of state and local infrastructure projects, including schools, hospitals, universities, airports, bridges, and highways, as well as water and sewer systems.

Here’s all you need to know, and how to buy them…

Munis 101

Municipal bonds are often thought of as tax-exempt vehicles that are appropriate only for investors who fall into higher tax brackets. However, municipal bonds can offer potential advantages to investors of all income brackets.

In general, municipal bonds fall into one of two categories: general obligation and revenue. The main difference between the two is the source of revenue that secures their principal and interest payments. Here are the specifics from the Invesco Primer on municipal bonds…

General obligation bonds are secured at the state level by the state government’s pledge to use all legally available resources to repay the bond. At the local level, general obligation bonds are backed by an ad valorem tax pledge that can be either “limited” or “unlimited.” The agreed-upon definitions of these terms that appear in ordinances across municipalities are:

 Limited tax: Secured by a pledge to levy taxes annually “within the constitutional and statutory limitations provided by law”

Unlimited tax: Secured by a pledge to levy taxes annually “without limitation as to rate or amount” to ensure sufficient revenues for debt service

Other than states, issuers of general obligation bonds include cities, counties, and school districts.

Revenue bonds are secured by a specific source of revenue earmarked for repayment of the revenue bond.

Enterprise revenue bonds are typically issued by water and sewer authorities, electric utilities, airports, toll roads, hospitals, universities, and other not-for-profit entities.

Tax revenue bonds are backed by dedicated tax streams, such as sales taxes, utility taxes, or excise taxes.

Muni bonds come with a large tax break for taxpayers. Without this, there are few reasons to hold them. How much is the tax break worth? As Invesco explains in their basic Muni primer, to work out the Tax Equivalent Yield (TEY) you have to do a bit of math:

Given that different investors pay different marginal rates of tax federal income tax, the tax equivalent yields that you receive from the same bond will be different. In simple terms, the higher your marginal tax rate, the higher your TEY.

There are several reasons why looking into the $4 trillion municipal bond market may make sense now.

Why Buy Munis?

One reason munis make sense for many investors is that many issuers have a monopoly over their services and don’t face competition like corporations do.

An even better reason is that issuers are often backed by durable revenue sources such as taxes. As a result, defaults tend to be rare, even during recessionary periods. For example, during the financial crisis of 2007–2009, only 12 rated issuers defaulted, compared with 414 corporate bonds of similar credit quality.

Currently, many muni issuers are financially strong. That’s due to substantial pandemic-related support from the federal government as well as recently surging tax revenues as the economy has recovered from the pandemic.

In fact, the balances of rainy-day funds—money states set aside to use during unexpected deficits—are at near-record levels. Even Illinois, the lowest-rated state in the muni market had a rainy-day fund balance of more than $600 million in 2022, compared with just $4.15 million in 2020.

Also keep in mind that, in general, muni bonds have strong credit ratings—usually higher than corporate bones. Nearly 70% of the Bloomberg Municipal Bond Index is rated in the two highest categories, compared with just 8% of those in the Bloomberg Corporate Bond Index.

And then, of course, we come to yields.

Raymond James’s Municipal Bond Investor Weekly shows that the yield on 10-year Single-A-rated Munis trades below U.S. Treasuries, but the Tax Equivalent Yield of 10-year Single-A-rated Muni trades at the equivalent U.S. Treasury yield plus 126 basis points.

Here is some of the commentary from the March 20 issue of Municipal Bond Investor Weekly:

All this [market] uncertainty has caused a flight to quality as investors shift out of risky assets and into bonds. As investors pour into high quality bonds, municipal bond prices have rallied sending yields lower. 10-year muni yields are ~25 basis points lower, but this pales in comparison to Treasury yields which are ~53 basis points lower from March 7-17, 2023. Longer maturities followed a similar path with 20-year muni yields lower by 16 basis points compared to Treasuries, down 32 basis points.…Taking a longer view, 10 and 20-year maturity municipal bond yields are at or close to their historical highs not seen since 2018. The past year has been marked with volatility and, while off their recent highs, 20-year muni yields are approximately 100 basis points higher than a year ago and 10-year yields are approximately 30 basis points higher.

How to Buy Munis

Your best bet may be to buy individual munis tailored to your specific financial situation. All the major brokerages have bond specialists that can do this for you.

