Investors Alley

I view liquefied natural gas (LNG) as the most critical energy source for the future. A recent report forecasts that LNG demand growth will continue to at least 2040 and double from current production levels. Several stocks let you participate in the attractive growth potential.

VettiFi recently interviewed Stifel managing director Ben Nolan to discuss the global LNG market. Nolan stated that he expects annual demand growth of 5% to 6%. Production of 400 million tonnes (metric tons) of LNG will double by the mid-2030s.

As luck would have it, there are two great stocks that will profit as this trend sets in. Let’s take a look…

There are a handful of factors that will propel demand growth for LNG.

For starters, global economic growth requires ever greater amounts of energy. LNG can provide a clean source of energy anywhere in the world. LNG can also provide energy security. When Russian gas was cut off to Western Europe, the European countries could replace the lost supply by importing LNG. LNG provides diversification of a country’s or region’s natural gas supply.

LNG is a clean energy fuel that can replace dirtier energy sources such as coal, fuel oil, and diesel for power generation. It remains significantly cheaper than fuel oil or diesel. Making the switch from one of these fuel sources can save energy producers significant money.

The U.S. is the world’s largest LNG producer. Qatar and Australia also have significant production capacity.

Cheniere Energy (LNG) produced 30 million metric tons in 2022. The company has more than 180 million tonnes of committed sales on long-term contracts. In 2010, Cheniere announced a plan to start a natural gas liquefaction project. The company began producing LNG in 2016. The thousandth LNG cargo from Cheniere was produced and exported in 2020. As of the first half of 2023, the company is shipping 600 cargo loads annually. Cheniere continues to build production capacity.

New Fortress Energy (NFE) initially focused on regasification facilities. Over the last couple of years, the company added LNG power generation services, LNG boiler conversion services, and its Fast LNG wellhead liquefaction projects. New Fortress operates in the Caribbean, Europe, Latin America, and the United States.

Either or both of these stocks would be an excellent place to get LNG exposure in your portfolio.
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Investors tend to take one particular U.K.-based electric utility for granted. Its history of predictable and defensive returns has long made it a no-brainer for income investors. Its dividend, which grows in line with inflation, has not been cut since 1996.

Let’s take a look to see if it’s worth your time…

The company I’m speaking about is National Grid (NGG), which the British government privatized in 1990. It owns, develops, and maintains the infrastructure that transmits electricity around England and Wales.

It also does the same, as well as distributing natural gas, here in the U.S.—in New York and Massachusetts—accounting for 45% of its profits.

National Grid

In the U.K., the company is essentially a monopoly and is therefore highly regulated. It is only allowed to make a certain rate of return, determined in advance by the regulator Ofgem (Office of Gas and Electricity Markets) and put in place for several years at a time.

Ofgem made its latest determinations for electricity distribution, covering 2023 to 2028, at the end of 2022. In its investor presentation, the company announced its new electricity distribution price control, targeting 100 to 125 basis points in operational outperformance as compared to the previous price control measure.

Ofgem’s price control framework is complex. However, in very simple terms, here is how it works: the bigger National Grid’s asset base becomes, the more money it is permitted to make—particularly given that its U.K. asset base is indexed to inflation.

The abundance of U.K. and the U.S. investment opportunities in aging energy transmission networks and renewable energy should be a boost for the business. For example, National Grid was awarded a $50 million grant from the U.S. Department of Energy (DOE) for a project that will deploy digital technology to optimize the use of distributed energy resources (DERs) to improve electric system reliability and resilience. In addition, an ever-growing network of renewable energy in Britain and the U.S. will push the company’s earnings and dividends higher.

Some worry that National Grid has low equity and lots of debt; however, it has been this way for many, many years. Dividend cover has been slim, even in the best of times, with earnings-per-share only slightly higher than dividends-per-share. But the company has almost always surprised investors in a good way—and analysts at Credit Suisse actually expect dividend cover to improve slightly over the next few years.

Back in 2021, the company decided to shift its focus completely to electricity and move away from gas. The goal was to transform National Grid from a low-growth gas transmission business to a higher growth utility business. It agreed to buy Western Power Distribution (WPD)—which ran grids in the English midlands and southwest regions, as well as in Wales—from U.S.-based PPL Corporation (PPL) for about $11 billion.

The company’s decision to sell off its gas assets should also free up some cash. In July, National Grid sold a further 20% stake in its U.K. gas transmission and metering business to the existing majority owners, an investor-consortium led by Australia’s Macquarie Asset Management. The stake sale was on the equivalent financial terms as when it sold a 60% stake to the consortium in January. That deal had implied an enterprise value of about $12.5 billion for the unit, National Gas.

