I’ve got a half dozen notes and comments on companies I own and follow for your Friday File pleasure today, but first I want to toss out a teaser solution for you to chew on… it’s a fun one.
The pitch is from Keith Kohl for his new High Yield Energy Report, a newsletter that Angel Publishing started late last year with both Keith Kohl and Christian DeHaemer supplying the ideas and commentary — I haven’t written about this letter before, but those two certainly have their share of both bust and boom teaser picks over the years.
This teaser ad gets our attention with the idea that Warren Buffett is bribing President Obama, which, given the current political climate and the leanings of most investment newsletter customers, is like throwing a limping zebra in the lion’s cage… the lion isn’t going to think about it, he’s going to jump on it and eat until he falls asleep. That’s the goal of such teaser pitches: to appeal to conspiracy ideas or political leanings so strongly that folks who believe the “red meat” you throw in the cage are inclined to believe everything else you say, and folks who don’t believe it will read carefully out of anger and maybe get sucked into the rest of the marketing message, giving you a chance to sell lots of newsletters to both groups if you trigger the right greed receptors in those brains.
The same thing happens with marketing on both sides of the political spectrum, of course — it’s just that the people who spend the most on investment newsletters tend to be (and have always been) affluent white men in their 60s and 70s who skew firmly Conservative/Republican, so that’s the profitable marketing message. And the worst thing a copywriter can do is create something that’s ignored, making people either cheer or scream when they read your ad is a way to be certain you’re not ignored.
None of that means the stock they’re pitching is necessarily bad (or good), of course — it just means we have to separate the stock from the marketing, as usual, so we can look at it a bit more dispassionately in the light of day.
So we’re going to get a solution to the tease for you… and on the way we’ll skip right over most of that baiting, but here’s just a small taste to give you an idea (you can see the whole ad here if you like):
“Buffett’s $44 Billion Bakken Bomb
“How the biggest buy in Berkshire Hathaway’s storied history completely (and violently) backfired…
“Leaving you with the chance to play the trend Buffett didn’t see coming for $738 per week….
“On November 3, 2009, Mr. Contrarian himself announced that Berkshire Hathaway had acquired the BNSF railroad for the extraordinary sum of $44 billion.
“He was so bullish on this play that he even told Charlie Rose he thought it would bolster portfolios for the next 200 years….
“what the world’s greatest investor couldn’t have known was that he was essentially writing his own financial death sentence….
“And it wouldn’t be long before Buffett would be found scrambling (even involving Obama in the matter) to correct what would turn out to be the biggest blunder of his storied career.
“Best part is… it’s a blunder that could end up making you $738 per week if you play the situation correctly.”
That’s a story that’s been circulating for a long time, the part about Buffett opposing the Keystone XL Pipeline and using his influence to help kill it because that pipeline would compete with the shipment of oil by rail using Berkshire’s BNSF railroad. The part about BNSF being a “blunder” of a purchase by Berkshire is a little hard to swallow — BNSF, like all railroads, is a very long-cycle business (ie, a “bet on the economy”) and was expected to be a pretty stable (almost utility-like) generator of returns for Berkshire for 100 years. The oil shipping has helped BNSF, Union Pacific (UNP) and Canadian Pacific (CP) quite a bit, certainly, but I suspect the business would have been decent without that. Maybe not great, since coal declined and they have fluctuated based on demand for coal, grain, and now oil shipments, but solid — and with the oil demand (which has also created a big capital investment requirement, as tank cars have needed to be built and tracks improved to deal with huge congestion issues brought on by crude and large grain harvests), the railroads have all done extraordinarily well.
Berkshire paid about $45 billion for BNSF (including taking over their debt), and they’ve gotten more than $15 billion in dividends from BNSF so far… way, way better than Buffett anticipated, at least publicly, this was supposed to be a way to put his giant pile of cash to work for the next century, not a way to make a quick windfall in a few years. And the railroad, if it were valued in the market like somewhat similar Union Pacific at about 5X sales, might be worth as much as $100 billion today (Berkshire’s market cap is “only” $240 billion). People called BNSF a blunder when Berkshire was buying it in 2009, but that’s because he bought it at a “full valuation”, not because there was anything wrong with the business… and recall, oil was still in the 2008 collapse then and the Bakken was highly uncertain, at least for the near term.
