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Investors Alley

Investors Alley by TIFIN

These Oilfield Services Stocks are Booming

The energy sector is one that keeps rewarding its investors. For example, let’s look at the so-called “Big Three” oil services companies: Halliburton (HAL), Baker Hughes (BKR) and SLB (SLB)—formerly Schlumberger.

In 2022, these firms registered their most profitable 12 months since the heyday of the U.S. shale boom, reporting an aggregate net income of $4.4 billion in 2022, which was the highest combined figure since 2014.

Most of this income came in during the latter part of 2022.

SLB racked up $3.4 billion in profits in 2022, almost a third of which came in the final quarter. Halliburton also brought in the bulk of its $1.6 billion in earnings in the latter part of the year.

Baker Hughes was the worst performer, posting a full-year loss of $601 million, thanks to parts shortages and write-offs connected to its Russian operations. But even it ended the year on an upbeat note, with record quarterly orders of more than $8 billion. Baker Hughes also posted $5.9 billion of revenue in the fourth quarter.

So, what comes next? Can the good times continue to roll?

Looking Ahead at Energy

Most of Wall Street is saying to stay away from anything energy related. Please, don’t listen to them.

Instead, listen to the people at ground level that actually see what is going on in the energy industry.

For instance, during SLB’s earnings call, CEO Olivier Le Peuch was almost giddy, saying: “We concluded the year with 23% growth in revenue; 70% growth in earnings per share, excluding charges and credits; adjusted EBITDA margin expansion of 152 basis points; cash flow from operations of $3.7 billion; and 13% return on capital employed (ROCE), its highest level since 2014.”

In addition, Le Peuch described 2022 as a “pivotal” year for the energy industry, which he said had just entered the “early phase of a structural upcycle,” adding: “The fourth quarter affirmed a distinctive new phase in the upcycle…Durability is here to stay—and we are talking about years.”

Higher energy prices over the past year have pushed up drilling and production activity and triggered a rush to secure the equipment and personnel provided by oil services companies. Equipment shortages, materials like frac sand, and insufficient manpower have allowed the oil services firms to raise prices. Meanwhile, the cost-cutting regimes put in place during the coronavirus pandemic have bolstered their profit margins.

Jim Rollyson, head of oilfield services equity research at Raymond James, told the Financial Times: “Rising profitability paired with constrained capital expenditures is allowing these companies to generate strong free cash flows.”

That’s why the stocks of oilfield services companies outperformed the broader market, as well as other energy stocks in 2022, and will continue to do so. The Financial Times reported oilfield services stocks, as tracked by the OSX (PHLX Oil Service Sector) index, rose 59% in 2022—their best performance since 2009!

And, as the CEO of SLB said, the outlook is bright going forward.

Company executives in the sector paint a universally positive outlook for the year ahead, thanks to rising oil demand, tight supplies, and a renewed focus on energy security.

“With years of under-investment now being amplified by recent geopolitical factors, global spare capacity for oil and gas has deteriorated and will likely require years of investment growth to meet forecasted future demand,” said Lorenzo Simonelli, Baker Hughes’s chief executive. “For this reason, we continue to believe that we are in the early stages of a multiyear upturn in global activity.”

The only unfortunate thing, from an investment standpoint, is that none of these companies have a high dividend yield. The highest-yielding stock out of the “Big Three” is Baker Hughes (2.4% yield), so let’s take a closer look at it.

Baker Hughes

The number-three oil services company as we know it today was formed from the merger of Baker Hughes and GE’s oil and gas business in July 2017.

The company’s industrial energy technology (IET) division drove most of the sequential revenue growth in the fourth quarter because of elevated demand for Baker Hughes’ gas technology equipment. Nearly 60% of the segment’s order intake was derived from gas technology equipment. The IET division overall garnered more than $4 billion in orders this quarter, nearly double the quarterly average since 2017.

There are two major bullish factors that will benefit Baker Hughes in the years ahead. First, the company’s strong market share in several oilfield services specializations (such as directional drilling) should lead to significant contract wins, as well operators seeking to maximize production efficiency. And second, high demand for liquid natural gas refineries over the next decade will ensure a robust project pipeline for Baker Hughes, even if oil demand falls.