Over the longer term, these monies—when plowed into infrastructure—should yield ample rewards for shareholders.

Investing in National Grid

If you’re interested in NGG’s dividend policy, it’s different from that of U.S. utilities.

The company’s dividend payout is linked with the rate of CPIH inflation in the U.K. CPIH is the Consumer Prices Index, including owner occupiers’ housing costs. CPIH inflation is currently at 6.3%, compared with a peak of 9.6% last October.

I believe that electricity infrastructure will play an increasingly important role in the move towards net-zero emissions. National Grid is well positioned to capitalize on this industry trend, given its demonstrated leadership on climate change. Its move to increase the weight of electricity networks over gas ones against a backdrop of accelerating energy transition has been sensible.

I consider the company a dividend aristocrat: it has been increasing its dividend every year since 1998, delivering an impressive 6.3% average annual growth over that time period. In the period from 2005 to 2012, the dividend grew at a 10% annual rate. And, thanks to the high selling price of its U.K. gas transmission assets, National Grid should be able to continue to grow dividends in line with inflation.

Keep in mind that inflation is a good thing for NGG, and its income-seeking investors. The stock (current yield 5.61%) is a buy in the $58 to $62 range.

In my 48 Hour Income service, a trade we considered, but ultimately did not place, was in Replimune (REPL) options. For 48-Hour Income, the goal of the service is to generate 1% to 3% returns per week by selling 2-day puts in certain stocks. REPL is a biotech company working on cancer treatment. Although put

It is well-known that investing into fixed income instruments has been a losers’ game ever since the Federal Reserve began raising interest rates.

2022 was the worst-ever year on record for U.S. bond investors, according to an analysis by Edward McQuarrie, a professor emeritus at Santa Clara University who studies historical investment returns.

And the Bloomberg Global Aggregate Bond Index, which tracks investment grade debt, like Treasuries, and is the benchmark for many of the world’s largest passive bond funds, plunged 16.3% in 2022, its worst on record. 

Bond performance this year hasn’t been as bad as 2022, but the “year of the bond” that Wall Street was touting at the start of 2023 has so far failed to deliver. The recent rise in Treasury yields to levels not seen since 2007 has sent the Bloomberg bond index down another 3.6% so far in 2023.

Yet, there is a small fixed-income exchange-traded fund (ETF) that has gained a remarkable 200% since the end of 2021. Let’s take a look at it.

Simplify Interest Rate Hedge ETF

The fund is the Simplify Interest Rate Hedge ETF (PFIX), which is also up another 40% over the past year. It seeks to hedge interest rate movements arising from rising long-term interest rates, and to benefit from market stress when fixed income volatility increases, while providing the potential for income.

So how has this fund turned in such an outstanding performance during this brutal bear market in bonds?

Bloomberg’s Ye Xie wrote about how the fund is the brainchild of Harley Bassman. While at Merrill Lynch in 1994, Bassman created the MOVE Index, which is a market-implied measure of bond market volatility. It is Wall Street’s most widely watched benchmark for U.S. Treasury market volatility.

Bassman told Xie that he first came up with the idea for the ETF in late 2020, a few years after retiring from Pacific Investment Management, where he worked with Paul Kim—who started Simplify in 2020—for three years. At that time, the Fed’s zero-rate policy and seemingly unending bond purchases to fight the pandemic were keeping both yields and bond market volatility near record lows.

Bassman, now the managing partner at Simplify Asset Management, realized the Fed’s metaphorical gravy train for bond investors couldn’t last forever. So, in May 2021, he launched the Simplify Interest Rate Hedge ETF. It’s not a fund to bet on the direction of the bond market, but a fund designed for investors to hedge against interest-rate risk and volatility.

Currently, it owns long-dated options—known as payer swaptions—on 20-year interest-rate swaps. This is equivalent to buying put options on 30-year Treasuries. It’s a trade that can pay off handsomely if yields rise along with volatility.

And it has certainly paid off for Bassman in a spectacular fashion. The 30-year Treasury yield surged above 5% this month for the first since 2007. At the end of 2020, it stood at a mere 1.6%. The quick rise in yields sent Bassman’s MOVE Index soaring. It has almost tripled to 135! 

Contrarian Indicator?

