For our Friday File today, before I head out the door to take a week of respite with the family for Thanksgiving (no Friday File next week, by the way, though we will have our annual “Turkey of the Year” piece next week), I thought I’d take a look at a teaser pitch going around for the kind of thing that has much broader appeal than the small-cap tech or biotech stocks or miners that spur thoughts of overnight riches: income.
Today’s pitch is from Mark Skousen’s Forecast and Strategies, which has been around for a long time (the ad letter is actually signed by his publisher, Roger Michalski), and he throws out hints about a couple dividend-paying stocks. Just the kind of respite we might need after a week of risky oil stocks, levered bets, and biotech gambles crossing the transom.
The first idea is a MLP, one of the major pipeline owners in the country, and he says it has “The Perfect Dividend Chart” (meaning, a dividend that grows consistently and rapidly over a long period of time).
The second idea, the one that gives us our “best company money can buy right now” headline today (that’s a quote from the ad, to be clear), is a Business Development Company (BDC), one of the less-discussed types of tax-advantaged income investments (REITs and MLPs are generally more popular).
Neither is likely to be a shocking “limited time opportunity” that sends you rushing to your broker’s order ticket, but both are large and well-run companies with stocks that have been good to investors for years. We’ll go through them one at a time.
Here’s the intro from the ad:
“The Secret Pipeline System Six Times Bigger Than the Controversial Keystone XL
“The Company Behind it is on Track to Transport $165 Billion Worth of Oil in a Single Year…
“Setting the Stage for one of the Most Dramatic Stock Moves We’ve Seen in Decades…
“And a Single Event in 2015 Will Kick Everything Off.”
No matter how you feel about the Keystone XL, it’s that feeling that is the driver of the decision and the argument — the pipeline itself is not likely, from my perspective, to dramatically alter the energy market or the environment, but it is something specific and clearly identifiable to fight about, a line in the sand that can be drawn and redrawn and tussled over by both sides until nothing matters except that line.
Here’s more from the ad:
“A new energy company (virtually unknown to most Americans) has secretly gone about creating an alternative pipeline system that’s set to generate billions in new revenue…
“The series of projects, already approved and in operation, is six times larger than Keystone.
“Keystone XL’s pipeline at maximum capacity can transport 830,000 barrels per day… Approximately $77 million worth at today’s prices.
“By comparison, this company’s pipeline system can transport more than 5 million barrels every day… About $465 million worth!
“It’s now transporting crude oil, natural gas, ethane, and more from America’s huge energy reserves. They’re connecting the Eagle Ford, Utica, Bakken Shale, the Gulf Coast, the Marcellus Shale, and virtually every other major natural gas and oil reservoir in the country.”
That gets your attention, that some company is “secretly” working around Keystone XL… because “secret” means “hey, no one knows so maybe I’ll get rich first!”… but that comparison, of course, is silly. That’s a little like saying that the Toronto 407 ETR toll road is not that big a deal because the New Jersey Turnpike is so fantastically successful. Transportation is all local — there are a lot of ways to get from point A to point B, whether you’re a truck driver or a barrel of oil, but there’s really only direct competition on comparable routes between two points. This company has not, of course, “secretly” built a big pipeline from Alberta, Canada to Cushing, Oklahoma, though they are one of the larger pipeline operators so they do have capacity to move product on many different routes around the country.
And this “secret” company is a big dividend-raiser, which is perhaps the best kind of stock around which to build a long-term portfolio:
“They recently set a new record in gross operating margin. They set a new record in cash distributions. They set new records in revenue, gross profit, and net income.
“And the cash distributions the company is handing to shareholders is unlike anything we’ve seen in years.
“They’ve never decreased dividends once in company history. And they’ve raised them — not every year — but every quarter since 2011.”
So that’s all well and good, and we can identify the company based on that — but why is now the time?
Because Skousen thinks (and he’s not alone on this, of course) that Congress will pass a bill lifting the U.S. crude oil export ban next year, allowing for exports from our booming domestic oil production (in addition to the push to export LNG, though that’s a much trickier business). Exports will essentially all go through the big ports in the Gulf of Mexico, most likely, so he thinks the companies — like this one — who control a lot of pipelines in the region will see more traffic in those pipes.
Here’s some of that argument in his words:
“As many of you remember, the 1970’s oil crisis led to panic about an energy shortage. Long lines at the gas stations. Price gouging and wild swings in oil prices….
“So the government implemented a ban on exporting crude oil.
“We could ship out gasoline and other products. But not actual oil.
“And in 2015, that’s finally changing.
“Since America is now an energy superpower, the government is finally allowing U.S. companies to ship out crude.
“And let me tell you, NO COMPANY stands to profit as much as the one I’ve talked about today.