Now, let’s look at the Baker Hughes dividend…

On October 27, 2022, the company did increase its quarterly dividend by 6%, to $0.19 per share, or $0.76 annually. The first payment at the new rate was made on November 18, 2022. Argus’ revised dividend forecasts are $0.80 (raised from $0.76) for 2023 and $0.84 for 2024.

The firm does consistently return cash to shareholders: Baker Hughes has paid annual dividends per share of $0.72 since 2018—even during the 2020 downturn when many of its peers cut or altogether suspended distributions to conserve cash.

Baker Hughes also completed $434 million worth of share buybacks in 2021 and is targeting annual buybacks of between $200 million and $300 million over the next few years. Management indicates it will revisit its shareholder returns strategy once GE—which currently owns about 16% of Baker Hughes’ stock—fully exits its investment position, likely by the end of 2023.

BKR stock is a buy anywhere in the low $30s.
It’s raised its dividend 37.5% on average, could be acquired, benefits from rising interest rates, trading at massive discount, and pays an 8% yield. This is my top pick for income during a rough market.Click here for details.

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Investors Alley by TIFIN

A Reverse Stock Split That Actually Works

A reverse stock split usually occurs when a company in some sort of financial trouble is in danger of being delisted from the stock exchange. Because of the negative connotation, I was surprised to see, on January 20, business development company Oaktree Specialty Lending (OCSL) announce a 1-for-3 reverse stock split.

A subscriber wrote in to ask me about this – what happened, why, and how the dividend payouts behave afterward.

And it reminded me that sometimes, these reverse stock splits actually work in our favor…

A reverse stock split increases the share price without increasing the value or market cap of the company. Most of the time, you will see a reverse split declared when a company’s share price decreases to one dollar or less, as a stock will be delisted from the exchange if it trades below a dollar for any length of time.

Typically, a company whose stock has dropped to the dollar range is also a company that is not doing well with its business. As a result, investors see a reverse split as a sign the company may be in trouble; increasing the share price with this maneuver won’t stop the price from continuing on a downward trajectory.

Because of the negative connotation, I was surprised to see, on January 20, business development company Oaktree Specialty Lending (OCSL) announce a 1-for-3 reverse stock split. Let’s go over what that meant.

With the Oaktree reverse split, investors would receive one share for every three they owned. If an investor had 300 shares, he would have 100 shares after the transaction. At the same time, the share price increases by the same factor. At the time of the reverse split, OCSL went from around $7 per share to $21. This means the 300 shares worth $2,100 became 100 shares worth $2,100.

A subscriber asked me what happens to a dividend with such a reverse split.

Oaktree Specialty Lending will adjust its dividend rate to match the reverse split. The company paid $0.18 per share paid at the end of December, meaning it will now pay $0.54 per share—or more, as the company has been growing its dividend. The adjusted dividend will keep the yield near the 10% level that was in effect before the reverse split.

The reason for the Oaktree reverse split seems to be a move to make the share price appear to have more value. Investors are sometimes leery of a sub $10 share price—but at $20 per share, OCSL trades on par with many of its BDC peers.

In the case of Oaktree Specialty Lending, the reverse split definitely is NOT a danger signal. The company is well-run, and I would give it a top-five rating in the universe of business development companies. BDCs become more profitable when interest rates are higher, and OCSL has been growing its dividend.

I currently recommend three other BDCs to my Dividend Hunter subscribers. If I decided to add a fourth, OCSL would be the most likely choice.
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Investors Alley by TIFIN

Time to Look at Emerging Markets for Returns

There has been one very apparent trend since late October 2022. Following more than a decade of outperformance, global stocks have been consistently outpacing U.S. stocks.

There are several reasons for this. But one major factor is the shift away from growth stocks—an area where the U.S. dominates—to value stocks.

It looks to me that when investors get interested in value, they get interested in rest-of-world stocks, too. That’s because stock markets outside the U.S. are heavily weighted on value sectors such as energy, industrials, and financials.