Meanwhile, despite the fund’s spectacular performance, investors have been selling the ETF in droves. Assets under management are down roughly 40% from a year ago. This is a contrarian indicator for me, feeding my belief that PFIX has a lot more gains in store.

Those selling the fund apparently still believe the drivel from Wall Street that interest rates will peak “any day now.” The latest moving (and always rising) target from Wall Street is that 5% will be the peak in the 10-year Treasury yield.

Even if the bond bulls are finally right, this fund could still be a good investment. Xie wrote that Bassman: “…acknowledges that unusually high volatility is difficult to sustain.” At its current level, the MOVE Index is at about double the average over the past decade.

As Bassman told Xie: “I want to sell interest-rate volatility. I want to buy the MOVE index at 60, and I want to sell at 130.” It is currently around 132. Bassman added a comment that I am in 100% agreement with: yields are just returning to a more normal level, based on history. The 10-year Treasury yield fell as low as a mere 0.3% in March 2020. “5% is not a crazy number,” he said. “Zero was a crazy number.”

Amen.

PFIX has a very reasonable expense ratio of 0.50%. It does make distributions on a monthly basis and has a current distribution yield of just 1.1%. Bear in mind, this fund’s focus is not income, but a hedge against interest rate moves and bond market volatility.

And, with its fabulous record on returns (up 58% year-to-date), I’d say it is performing its function perfectly.

PFIX is a buy on any weakness, in $90 to $115 the range.
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The real estate investment trust (REIT) sector has suffered for almost two years in a bear market that started at the end of 2021. REIT share prices should soon bottom, and it’s a great time to invest in the sector.

You want to find the best-run companies with the strongest potential for strong dividend growth.

Let me show you two…

REIT values dropped with the rest of the stock market during the 2022 broad-based bear market that bottomed in October 2022. REITs have not joined in the somewhat bumpy bull market that started a year ago.

The problem for REITs has been the Federal Reserve’s continued interest rate increase.

REITs must pay out 90% of their income as dividends, which means investors view these stocks as income investments. Income investment prices tend to move in the opposite direction of interest rates. As rates rise, investors want higher yields, which pushes down prices.

REITs own commercial properties, and—as real estate investors do—these companies use debt to pay for a large portion of the investment properties purchased and owned. Rising interest will increase the cost of debt as commercial mortgage loans or bonds mature and must be refinanced. Higher interest expenses can squeeze net income and the cash flow to pay dividends.

In addition to the interest rate challenges, REITs have been hit by the challenge of empty office buildings as employees resist the idea of returning to in-office work. Owners of city center office buildings face serious challenges.

In investors’ minds, office sector challenges have tarred the entire REIT sector. The reality is that there are a couple dozen different types of commercial properties, and most REITs focus on just one.

With the Fed close to finishing with increasing interest rates and expecting they will be able to start reducing rates next year, we should be close to the bottom of the decline in the REIT sector.

Here are a couple of investment ideas in the REIT sector. One is an ETF, and the other is a well-run but beaten-down individual stock.

The Hoya Capital High Dividend Yield ETF (RIET) employs a balanced approach to diversify the portfolio across small, medium, and large REITs. Here is the targeted portfolio breakdown:

RIET pays stable monthly dividends and currently yields over 10%.

Kilroy Realty Corp (KRC) is an office sector REIT. Kilroy develops, owns, and operates a portfolio of Class A office properties on the West Coast and in Austin, TX. Owners of lower-quality properties will feel the office sector problems. Class A buildings should stay fully leased.

Kilroy Realty has a long track record of above-average performance. With the share price down by more than 50% since April 2022 and a current yield of over 7%, the return potential from here for KRC is outstanding.

An old saying is that the stock market doesn’t ring a bell at the bottom of a downturn to announce the next bull market. REITs are poised for a bull market that could go on for several years.
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Last week, one of my favorite income stocks issued a press release with its preliminary third-quarter results. This business development company (BDC) extended its long tenure as the best company and stock in the category. If there ever were a “buy-and-hold forever” stock, this one would be at the top of my list.

Let me show you why…

Congress created the business development company structure to provide debt and equity capital to small-to-midsize corporations. A BDC must, by law, distribute 90% of its net investment income as dividends to investors.

Most BDCs focus on the lending side, making loans to generate relatively stable net investment income. Main Street Capital Corp (MAIN), the stock in question, is different. The company does make loans, but it also owns a significant amount of equity in its client companies. Main Street helps its clients with extensive management support.