However, there are municipal bond mutual funds and ETFs that you can buy online in your brokerage account. Here are a few examples…

The largest muni bond ETF is the iShares National Muni Bond ETF (MUB). It is up about 1% year-to-date and has a 30-day SEC yield of 3.15%. The expense ratio is a tiny 0.07%.

There are also closed-end funds that focus on munis—and often on specific states and that often have a higher yield.

The largest national muni closed end fund is the Nuveen Municipal Value Fund (NUV). It is up about 0.50% year-to-date and has a distribution rate of 3.85%. However, its expense ratio is higher at 0.50%.

The biggest of such funds focused on a single state is the Nuveen California Quality Municipal Income Fund (NAC). Many of the larger states have a closed fund dedicated to them, so make sure to check on the internet for a list.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Oil is going to $50.

Or it’s going to fall all the way down to $20.

Or is it?

If you follow oil prices at all, the last few weeks would have you believe that the world is awash in oil all over the world, demand was declining, and renewable energy was cheap and easy to build.

None of that is the truth.

Here’s what’s actually happening…

And how you can play it.

The International Energy Agency said earlier this month that it expected oil demand to surge, thanks to increased air travel and the continued reopening of China. As a result, the agency expects global demand to exceed supply starting in the second half of 2023.

More demand than supply leads to higher prices, according to any introduction to economics textbook.

This is not going to be a short supply-demand cycle either. While I am all too aware that the pundits and alleged energy experts would have you believe that renewable energy will be our primary fuel source and that we will all drive an electric vehicle by next Christmas, that is not the case.

According to the Energy Information Agency here in the United States, we will still use more oil and more gas than we do renewable energy. In its 2023 Energy market outlook, the agency said that while renewable energy will be the fastest-growing fuel source in the coming years, we are still several decades away from it being the primary fuel source.

The Energy Information Agency also suggested that while government officials are talking about 100% electric vehicles, the actual percentage of electric vehicles sold will be about 30% of all cars purchased if oil prices are at a high level, or less than 15% if gas is cheap.

All the campaign trail and Green New Deal hollering about renewable energy and EV usage simply are not true—we will be using oil and gas for decades.

If I am right about that (and I am), then oil and oil-related equities are cheap.

I am not the only one who thinks this is the case. A guy you might have heard of named Warren Buffett has a pretty decent record of identifying undervalued industries and companies. And he has been buying energy stocks hand over fist in recent months.

Buffett’s largest recent purchase has been Occidental Petroleum (OXY), and he keeps buying more shares when the price falls: last week, he added an additional $466 million worth of shares to his position. The week before, he spent $354 million on Occidental shares.

Berkshire now owns about $12.5 billion worth of Occidental shares.

Buffett is not buying Occidental and its collection of oil-producing, storing, and marketing assets because he thinks oil’s long-term price will decrease.

Occidental just raised its dividend by 38% and announced a new $3 billion stock buyback. The company also plans to use some of its free cashflow to redeem its preferred stock. This is on top of the $3 billion buyback plan Occidental completed in the fourth quarter of 2022.

Apparently, Ocidental’s board does not think oil prices are falling anytime soon, either.

Executives at Devon Energy (DVN), the large oil and gas exploration and production company, also have signaled with their checkbooks that they think oil and gas prices will move higher and create free cashflow for the company.

CEO Richard Muncrief has made open market purchases of almost $1.2 million of Devon Energy shares in the past two weeks. The company’s chief operating officer bought almost $1 million last week as prices fell. And one of the directors of its board bought just shy of $250,000 worth of stock.

Devon Energy is a free cashflow machine that generated $6 billion in excess cash last year.

The company uses the cash to reward shareholders. It just raised the dividend, and the stock now yields more than 10% after the recent pullback.

Devon has also been buying back a lot of stock, with $700 million left on a $2 billion buyback authorization. The company increased the buyback amount twice last year; additional increases in 2023 will not surprise me.

Insiders are not buying because they think oil and gas prices will decrease.

Both the International Energy Agency and the US-based Energy Information Agency think oil and gas demand will decline over the next several decades.

Warren Buffett is making a massive bet on oil prices rising long term.

Energy prices may be volatile, but buying energy companies and assets at current valuations should deliver spectacular long-term returns for patient-aggressive investors.
Silicon Valley Bank, Signature Bank, First Republic Bank, and now Credit Suisse… The Fed’s interest rate hikes are putting more and more pressure on weak banks.Your investment portfolio could be exposed.But this revolutionary new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

2022 was a terrible year for the media industry companies.