Here’s where to look for the best emerging market stocks…

More importantly, for those investors who simply define “value stocks” as “cheap stocks,” global stocks are so much cheaper than U.S. stocks. Despite a bad 2022, the S&P 500 still trades at a premium of almost 50% to the Euro Stoxx 600 or Japan’s Topix index (measured in terms of price/earnings ratios)! That’s historically high and about as wide as the discount gets, in recent decades.

Why Emerging Markets Now

The same holds true even more so when you look at emerging markets, where markets were concerned about a worldwide recession, weighing on valuations throughout 2022.

That was a period in which the MSCI Emerging Markets index fell by about 20% in dollar terms. And last year’s severe slump in the MSCI index came about even though the economies of India, Brazil and Indonesia grew at a faster clip than the U.S.

Here’s why emerging markets look so interesting now…

First, historically emerging markets have recovered from previous economic cyclical downturns ahead of their U.S. and other developed world counterparts.

Second, emerging market economies have been relatively resilient this time around, compared to prior economic cycles. Current account deficits are significantly lower than they were a decade ago, leaving economies less vulnerable to capital outflows.

Third, most emerging market borrowing now takes place in local currencies. That means we should not expect the kind of explosive debt crises in the major emerging markets like those seen in the past because of a rising U.S. dollar value.

Also, many emerging markets have been on the front foot with rate hikes. This has resulted in a higher interest rate differential between the U.S. and emerging markets, which has limited outflows from the riskier countries.

Next, earnings revisions for many emerging markets companies for 2023 moved into positive territory in late 2022. In addition, after falling to 9% during the pandemic, profitability—or return on equity (ROE)—in emerging markets has increased by 5%, to approximately 14%.

And finally, emerging market stocks are dirt-cheap, compared to developed market stocks.

An analysis from Lazard Asset Management demonstrated that emerging market valuations are cheap in both absolute and relative terms.

Here is how Lazard described the numbers:

Emerging markets valuations, on both a price-to-earnings (P/E) and price-to-book (P/B) basis, are cheap in absolute terms and relative to developed markets equities. Emerging markets have been trading at a 35% discount to developed markets on P/E terms and at a 44% discount on P/B terms, among the cheapest discounts in nearly two decades. The 1.6x superior dividend yield for emerging markets (3.3% versus 2.1% for developed markets) is three standard deviations above the 23-year average relative yield.

For those investors with more risk, China is even cheaper than other emerging markets. The average forward price/earnings ratio for constituents of the MSCI China index stands at a multiple of 8.2 times, versus 11.5 times for the MSCI Emerging Markets index.

EM Rally

Emerging market stocks looked to have bottomed. The MSCI Emerging Markets index has risen more than 21% from its intraday low on October 25, according to Refinitiv data. This upbeat recent run comes after a painful stretch between February 2021 and late October 2021, when the MSCI EM index tumbled more than 40%.

As of October 2022, the decline of the MSCI Emerging Markets Index had exceeded the average decline of the previous 10 bear markets, including the 1997 Asia Financial Crisis.

Chinese stocks, which are the biggest weight in the MSCI Emerging Market index, have risen sharply since the autumn. The MSCI index tracking China’s stock market has rallied more than 45% since October 31 in U.S. dollar terms, according to FactSet data. The more widely followed CSI 300 index is up 23% since then.

What Comes Next

I find myself largely in agreement with Lazard’s assessment of emerging market stocks, which said:

For investors, the steep drop in equity markets overall in 2022 may raise the question of where to find value and long-term opportunity. We believe that emerging markets may be one of the most mis-priced asset classes, with attractive valuations compared with historical levels.…

Much capital has left emerging markets in recent years, and many parts of the asset class are under-owned and attractively valued as a result. Overall, emerging markets equities are among these particularly attractively valued assets with high financial productivity (or return on equity, free cash flow yield, and dividend yield).

I believe the end of China’s zero-Covid obsession and the reopening of its borders will act as an immediate growth catalyst, while moderating bond yields and a lower U.S. dollar valuation should also boost emerging market performance.