“Because if any energy company wants to export oil, they first have to get it to an export facility.
“And to get it there, guess what they need…
“And who created and controls 50,000 miles of pipeline while everyone else was arguing about Keystone?
“This single company.”
A lot of that pipeline was created even before the crude export ban, and over the many decades since — well before Keystone XL became a political flashpoint — but yes, here Skousen is hinting at Enterprise Products Partners (EPD).
EPD is a Master Limited Partnership (MLP), a tax-advantaged vehicle that was created under Reagan to spur development of energy infrastructure in the United States. These investments are often teased as “oil pensions” or “oil paychecks” because they’re essentially utilities — most pipeline MLPs make the lion’s share of their earnings from tolls on the use of their pipelines, and those pipelines, particularly the interstate ones, are often regulated or irreplaceable and have pretty consistent pricing increases and profitability, and these pipeline networks generate huge amounts of cash flow.
Their goal is to return that cash flow to investors, since these are set up as income-focused investments, and MLPs are uniquely tax-advantaged not only because they don’t pay corporate income tax as long as they distribute almost all of their income to unitholders… but because their cash flow is so much greater than their income, and they distribute a lot more than their income.
Huh? They distribute more than they make? Isn’t that a bad thing? Not necessarily, at least not for MLPs and other owners of huge capital-intensive assets. Those who don’t follow accounting don’t necessarily find this easy to understand, but “income” isn’t the same as what a small business would call “cash earnings,” the money you can take home at the end of the night. A key benefit of MLPs is that pipelines have high depreciation costs — to get the taxable earnings, you have to calculate depreciation for these big, expensive pipeline networks, and they get depreciated over relatively short periods of time… it might be that the asset has to be “written down” over seven years, or over 15 years, or something else that the courts and CPAs require, but the pipeline may well be in use for 20 or 30 or 75 years, and the depreciation cost might be (and typically is, one assumes) much higher than the actual cash maintenance/restoration costs that these pipes incur over time.
So pipeline companies hold back some cash for maintenance and capital expenses, but they distribute most of it to unitholders — some more aggressively than others — and the amount of the distribution that exceeds the actual accounting profits of the partnership is classified not as income, but as return of capital. That’s key, because it means you don’t pay tax on it that year — it just reduces your cost basis.
So if you have a $30 MLP unit (they typically call them units, not shares or stock, but it’s mostly the same thing) and you get a $3 distribution (they usually use that term instead of “dividend”) and $2 of that is return of capital (mostly because it’s counted toward depreciation on the books), you pay income taxes only on the $1 that’s actual earnings… and then your cost basis in the unit goes down to $28… if you sell it right away, you have that $2 per share profit on the sale of the unit that should be taxed as a capital gain, but if you don’t sell it right away and hold on for years (or decades), the cost basis keeps going down and you don’t owe any taxes along the way on those “return of capital” distributions until you do sell and realize that capital gain.
Those who are estate planning often love these, too, because as the law stands now my understanding is that MLP units that are passed down to an heir get a re-set of their cost basis… so if you collect income for ten years and the cost basis goes down to zero, meaning you’d theoretically have a big tax bill on that $30 per share of capital gains if you sold, your estate can pass those on to an heir and the tax obligation disappears, that heir’s cost basis is reset to the then-current price. I’m not a tax lawyer, but that’s how I understand it — please don’t make any decisions based on my explanation, ask an actual expert if this is important to you.
So what’s the downside? Well, Enterprise Product Partners (EPD) is huge, with an enterprise value above $90 billion. And a little bit complicated, in that they also do a lot of “midstream” work, they own storage facilities, and they produce and move a lot of refined products, particularly from natural gas, they’re not just an interstate pipeline operator… but really, the larger issue long-term is interest rates. Like many income investments, EPD and the other MLPs have been rising in price on a pretty dramatic trend over the past five years, and the yield has been stepping down over that time as investors have grown increasingly more desperate for income.
EPD’s yield now is about 3.75%, which is historically very low for them — but, of course, the competition is very low by historical standards, too, whether you’re looking at REITs or other MLPs or bonds or even savings accounts. When the 10-year note is around 2%, getting twice that much from an investment that’s steadier than many stocks and should be able to grow the distribution to keep up with inflation is quite appealing (those 10-year notes, by contrast, will pay the same coupon every year until they mature, no possibility of increase). Whether EPD will perform well if and when those bond yields get back to 4-5% is part of the concern for long-term investors, but it certainly doesn’t seem likely that this will happen anytime soon. EPD’s yield over the last 15 months or so has almost exactly tracked the 10-year note yield, though with much more volatility.