This was because competition among streaming services has come to an all-time high and consumers are getting pickier about their number of subscriptions. On top of that, companies are contending with lower ad revenue and more cord cutting.

When Netflix (NFLX) reported it lost subscribers in the first quarter of 2022—the first time in more than 10 years—the news sent a shockwave throughout the sector. The company blamed heightened competition, and began exploring a cheaper, ad-supported option for customers. Since then, other media companies have followed suit.

The video streaming market is currently being reshaped after last year’s collapse in investor sentiment toward these companies.

Both Netflix and Disney (DIS) have changed chief executives and stripped subscriber growth forecasts from their results. The focus now is solely on profitability, which may put Netflix ahead of its competition…

Netflix is staging a recovery from the share price slump suffered at the beginning of last year. In April 2022, its market capitalization was 70% below its 2021 peak. However, after a series of positive results, the company’s stock has regained some of its lost luster.

In the fourth quarter of 2022, Netflix added 7.66 million net subscribers, well ahead of guidance of 4.5 million added, to reach 230.75 million subscribers. This marked the second straight quarter of subscriber growth, and a 4% year-on-year increase. That’s quite a change from the two quarters of subscriber losses at the beginning of last year which led to the steep selloff in the stock.

The stepping down of founder Reed Hastings is highly symbolic of the company’s move away from a growth-at-all-costs strategy. The new management team, with co-CEOs Greg Peters and Ted Sarandos, is taking some steps to improve the company’s cash flow. For example, Netflix has plans in place to cut down on password sharing.

While this may lead to cancellations over the short-term, it’s a smart longer-term strategy. Despite the risk of losing some customers, the move should turn out to be cashflow positive.

Netflix estimates around 100 million people use its service without paying for it. That huge number is why many Wall Street analysts are confident a large chunk of money will come to Netflix once these viewers become monetized. FactSet reports that estimates for Netflix’s free cashflow will more than double to $3.15 billion this year, and then rise again to $4.7 billion in 2024.

The biggest problem for Netflix’s cashflow though remains the cost of developing content and using technology. In 2022—despite trying to keep costs in check—the company spent 19% more on technology and development.

To bring this under control, Netflix has been experimenting in Japan with the usage of generative artificial intelligence (AI). Earlier this year, it produced an anime show called Dog & The Boy, which caused an outrage among some because it incorporated AI-generated art.

Netflix’s Outlook

While Netflix’s outlook is improving, there is no denying the U.S. streaming market is saturated. That means if any further growth does come from Netflix, it will come from overseas. Already, Netflix has more customers outside the U.S. than inside the country.

A particularly strong region for Netflix is Asia. The market research firm Ampere Analysis explains that: “[Asia-Pacific] is likely to represent Netflix’s biggest growth potential in the future, accounting for over 60% of net additions to its global subscriber base over the next five years.”

Although that pricing in places like India is far below pricing here in the U.S., Morningstar forecasts that—on the international side—increased customer penetration will generate average revenue growth of 11% in Europe, 7% in Latin America, and 15% in the Asia-Pacific through 2027.

Overall, Morningstar forecasts average revenue growth of 9% for Netflix, with the operating margin expanding to 25% in 2027 from 21% in 2021, after dipping to 18% in 2022.

Netflix has been targeting $3 billion-plus free cashflow in 2023, versus $1.5 billion in 2022, as the five-year build of the studio to produce a majority of original titles (60% of content assets) are now past the most capital-intensive part of the process.

The main takeaway is that Netflix is now a company that has swapped its role as a disrupter for that of being the dominant incumbent… it is now the only profitable big streaming service in the world, with a subscriber base of 231 million and annual content budget of roughly $17 billion.

All of the factors discussed make Netflix a speculative buy anywhere in the $290 to $320 range.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Normally sleepy regional banks have been wildly active in options trading after the SIVB crisis from last week. First Republic Bank (FRC) is a regional bank that investors have been very concerned about, with the stock down over 70% in a week. Despite bankruptcy concerns, some options traders Brokers don’t typically advertise “Income Accelerator Accounts…”

It got bumpy out there all of a sudden.

Although I was surprised that Silicon Valley Bancorp (SIVB) lit the fuse, I am not shocked that something blew up. Every time the Federal Reserve has a rate increase cycle, something blows up.

Signature Bank (SBNY) and Silvergate, on the other hand, were not that much of a surprise, as I have been highly critical of all things crypto for a long time.