But anyway, that’s not the main point of the teaser pitch — it’s just there to get your attention. The point from Kohl is that the crisis that will bring down BNSF is the fact that pipelines will inevitably expand to replace the “blunder” of Buffett’s “oil by rail” business, whether Keystone specifically is built or not, and that this is largely because of the risky nature of shipping oil by rail. That’s headline news every few months as a crude-carrying train derails and explodes, as happened most recently to a CSX train in West Virginia, and it’s probably true — efficiency demands that more oil move through pipelines, which are a much cheaper way to transport liquids long distances, and less in tanker cars. It’s obviously not going to happen overnight, and pipelines can’t reach everywhere, but it’s certainly possible that rail shipments of crude oil will fall (particularly if production falls for a while with lower oil prices), and that should hit profitability at the railroads. I sure wouldn’t sell Berkshire for that reason, but that’s not the point of the ad.
No, the point of the ad is that you should buy the company that Kohl says will benefit from increased scrutiny of pipelines, and from the pressure that’s being put on pipeline operators by government regulators (bribed by Buffett, naturally — kidding!) to improve safety and reduce spillage and seepage, the things that worried Keystone opponents most of all (the opponents like midwestern farmers and other folks on the route who worried about spills and their aquifer, at least — Keystone expansion became a political litmus test after a while, so it seems everyone is either an opponent or a proponent now, and feels desperately strongly about it whether they know anything about the issue or not).
So after all that hullabaloo, it appears we’ve got a pipeline service company being teased. And given that the newsletter is called High Yield Energy Report, it’s almost certainly a big dividend payer — so it’s probably either Canadian or a MLP. Let’s dig in to the clues, shall we?
He starts by implying that Buffett got into pipelines to “save” his investment in the railroad after one of the rail car explosions was “blowing up” in his face…
“Buffett knew no amount of presidential pandering could save him.
“So, on the exact same day that Casselton went up in flames (and thousands of gallons of crude flowed into a nearby lake), Buffett switched gears entirely.
“While his railroad investment was literally burning, he quickly and quietly spent $1.9 billion to alleviate his financial losses with a pipeline company… the very type of investment he’d bribed the President to kill.”
Berkshire has bought quite a few pipeline-related assets over the years as they’ve built up their MidAmerican Energy subsidiary into a major utility/distribution powerhouse (and, like a railroad, a capital-intensive long-lived portfolio of assets that should generate solid returns for decades), they were buying pipelines well before Buffett was making his big investments in railroads. This investment, though, was specifically in a pipeline services company — at the same time as the explosion of the BNSF train, Berkshire was preparing to announce that they had effectively swapped their stock position in Philips 66 for the pipeline services division of that company, and they then effectively tucked that division — which makes chemicals that help make pipelines flow more efficiently — into Lubrizol, Berkshire’s large chemical company bought a few years earlier. I don’t know that it was exactly $1.9 billion they spent in the end, but presumably this is the deal Kohl is talking about.
Here’s some more of the ad:
“All of the major gains in energy transportation in the next two years are going to come from the pipeline sector.
“There will be little to no expansion of rail, and hauling oil by truck is far too expensive (and slow).
“On the flipside, pipelines are cheaper, more reliable, and more efficient.
“So it’s no wonder Buffett is now frantically piling whatever money he can from BNSF into the pipeline movement.
“And while I highly suggest you do the same if you want to make money in the energy sector over the next decade, there’s one caveat…
“I’m not recommending an actual pipeline company today.”
So… what is he recommending? More clues:
“… the company I’ve found researches and develops technologies that improve the flow of pipelines overall.
“So rather than having their hands on just a single project, these guys are involved in every single mile of pipeline that exists and that’s currently being built…
“… it could easily be argued that no single company will be as important to the pipeline boom as the company I’m revealing to you today….
“This play only costs about $13 per share….
“… this new company I’m about to reveal to you — the one that’s about to outperform the market and Warren Buffett — is one of the landmark plays in my service.”
And then, as usual, we get a few more specific clues to whet the appetite (and feed the Thinkolator):
“The group I’ve found looks much more profitable than your run-of-the-mill midstream conglomerate….
“Rather than collecting money from oil companies and spending billions of dollars to dig and lay pipes, this company merely skims a little cash off of the top.
“It collects a small amount of money from each project it can get its hands on…
“And last year, this amount totaled about $200 million….
“… our pipeline capacity is set to double in the next two years….
“That means the new construction could double, maybe even triple the amount of money this company is raking in now.”