Main Street typically announces preliminary quarterly results a few weeks before the release of the official results. The press release says it best, so I have excerpted it here (emphasis added):

In commenting on the Company’s operating results for the third quarter of 2023, Dwayne L. Hyzak, Main Street’s Chief Executive Officer, stated, “We are pleased with our performance in the third quarter, which resulted in continued strong recurring operating results, a new record for net asset value per share for the fifth consecutive quarter and a return on equity of over 17%. These third quarter results continued our positive performance over the last few quarters and resulted in a return on equity of over 17% on a trailing twelve-month basis, highlighting the consistency of our positive performance.”

Mr. Hyzak continued, “Our distributable net investment income in the third quarter exceeded the monthly dividends paid to our shareholders by over 45% and the total dividends paid to our shareholders by over 5%. Based upon the continued strength of our performance in the third quarter, we expect another meaningful supplemental dividend to be paid in the fourth quarter of 2023. This would represent our ninth consecutive quarterly supplemental dividend, to go with the six increases to our regular monthly dividends in the same time period, allowing us to deliver significant value to our shareholders, while continuing to maintain a conservative dividend policy and retain a meaningful portion of our income for the future benefit of our stakeholders.”

For the third quarter, MAIN paid a monthly dividend of $0.23 per share and a supplemental dividend of $0.275 per share. The monthly dividend was increased to $0.235 per share for the fourth quarter.

In the third quarter, MAIN paid $0.965 in total dividends, and the NAV increased by at least $0.61, to $28.30 at the bottom of the forecast NAV range. The dividends paid plus the book value growth gives a 5.7% return to investors for the third quarter.

This level of total return is not an outlier. The press release noted that supplemental dividends have been paid for nine consecutive quarters, with another likely for the fourth quarter. The monthly dividend has grown by 15% over the last three years. Over the same period, the NAV increased by 12.5%.MAIN has been a portfolio stock in my Dividend Hunter service since our second issue in July 2014. It is a stock that every investor should own.
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What do consumers do when they want the latest fashion, but inflation has priced it out of range? Answer, buy “used”, but authenticated, jewelry and watches from a company like Envela (ELA – Get Rating).  

Envela is in the “re-commerce” business operating in two segments. The first is consumer focused, and involves selling preowned luxury goods and metals. This includes high end jewelry, watches, and precious gems, as well as silver and gold. These items are sold through retail outlets and via its online presence. 

The second line of business is commercially focused and involves recycling and/or refurbishing consumer electronics and commercial IT. It’s a fairly unique model for a publicly traded company. 

If economic conditions continue to tighten and growth slows, Envela is in a great position, as sellers encountering tough economic conditions can liquidate their high end jewelry, but buyers seeking “value” have an option to still purchase high end goods. 

CEO Loftus highlighted this point in ELAs latest earnings release stating, “We are confident that our retail expansion strategies will not only generate increased revenue, but also enhance our market position, and ultimately provide strong returns for our investors. Supported by our solid foundation of financial health, we are still in the early stages of expanding our store footprint.” 

Envela presents a solid value here, with a PE of only just over 8, and trading at 8.4x earnings and 10x projected earnings. It possesses a strong balance sheet and good track record of sales and earnings growth. 

ELA’s strongest rating component in our POWR Ratings is in the Sentiment category, which aligns with my thoughts around the company doing well in a challenging inflation and growth environment. 

The stock is currently trading at the bottom of a long trading range dating back to late 2020, at just over $4. The stock has traded in the $8 range earlier this year, and could move back in that direction as demand for its products grows. 

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ELA shares were unchanged in after-hours trading Thursday. Year-to-date, ELA has declined -22.62%, versus a 12.74% rise in the benchmark S&P 500 index during the same period.

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Last week, in my 48-Hour Income service, we sat on our hands. First off, 48-Hour Income is a cash secured put selling service where the goal is to generate 1% to 3% returns per week. We generally make one trade a week with the occasional two-trade week. However, last week we made no trades. Why?

Last week, ONEOK Inc, finalized its acquisition of Magellan Midstream Partners. The deal produced a unique merger with some big effects on energy income investors like us.

So let’s review some pre-merger financial results and make a guess about ONEOK’s future.

In May, ONEOK Inc. (OKE) and Magellan Midstream Partners (MMP) announced an agreement for ONEOK to acquire Magellan in a deal valued at $18.8 billion. This was a unique deal: while both companies operate in the energy midstream space, ONEOK is organized as a corporation, and Magellan was structured as a master limited partnership (MLP).