An easy way to get broad exposure is through the ETF based on the MSCI Emerging Market index—the iShares MSCI Emerging Markets ETF (EEM). It is already up 9.5% year-to-date and trading at $41.87. It’s a buy on any short-term weakness.
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Investors Alley by TIFIN

How My Favorite Income Idea Became Internet Famous

I keep track of the income-focused investments other writers recommend across the Internet. It is interesting to see what they report when one of my Dividend Hunter recommendations becomes a “hot idea” in the financial press.

Recently, at least a half dozen writers on Seeking Alpha have written (mostly positive) articles about one of these recommendations.

And I don’t blame them. Let me show you why I like it so much for generating income in my investment portfolio…

I’m talking about none other than JPMorgan Equity Premium Income ETF (JEPI). The fund launched in May 2020, and since that time, it has grown to be one of the ten largest actively managed ETFs.

I added my first covered call ETF to the Dividend Hunter portfolio in July 2020. I added JEPI a year later, in July 2021. Seeing a fund that my subscribers have owned for more than a year and a half get “discovered” by a broader audience is fun.

Covered Call ETFs use an option selling strategy (covered calls) to generate income from an underlying portfolio. Many investors use covered call trading to generate cash income from their stock portfolios. At the institutional level, such as with JEPI, the portfolio managers has access to advanced, synthetic securities that more efficiently mirror a covered call trading program. The JP Morgan website includes the below in describing its JEPI strategy:

Defensive equity portfolio employs a time-tested, bottom-up fundamental research process with stock selection based on our proprietary risk-adjusted stock rankings.

Disciplined options overlay implements written out-of-the-money S&P 500 Index call options to generate distributable monthly income.

JEPI sports a current SEC yield of 11.77%. Covered call selling generates attractive cash income with the trade-off of capping potential gains. I like to look at potential returns with different market scenarios.

A well-managed covered call strategy should outperform the underlying portfolio in a flat to slowing-rising stock market. Selling out-of-the-money calls gives some capital appreciation potential and income from selling options.

In a falling market, a covered call strategy won’t magically produce positive returns, but it will limit the damage. For example, in 2022, the SPDR S&P 500 Trust ETF (SPY) lost 18.8%, and JEPI posted a negative 3.54% return. The fund gave almost 15% better return.

A covered call ETF will not keep up in a rapidly rising bull market. In 2021, SPY returned 30.6%. For the same year, JEPI returned 21.5%.

For my Dividend Hunter service, I use JEPI and other variable dividend investments to provide some higher-yielding balance to the stable dividend payors in the portfolio. I always emphasize that proper portfolio management offers more stability and better returns than focusing on individual investment ideas. I have found JEPI to be one of the best covered call ETFs.
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Investors Alley by TIFIN

Rio Tinto is Paying Off Big-Time for Investors

In perhaps the most famous line from the mid-1980s television show The A-Team, A-Team leader Colonel John “Hannibal” Smith (George Peppard) often said: “I love it when a plan comes together”.

Apparently, Hannibal Smith retired from the A-Team to join the executive team at the global mining giant, Rio Tinto PLC (RIO), because the company’s strategic moves over the past few years are really starting to come together. Long-term decision-making and some smart acquisitions are providing a strong growth path for the miner.

And you can still get in.

Production guidance for 2023, released in mid-January alongside Rio Tinto’s fourth quarter output numbers, shows increased output for iron ore, copper and alumina/bauxite. And the company is moving quickly to build a lithium test plant at the Rincon mine in Argentina, which it bought last year—a really important move for Rio Tinto’s future.

RBC analyst Tyler Broda recently agreed that the company’s long-term planning was bearing fruit. He told clients that “The company’s portfolio has some compelling options and, unlike the other majors [mining firms], offers growing lithium exposure.”

I believe lithium will become a bigger part of the company’s future.

Rio Tinto signed a memorandum of understanding with Ford in 2022 that could result in the carmaker becoming a flagstone customer for the miner’s Argentine lithium supply. As the company’s CFO, Peter Cunningham, said: “Critical minerals is clearly important from a policy perspective for many governments [and companies] for security of supply.”

Rio Tinto Guidance

Rio Tinto is already an extraordinary company and organized into four segments: iron ore (65% of first half 2022 EBITDA), aluminum (18%), copper (9%), and minerals (8%). The minerals division produces salt, borates, mineral sands, and diamonds.