And a wee bit more about the company:
“What this company does, among many other things, is test pipelines, oil and gas gathering systems, pump and compressor stations, storage facilities and terminals, and underground disposal wells for safety.
“Since governments in Canada and the United States are now slapping harsh mandates on new pipelines, this company has made its business essential to oil producers, refiners, and midstream companies.
“It currently has 63 customers just for its pipeline inspections alone….
“… since all of the coming gains in the midstream sector will be from pipelines, the company I’ve found stands to have its hand in every single piece of pipe that gets built, every nut and bolt, and every single dig for new construction.”
OK, so that’s an interesting thesis for buying a stock — governments are making it tougher to build pipelines, so they have more safety and inspection mandates…. and more pipelines are getting dangerously old and being replaced or monitored closely, along with new pipelines being built, so the market for these kinds of services should expand substantially.
Who is this company being pitched by Kohl? Thinkolator sez it’s Cypress Energy Partners (CELP), and the info is a little bit stale in the teaser pitch. I got the ad on February 22, but the pricing for CELP (the $13/share and the 12.5% yield) is from about six weeks ago. The stock has staged a pretty strong recovery since then, getting back up to $18 (for a 8.5% yield). The company apparently has a “targeted” distribution amount of $1.55/share (annually — paid quarterly), but is slightly above that now with a run rate of a bit over $1.60 if the payout remains stable. Here’s the quote from their FAQ section, which is a short version of what’s in the prospectus:
“We intend to make a minimum quarterly distribution of $0.3875 per unit ($1.55 on an annualized basis) to the extent we have sufficient cash from operations after establishment of cash reserves and payment of fees and expenses, including payments to our general partner.”
So yes, you could theoretically get the equivalent of a payout of $738 per week from Cypress, but (unless I hiccuped while doing the math) at the current yield that would mean you’d have to own about 24,000 shares, an investment of something like $450,000 at today’s prices. Maybe you have that kind of cash to throw at a small, new and fairly speculative MLP, or maybe you have time for your $5,000 to grow and compound for several decades (assuming the partnership does spectacularly well) to get to the point where it’s spitting out that kind of income. That’s a little above my pay grade — but then, I’m also not counting on any of my individual investments creating that kind of dividend income for me right now.
Cypress Energy Partners is an oilfield services company, initially primarily handling water cleanup and disposal from fracking operations in the Bakken and Texas (they own a bunch of saltwater disposal wells as a primary asset, and manage some others, as well as some water pipelines), and it so happens to have bought a pipeline testing company called Tulsa Inspection Resources over the last year and a half or so (they bought control of it in 2013, and bought the rest in a drop down from the general partner or other affiliated entities just this month, paying about 7X EBITDA). The company’s strategy is playing out pretty nicely on that front, since pipeline inspection should be a steadier business than water disposal if drilling activity continues to slow in the Bakken.
They are very new as a MLP, they have apparently existed since 2012 but went public in January of 2014 at $20 (the “minimum distribution” target is a 7.75% yield on that IPO price, which presumably is what the market required to get interested at the time), and it was well-received, hovering around $24 for the first half of the year until it started to dip with oil prices in the late Summer and Fall, bottoming out between $12-13 in December and January before the recent recovery.
It’s a little tough to get a handle on the business, because although water disposal should be driven by new wells and drilling activity it does also have a sustaining factor — the wells produce water throughout the life of the well, so it’s not like water stops being produced if people halt new drilling for six months, but clearly demand for water disposal will be lower with lower drilling activity. And that is their high-margin business, though it’s a far smaller business in revenue terms than is the inspection business.
Which makes sense — the water disposal business is more typical of the MLP structure, it consists mostly of assets (water pipelines and disposal wells) that have limited ongoing capex requirements and steady cash flow, giving a pretty nice cash margin on the fee income they receive for transporting and disposing of waste water. The inspection business is essentially a consulting business — they get paid a daily fee for each inspector they send out, so the number of inspectors employed is a key indicator of revenue… but though it’s not capital intensive it’s also not terribly scaleable, they also have to pay each inspector, so margins are not particularly high and there isn’t a lot of depreciation or other non-cash stuff that they can take advantage of with a big workforce the way they can with a big physical asset.
I grabbed the results from the first three quarters here to give you an idea of how this plays out in the income statement — you can see the huge disparity in revenue, but the cash flow (adding operating income to depreciation, etc.) indicates how dramatically important the water and environmental services division is for creating that steady cash flow for the distribution. The growth in pipeline inspection shown in this table comes mostly from the fact that the 2013 numbers are really only one quarter, not three quarters, since they made the acquisition in June 2013. You can see the full filing here for more details.