What I am surprised by is the cries of contagion and fraud surrounding the SIVB blow-up. Silicon Valley Bank made a bet that rates would remain low. It was stupid, but not fraudulent.

Here’s why there’ll be no mass bank crisis.

But if you’re worried, and want to wait this out, here’s how to do that safely while scoring big yields…

A rare set of circumstances specifically related to early-stage venture capital companies and social media panic led to the deposit run that blew up SIVB.

The clickbait crew has been out in full force. I have seen lists of 20 banks that will fail next, containing some of the strongest banks in the United States. People who know nothing about banking are taking data from the headlines and trying to pinpoint the next Silicon Valley Bancorp situation.

There is no next – it was a unique situation.

Anything next will be caused by social media-inspired panic.

On Wednesday, we got some add-on fear from Swiss bank and perennial source of drama Credit Suisse Group AG (CS), when its biggest investor, Saudi National Bank, announced it would not be injecting more capital into the struggling institution.

Again, this is no surprise. I have been negative on the Swiss bank for a long time.

Last year I sent around a report on European banks to buy. Credit Suisse was not on the list.

Management has done so much wrong I would be hard-pressed to think of a single positive comment about Credit Suisse. Its troubles should have little to no impact on a community bank in the middle of America. These banks have been selling off anyway.

So have real estate investment trusts (REITs), business development companies (BDCs), insurance companies, and even energy stocks.

As an aggressive and patient investor, I am buying selected banks that pass my stringent criteria and adding to my stake in financially solid REITs.

Energy stocks and other companies with strong fundamental conditions are also being considered.

I might be making different choices if I were 10 or 15 years older. People more concerned about the return of capital than the return on capital, and those that value a high sleep-tight factor, might look towards the corporate bond market. BB+ and BBB bonds offer a very attractive combination of yield and safety right now.

Prices may fluctuate while you own the bonds, but as long as the company does not fail, you get back full face value at maturity.

Most of the bonds I am tracking trade at less than face value. The bonus here is that if the Fed does start lowering rates before your bonds mature, you could see double-digit price gains on top of the interest payments.

Vici Properties Inc. (VICI) owns one of the largest portfolios of casinos and gaming-related properties in the United States, and produces huge cash flows. Even during the coronavirus pandemic shutdowns, Vici never missed a payment. The REIT has bonds due in each of the next three years that will yield more than 6% if held to maturity.

Advanced Auto Parts Inc. (AAP) has been in business for 95 years. It is a safe bet they will be around to make good on their bonds maturing in 2026 and 2029. The yields range from 5 to 5.5%.

Marathon Petroleum Corp. (MPC) has bonds available, yielding anywhere from 6 to 7.5% over the next decade.

Radian Group Inc. (RDN), one of the four major mortgage insurance companies left, has bonds that mature in 2028, with a yield to maturity of 7.5%.

Right now, the developing opportunity in financial assets is extraordinary. I talked to a collection of investors and bankers nationwide this week, and they are all excited and active buyers of banks and REITs.

For many people, however, there is a time when being risk-averse and clipping coupons makes a lot of sense. BB-and-above bonds represent an opportunity to lock up high yield for several years.

You still have a potential kicker if the Fed begins lowering rates while you hold the bonds.

Or, in the worst case, you get reliable cash flows and your money back at maturity.
Silicon Valley Bank, Signature Bank, First Republic Bank, and now Credit Suisse… The Fed’s interest rate hikes are putting more and more pressure on weak banks.Your investment portfolio could be exposed.But this revolutionary new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

With the collapse of Silicon Valley Bank, the hit to financial sector stocks has been brutal. As a reference, the iShares U.S. Regional Banks ETF (IAT) dropped by more than 30% in a few days. During a follow-up webinar with my newsletter subscribers, I discussed how steep market corrections have been showing up more often…

And how market drops like these are by far the best way to build your income and wealth.

Let me show you…

Psychologically, it’s hard to watch the value of your portfolio go down for an extended period. A ten percent drop is uncomfortable. If prices drop by 20%, fear takes over, and many (most) investors bail out, locking in their losses. They don’t often understand that steep declines occur about every other year. Using the S&P 500 benchmark, here is a quick history:

September to December 2018: The market took 95 days to drop by 19.8%

February to March 2020 (the pandemic): The market took 33 days to lose 33.9%

January to June 2022: It took 164 days to drop by 24.5%

The 2022 bear market, from which stock prices have not yet recovered, hit a lower low in October, but the period from June 2022 until the present has been marked by failed recoveries and modest declines.