So if you’re not worried about interest rates spiking up rapidly (I’m not, which is why I own several REITs), then these kinds of investments are certainly good performers. And whenever possible, long-term investors should reinvest their dividends or distributions — you can see from this chart what the difference is over time, the orange line is the “total return” for EPD over a decade, with distributions reinvested; the blue line is the price performance if you took those distributions in cash and did something else with them (the chart assumes you blew it on comic books and soda, though you could instead have perhaps used those distributions to buy shares of something that did far better over that decade, like Google or Monster Beverage or Allergan).
Pipeline MLPs distribute most of their cash, so they need to borrow or issue more shares to grow, and they sometimes get richly rewarded by investors for growing… but it becomes more and more difficult to grow rapidly the bigger you get (each new pipeline or extension or facility has a smaller impact on the overall cash flow). But EPD has been doing this a lot better than most, growing both by building new assets and through acquisitions.
Skousen is not the only one touting MLPs as a good play on the boom in oil production, or as a way to invest in oil production without much oil price sensitivity (at their best these kinds of companies are toll collectors, they don’t have big exposure to commodity prices from buying and selling products, so the crash in energy prices should be good for them… as long as it doesn’t lead to a substantial drop in U.S. energy production). In the past, the big drops in oil prices that have also brought down MLP prices have turned out to be big MLP buying opportunities — though that might not be as easy to profit from now, as the spike down in EPD (partly on oil panic) was very brief in October, and the shares recovered very quickly.
If you’d like some additional cheerleading on that front there’s an article from Marketwatch here, or there’s an exhaustive look at EPD as of their last quarterly update from Market Realist here. The short sum-up of EPD is that it’s the biggest and the best MLP by many measures, and it also has the lowest yield and one of the more consistently growing yields — investors are very confident in this one, it’s got plenty of cushion to keep raising distributions for years, and it’s a proven performer. It may well not return nearly 500% over the next decade, particularly since interest rates are not likely to be in a continued downtrend for another decade, but substantial growth is certainly possible and continued dividend growth is very likely — and it will probably have less downside than the higher-yielding, riskier MLPs.
And what was the other income stock touted by Skousen, the BDC? Let’s check out his clues — here’s the lead-in:
“The Best Company Money Can Buy Right Now
“One of the biggest stories going right now is the scorching hot IPO market.
“For example, Twitter jumped 73% on it’s opening day. Sprouts Farmers Market rose 123%. And most recently, Alibaba gained 36% on its first day.
“But the real money was made far earlier.
“For example, early Twitter investors made over 610%. Some Sprouts insiders got 1,354%. And Alibaba insiders reportedly quadrupled their money.
“But unfortunately, all those gains were reserved only for people who had insider connections to venture capital funds, and millions of dollars in investment money.
“The second company Dr. Skousen is recommending is quickly changing that.
“In short, this company targets cash flow positive private businesses BEFORE they go public and helps regular people get a piece during the highly profitable early days.”
And apparently things have been going well for them…
“Over the past two years, they’ve doubled the money they’re bringing in.
“Operating income is soaring. The company offers one of the highest yields in the business. Dividends are up dramatically since even before the financial crisis struck.
“In fact, this company likes to do something a little unorthodox.
“Whenever they have a great quarter, they reward investors with big blowout spikes in dividend payments.”
And there’s also been a lot of insider buying, we’re told:
“In the past year, no fewer than 12 company directors, owners, and board members executed 26 separate transactions to acquire more shares themselves — all of them at market price.
“It’s rare to find a stock with high yield, growing dividend payouts, huge increases in income, solid management, insider buying, and bright prospects for the future.”
So which one is this? Thinkolator sez it’s Main Street Capital (MAIN), but that doesn’t exactly match the clues — I think that’s because Skousen’s ad copywriter copied down the data from an older report of Skousen’s without paying close attention. The quote is actually a direct match with one from a special report of Skousen’s that I ran across online recently here (that report also gives his take on EPD, perhaps this is even the special report they’re now trying to peddle to get folks signed up for Forecasts and Strategies — I’m not sure why it’s freely available online).
And actually, consistent insider buying is a hallmark of a LOT of BDCs — many of them have long runs of frequent insider buying, sometimes even tiny purchases every few weeks or every few months by lots of different insiders. None of them match up exactly with the “12 insiders making 26 purchases” in a year… but MAIN insiders did that in a month, last December. It could be that a lot of these are effectively insider dividend reinvestments, I’m not sure — MAIN pays a monthly dividend instead of a quarterly one, which is one of the reasons a lot of investors love it. They have also paid special dividends to boost that base payout pretty frequently, typically twice a year (mid-year and in either December or January).