What really impressed me was the company’s exceptional fourth quarter results and its raised guidance. Rio Tinto’s 89.5 million tons of iron ore production translates to annualized production of nearly 350 million tons. Guidance for 2021 was at 320 million to 335 million tons. The company held onto 2022 cost guidance, and more specific numbers will be released next month. I suspect iron ore guidance will be raised at that time.

Rio Tinto hiked another key metal—copper— for 2023, to between 650,000 tons and 710,000 tons after the company bought out the minority investors in the Oyu Tolgoi holding company Turquoise Hill Resources for $3 billion. Copper production last year for Rio Tinto was 521,000 tons.

For those of you unfamiliar with Oyu Tolgoi, it is located in the South Gobi region of Mongolia and is one of the world’s largest known copper and gold deposits. At peak production, Oyu Tolgoi is expected to produce 500,000 tons annually of copper.

Why Buying Rio Tinto is a Good Idea

Argus Research summed up nicely why Rio Tinto is a buy: “Rio Tinto has strengthened its operating performance and balance sheet by cutting costs and selling non-core assets. It also continues to return cash to shareholders through dividend increases. Despite the recent drop in commodity prices, we note that Rio has traditionally performed well during difficult economic times, and, in our view, has strong long-term growth opportunities.…On the fundamentals, Rio’s ADRs are trading at 7-times our 2022 EPS estimate, well below the five-year average.”

I would add that the expected full reopening of China’s economy after several years of coronavirus pandemic-related lockdowns will boost demand greatly for what Rio Tinto and other miners produce. China accounted for about 60% of Rio’s sales in 2021.

And Rio Tinto has a large portfolio of long-lived assets with low operating costs. That means it is one of few miners that can remain profitable throughout the commodity cycle. Most of its ore sources come from operations located in the safe havens of Australia and North America.

Rio Tinto pays a regular dividend twice a year, in April and September, and often also pays a special dividend. Management’s target payout ratio is 40% to 60% of underlying earnings.

The 2018 dividend was $4.08, or $3.08 from the regular dividend plus a $1.00 special dividend. The 2019 dividend was $4.43, including a regular dividend of $3.82 and a special dividend of $0.61. In 2020, it paid a regular dividend of $4.64 and a special dividend of $0.93. In 2021, it paid total dividends of $13.49 per share.

Dividend estimates are $8.00 for both 2022 and 2023. However, with China reopening, commodity prices are likely headed higher in 2023. This will boost the fortunes of Rio and other miners.

I suspect the dividend for 2023 will be closer to $10.00 per share. But even if it does come in at $8.00, the dividend yield would still be in excess of 10% based on the current stock price.

Rio Tinto is a buy anywhere in the $70s per share.
That’s what my old coworker told me years ago. I listened up because he was the most successful broker I ever worked with. And also incredibly lazy. He found a small niche in the market no one talks about and made enough to buy in the most expensive zip code in Maryland. Here’s what he invested in.

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Investors Alley by TIFIN

How to avoid big drawdowns in your portfolio in 2023

Last year, if you held your stocks…

You’re likely sitting on double-digit losses over a 12-month timeframe. 

Drawdowns in your portfolio can be crippling to your future wealth and income. 

If you lose 50% of your portfolio… it requires a 100% return to get back to even. 

As you can imagine, losing 50% is much easier than making 100%. 

I talk a little about this phenomenon today in my free weekly video. 

It’s only 3 minutes long, but I discuss this topic…

But, as a bonus, I share what investment YOU MUST buy in this market that’s almost risk-free. (that bonus is at the end). 

Hint — it’s NOT a stock.

Click here to learn more about avoiding drawdowns and what asset to buy now, 
If you’re not doing this in your portfolio right now…You could be missing out on $5,900 per month in retirement.I’m not referring to some new dividend strategy…And this does NOT involve forex or anything complicated or risky like that.But this “Recession-proof” strategy can generate up to $5,900 per month… in up markets… down markets… and anything in between.Click here to learn how to collect up to $5,900/month.

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