This year, the banking sector crashed, which—as I noted above—took down the regional bank ETF by more than 30%. That crash affected the full range of financial business companies, including business development companies (BDCs) and real estate investment trusts (REITs).

In less than four and a half years, investors have gone through four broad market or sector-specific, gut-wrenching selloffs. These market events seem to be coming with very short intervals in between.

I don’t think individual investors will be successful in timing the markets for capital gains. Disruptive events are too unpredictable. The latest include a pandemic, large bank failure, and the failure of the Federal Reserve to recognize that inflation was not transitory.

If you invest to generate dividend income, these stock market disruptions become attractive opportunities to pick up high-yield investments at even higher yields. For example, in “normal” times, Starwood Property Trust (STWD) is priced to yield 7.5% to 8%. During the recent market downturns, the share price dropped enough to push the yield above 10%.

Eventually, the share price will recover, generating gains in your portfolio value, while you will have locked in a 10% yield on your committed capital. It’s a win-win.

To successfully employ a high-yield stock strategy, you need to be confident that the stocks you pick will be able to sustain their dividends. The pandemic-triggered crash gave us a good list of companies that continued to pay dividends and take care of their shareholders.

My Dividend Hunter service provides a diversified recommended portfolio of this type of high-yield investment.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Well, that was unexpected.

The bank run we saw last week at Silvergate (SI) and Silicon Valley Bank (SIVB) was stunning and completely unforeseen.

Unless, of course, you were listening to what I’ve been saying for 18 months: the Fed’s rate hikes make unprofitable, risky companies much less valuable, and fast.

But the vast majority of banks will be completely unaffected by this.

Which gives you and me a great opportunity to snap up some stellar banks at dirt-cheap prices…

Earlier this year, I spent some time at the Acquire or Be Acquired conference in Phoenix, Arizona, with more than 1,000 bankers and dozens of Wall Street analysts, plus investment fund managers, industry journalists, and private bank investors.

I can promise you that the subject of a bank run never came up.

We did talk at length, however, about the securities issue banks were dealing with this year. Banks that had been buying securities at very low rates since the start of the pandemic saw the value of these securities plummet as the Federal Reserve raised interest rates at a rapid pace to fight inflation.

While the losses on fixed-income securities impacted earnings and accounting measures of book value, they did not impact regulatory capital levels. Furthermore, these losses would be fully recovered if the banks just held the securities to maturity.

So, no one was losing any sleep over the securities portfolio.

Then we saw the deposit run at Silvergate as its crypto industry customers needed to withdraw deposits to pay off their investors. The bank had to sell securities to meet the demand for cash and, by doing so, turned paper losses into actual losses.

Silvergate took losses of more than $1 billion in the fourth quarter of 2022, and the forced selling continued into this year. Last week, the bank threw in the towel and announced plans to liquidate.

On Monday, January 6, the management of Silicon Valley Bancorp was overseeing a bank that was turning 60 this year and had a market capitalization of over $20 billion.

On Friday, March 10, the bank was out of business, with a market cap of zero.

What a wake-up call for the venture capital industry, which has now realized that there was a severe funding shortfall, especially for early-stage companies. Funding for early-stage companies has all but disappeared.

It seems that the reality of what I have been saying for 18 months finally occurred to the residents of Silicon Valley: rising rates make unprofitable, risky companies worth a lot less money.

Warnings of the possibility of losing access to whatever cash they had left caused many early-stage venture capital firms to transfer funds out of Silicon Valley Bancorp to smaller, more traditional banks all across the United States.

Other companies followed suit, and the run was on. Silicon Valley Bancorp had to sell securities to meet demand, turning billions of dollars of paper losses into real losses. The bank tried to raise capital, but buyers were nowhere to be found. And so early Friday afternoon, the FDIC seized the bank.

Bank stocks sold off across the board. After all, most banks have securities losses this year. It was hard to avoid with rates rising as fast as they did. Still, unless the news media sparks a national bank run with breathless headlines foretelling a repeat of 1929, 99% of all banks will be just fine.

Banks are going to have to raise the rate they pay on deposits to keep cash from walking out the door.

That will pressure earnings for the rest of 2023 and into 2024. It will not, however, cause any more banks to close their doors.

The current situation in banking does set up an opportunity for investors looking for a steady income stream with the potential for an eventual significant capital gain of 20% or more: bank-preferred stocks have also been selling off in the past week. This includes preferred stocks issued by some of the safest banks in the country.