How else does it match? Well, MAIN did indeed just about double their operating income over the past two years (doesn’t really matter whether you’re working back from now, or from 2013, it’s been a good period for them)… but since this is a BDC, which like REITs and MLPs can’t reinvest it’s own earnings to grow, it sells new units to give it more cash to lend, and therefore more fuel to grow. It’s always important to check the share count when you’re looking at growth — income growth is not the same as per-share income growth. So yes, like most such companies, doubling the operating income has gone along with a bit boost in share count… though the share count only went up about 65% over those two years.
Business Development Companies are set up to be pass-through entities, much like MLPs or REITs, but their business is typically “small” or “mid market” business lending — financing the companies who are too big to rely on loans from their local bank, but too small to get decent terms from investment banks or issue public debt. This is not the same thing as “venture capital”, most BDCs (including MAIN) do not really focus on early-stage ventures — they’re lenders, not venture capital speculators, though they do often get an equity “kicker” along with their loan that they hope will boost returns (that’s not a hard and fast rule, there are earlier-stage BDC companies, including GSV Capital (GSVC), which gets teased often as a way to get “Silicon Valley Rich” and buy Dropbox and other hot pre-startups for pennies). Dividend Detective does a pretty good job of explaining the basics of these (and listing them). Essentially, they’re private bankers who sometimes also make equity investments in the companies they lend to.
Here’s how MAIN describes itself:
“Main Street is a principal investment firm that provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies. Main Street’s portfolio investments are typically made to support management buyouts, recapitalizations, growth financings, refinancings and acquisitions of companies that operate in diverse industry sectors. Main Street seeks to partner with entrepreneurs, business owners and management teams and generally provides “one-stop” financing alternatives within its lower middle market portfolio. Main Street’s lower middle market companies generally have annual revenues between $10 million and $150 million. Main Street’s middle market debt investments are made in businesses that are generally larger in size than its lower middle market portfolio companies.”
This has been one of the better-performing BDC’s for a long time, though the performance of this group is highly impacted by the financial crisis and the bounce-back from that crisis — so if you go back to 2007, MAIN is the top BDC among the big ones who’ve been around for a while (including PSEC, ARCC, ACAS, PNNT, for example) with a total return, dividends included, of about 300% over the last seven years…. for different time periods, others stand out, like ACAS over the past few years because it fell so much harder than many others in 2009 that the bounce back was more dramatic. This year, MAIN leads the pack with a total return of about 13%, but the group has been flat to down for a couple years and is, even more so than MLPs, both interest-rate sensitive and cyclical.
BDC’s typically lend to mid-size companies, so they have exposure to firms that are often not very sturdy or are economically sensitive — companies that might be more likely to default if the economy goes south, and because BDCs themselves are levered (though they don’t tend to borrow “up to the limit” now like many of them tried to back in 2007 and 2008), they can feel the pain sharply if their access to wholesale financing dries up at the same time that their customers have trouble making loan payments (as in, 2009). I expect the next crisis to hit the stock market will probably be different from that last crisis, so from my perspective it’s likely to be the interest rate pressure that hits BDCs harder — whenever the Fed starts talking “bearish,” income investments all take a hit, and BDC’s more than most because they are at the high-yield end of the income spectrum. MAIN shares dropped by about 20% during the “taper tantrum” in the Spring of 2013, when the Fed was starting to talk tough about ending quantitative easing, so that’s the worry that most investors have about BDCs (and REITs, and corporate bonds, etc), that a shock that spikes interest rates up will, thanks to the wonder of math, drive prices down for income investments again.
I’m not so worried about that as an immediate or sharp risk, but BDCs are also sometimes hard-to-predict organizations, with accounting that’s somewhat difficult to understand and, often, a history of paying out more in dividends than they can really afford (MAIN’s payout ratio varies widely, but seems generally to have been at least close to sustainable from their earnings), so I might not blame you for wanting to look at an ETF instead of at the actual BDCs.
MAIN has historically been a very good performer, maybe the best in recent years, and investors seem to love that monthly dividend. The trailing yield (including those two special dividends over the past 12 months) is about 7.7%, so that’s pretty good. If you want to consider a fund instead, the two available ones are BDCS and BIZD, the latter has done better since inception, but the former has been around a lot longer. BDCS is actually an ETN, not an ETF, so it’s technically a debt security (and carries the credit risk of UBS), but it has a higher yield than BIZD… and it’s also offered in a 2X levered version which, though obviously more volatile, offers double that yield at more than 15% (BDCL is the levered version of BDCS — so that leverage would mean ). You can see the info on BIZD here, and on BDCS here and the levered BDCL here.
MAIN has beaten the average BDC, as represented by most of those big ones I can think of and by BDCS over the last few years, and it’s one of the few (relatively) big ones that is actually up on a total return basis this year, but any individual BDC will be more volatile and require more attention paid than the ETFs. And be wary about counting on anything beyond those dividends — since the March 2013 “taper