The different business structures meant the deal would be a taxable event for Magellan investors. With an MLP, distributions paid are not taxable but instead reduce an investor’s cost basis. As a result, many MMP investors entered the deal with large taxable gains. Despite this issue, Magellan shareholders approved the acquisition, which is now a done deal.

Let’s look at what each company brings to the new combination.

Magellan Midstream operates a pipeline and terminal network transporting crude oil and refined products, and owns the most extensive common carrier refined products pipeline system in the U.S. The emphasis is on refined products, with 9,800 miles of pipelines and 54 terminals. Crude oil assets include 2,200 miles of pipeline and 39 million barrels of storage.

Here are MMP’s results for the first half of 2023:

Total revenue: $1.75 billion

Net income: $513 million/$2.52 per share

Free cash flow: $552 million

Distributions paid to shareholders: $425 million

ONEOK owns and operates a natural gas gathering, processing, and transport system.

Here are OKE’s results for the first half of the year:

Total revenue: $7.53 billion

Net income: $1.52 billion million/$3.38 per share

Adjusted EBITDA: $2.67 billion

Distributions paid to shareholders: $857 million

Shares outstanding 449 million

ONEOK issued 135 million new shares in the acquisition, increasing its share count by 30%. You can see that the MMP net income adds about the same percentage to the OKE results.

At the time of the merger announcement, ONEOK said it expects the deal to be earnings accretive starting next year. Earnings growth of 3% to 7% per year is expected through 2027, with free cash flow growth of more than 20% annually.

ONEOKE has been a Dividend Hunter-recommended portfolio stock since 2018. I like the stock for its attractive 6% yield combined with a long history of dividend growth. The dividend has grown by 28% since the addition. I expect the MMP acquisition will produce high single-digit annual dividend growth.
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I was pleasantly surprised to read a recent Wall Street Journal article highlighting the investment benefits of Business Development Companies (BDCs).

The article included a couple of BDCs that are on my Dividend Hunter recommended portfolio.

Let’s dig in, and take a look at why these BDCs are such great income investments…

The WSJ article was titled “The 11% Yield That Isn’t in Your Mutual Fund.” It took an evenhanded look at BDCs. Here are some excerpts and, when appropriate, my comments.

BDCs typically raise money from public stock investors that they then lend to small, often private, companies. After banks pulled back from lending in the wake of the 2008-09 financial crisis and again in March following the collapse of a handful of midsize lenders, BDCs helped fill the void.

BDCs have operated in good financial times and bad. It’s just when things turn bad that these stocks get more investor interest.

They give individual investors the opportunity to tap into high-yielding private markets that are usually only open to big, sophisticated institutions. The companies pay out at least 90% of the interest they receive in cash dividends, much like real-estate investment trusts, adding to their popularity among small investors.…

The fat yields on BDCs come with a catch: Unlike a standard fixed-pay bond, the payouts aren’t set in stone. What the shareholder actually receives depends on what the BDC earns from its investments. BDCs could end up paying dividends that are smaller—or larger—than projected.

The top-tier BDCs have consistently grown their dividend rates. These are businesses that can be managed for growth.

“As BDCs have become larger, we can now offer financing to much larger and more important companies than before,” said Craig Packer, CEO of Blue Owl Capital Corp. “Today, we lend to companies that any lender would like to finance.”

Blue Owl lends to nearly 200 companies for a total portfolio of nearly $13 billion.

Tim: Blue Owl Capital Corp (OBDC) has been a Dividend Hunter recommended investment since its 2019 IPO. The company has grown to become the second largest in the sector.

Rising interest rates have been a boon to the sector. About 80% of BDC assets are floating rate loans, according to Robert Dodd, senior analyst at Raymond James. That means the companies earn extra income from their loans when rates go up, as long as their borrowers can make their payments.

Many BDCs are earning much higher net interest income. Instead of increasing their regular dividends, the companies have been paying and declaring supplemental dividends. This dividend strategy allows investors to count on stable dividends if and when interest rates decline.

Shares of BDCs aren’t found in many common investment products. Securities and Exchange Commission rules require any mutual fund or index fund that owns BDCs to report management fees earned by the company as a fund expense. That drives up expense ratios reported by funds and, in turn, limits interest from institutions in the sector.

This last fact was new to me. It feeds into the investors’ focus on lower fees instead of investing for better returns.You don’t need an ETF for a mutual fund to get into BDC investing. These are publicly traded stocks, easily purchased through your brokerage account. I currently have four top BDCs on the Dividend Hunter recommended portfolio. To join and get the full list, take a look below.
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