Bank of Hawaii Corp. (BOH) is an excellent example of what I am seeing right now. This bank has been around since 1897. When it opened its doors, it had only been four years since Stanford Dole overthrew Queen Liliuokalani to assume control of the islands. Hawaii did not become a U.S. territory until the following year.

The bank has survived countless geopolitical events and economic crises since it opened; it will survive this one as well.

Bank of Hawaii has a preferred stock (BOH-A/BOH-PA) trading with a coupon of 4.38%. Based on the $25 par value, every share receives dividends of $1.09 annually (payments are made quarterly.) Thanks to rising rates and bank-related fears, the stock traded hands last week as low as $17.22. At that price, the shares yield 6.33%.

That is not the whole story.

When the current bank-related fear leaves the market, the shares will trade higher, possibly climbing back above the $21 level where it sold last month—a gain of more than 20%. And, the shares should move higher when the Fed stops raising rates.

If we have a recession later this year or early next and the Fed has to lower rates, Bank of Hawaii preferred shares could easily trade back toward the par value of $25, which would be a gain of more than 40%!

As long as the bank stays in business, you collect more than 6% on your capital.

The risk-reward for bank-preferred stocks is being skewed in a very positive manner, and the Bank of Hawaii preferred is a very attractive issue right now.
Regulators recently seized Silicon Valley Bank due to concerns about its financial health and compliance practices, leading to investors losing confidence.As a result, funds and investments tied to the bank could be vulnerable to significant losses and market volatility.But this new AI investing tool can help you figure out if your investments are at risk, what to do about it, and find new opportunities for you to invest in.Click here to see how.

Recently, I dug into recent financial results of several downstream crude oil refiners. I am a fan of the energy subsector, but I was surprised at how well these companies can and will perform in the current energy price environment.

So surprised that I was happy to add a new refiner stock to my dividend growth-focused investment service recently.

Here’s why – and three refiners to consider for your own portfolio…

Successful fuel refining companies are some of the best-managed businesses in the U.S. They operate in an industry where the prices of both the raw materials (crude oil) and finished products (gasoline and other fuels) are set by outside market forces. Refiners have to live with whatever the commodity markets give them.

Refining profitability relates to the crack spread. The spread is the calculation of the price difference between refined products and the cost of a crude oil barrel. The benchmark 3-2-1 crack spread is the difference between three barrels of oil, two barrels of gasoline, and one barrel of distillates (diesel, jet fuel, heating oil). Put another way, the crack spread is the gross profit margin per barrel of oil when refined into fuels.

A modern, efficient refinery has an operating cost of $5.00 to $8.00 per barrel. Factor in other corporate expenses, and you get a breakeven at around a $10.00 crack spread. On this chart, the blue line is the U.S. crack spread with the corresponding value on the left side of the chart:

Over the decade, the crack spread ranged from a low of $7.50 in early 2020 to more than $58.00 last Spring. Historically, you can see the spread tended to be in a range of $15.00 to the low-$20s. The Russia-Ukraine war caused the prices of crude oil and fuels to spike higher, pushing the crack spread to record levels.

Next, let’s look at the same chart for the last six months:

If you watch the financial news, you may have observed that crude oil trading has been relatively stable, in a $70 to $80 range. You may also have noted that gasoline at the pump has been stable for several months. In my area, every station shows regular unleaded at $3.29 a gallon.

The recent price stability, from the end of November to the present, kept the crack spread locked in at $30 to $35 per barrel. At these levels, the refining companies are hugely profitable. Let’s look at the fourth quarter results from the three large independent refining companies:

Marathon Petroleum Corporation (MPC) reported earnings of $6.65 per share, compared to $1.30 a year earlier

Phillips 66 (PSX) reported earnings of $4.00, up from $2.94 in the last quarter of 2021

Valero Energy Corp (VLO) reported $8.45 per share, up from $2.47 per share

If you annualize the Q4 earnings, these companies trade at a P/E ratio ranging from 4 for VLO to 6 for PSX. On a fundamental evaluation, these stocks are very cheap.

I expect the price of oil and the crack spread to stay current. We are already most of the way through the 2023 first quarter, and you can see that profits this quarter will be excellent.

I have one of the three listed refining companies in the portfolio for my Monthly Dividend Multiplier service, which employs a dividend growth strategy. This month I am adding a smaller regional refining company. Now is a great time to get overweight in the downstream energy space.

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.