I’m not sure exactly when they will report their fourth quarter — the annual report filing is due by the end of March, it appears, and they will likely issue a press release and have a conference call before then sometime.
For me, this looks kind of interesting as a high yield “washout” play to maybe buy when investors are convinced that things were terrible — so had I known about it two months ago when it was in the $13 range it would have been more compelling, but with a yield of just a bit over 8% and what I would consider to be substantial uncertainty about whether they’ll be able to grow that distribution at all, along with a complex structure that has non-publicly-traded related parties involved and selling assets to the partnership, it’s not as compelling. The hope seems to be that the water disposal business will remain fairly stable, though almost certainly at a lower cash flow-generation rate than in the heyday of earlier 2014 when drilling activity was much higher, and that they can grow by continuing to hire more inspectors and get them into the field with their customers.
The inspection business looks like a good business, but it takes a lot of hiring and management and selling to get the revenue numbers up, and the margins don’t seem likely to improve dramatically. If the water and environmental services cash flow gets cut in half, for example (which would probably be very extreme), or they have a lot of expenses crop up in that business, I’m not sure whether the inspection growth can catch up — the low-margin nature of that consulting/services business means they’d need to generate another $25 million in revenue to generate another million dollars in operating income (about $1.1 million in distributable cash, probably).
It’s too early to see any kind of pattern in the business, particularly because they’re small and just finished a big acquisition, and because the sector is unsettled with crashing oil prices, but the September quarter last year (before oil crashed) was a little unsettling, with expenses coming in to turn 18% revenue growth into just 1% growth in distributable cash flow. So there is something to the company, they’re interesting to consider, but I don’t think it’s so strong that I’d be all that tempted to buy for an 8% yield that I’m not entirely convinced is sustainable (I haven’t seen any information from them about operations after October 1, other than the drop-down purchase of the rest of the inspection business and the distribution announcement for the quarter which seems to have helped assuage investor worries).
So, there you have it — something to chew on during a chilly weekend to end our shortest month. Let us know if you’ve got an opinion on Cypress, I like the inspection business but I’m a little worried about water disposal volumes and more worried about their valuation and their uncertain (for me, at least) ability to grow the distribution in a sustainable way from here. If you forced me to choose right now at these prices, I’d certainly buy more Berkshire Hathaway before buying Cypress Energy Partners.
Now, on to a few other notes that I wanted to share with you…
It’s been an interesting couple of weeks, with some reports from companies that I own and follow catching my eye — here are a few updated thoughts:
Medical Properties Trust (MPW) is officially now a dividend raiser, with indications of more raises in the future, so I’m adding them to the “core” list and segmenting it out a bit — there’s now a separate section of core income stocks, including the REITs and the one pipeline company I’ve stuck with on the Irregulars list for several years.
“Dividend Raiser” doesn’t necessarily mean that the hikes will continue forever, or that they are irrevocably committed to raising the dividend every year — it will take a while to build that pattern and that expectation, but they have now raised dividends twice in five quarters and spoken about continuing to raise it, and that’s good enough for me to increase my confidence in this high yielder (current yield 5.8%).
“Core” doesn’t mean “buy at any price” — at least not for me — but it means stocks I have a high degree of confidence in and am willing to give a lot of latitude to without worrying about every little bounce. Just about all of the REITs are at the high upper end of reasonable valuations right now, so I consider nibbles from time to time but I continue to want to wait until interest rates fears heat up and drive the prices down to load up on the best REITs. I don’t think the REITs in our list — MPW, COR, and ROIC — will be irreparably damaged by slowly rising rates, but I do think we have a chance for the stocks to get cut by at least 10-20% on a panic at some point as we move toward a rising interest rate environment, and they certainly would suffer if we hit real inflation all of a sudden that brought 1-year CD rates of 5% again, REITs generally hold their value in inflation over the long term but it can take a while for rising rents and asset values (and dividends) to catch up with investor inflation expectations. I’m guessing that we’ll see that opportunity (not real hyperinflation, but a rising rate panic) sometime this year, but I don’t really know… so I’m mostly holding, though I wouldn’t argue against nibbling on any of those REITs that I like on down days if you don’t want to wait for better prices that might not soon come.
MPW would still be my favorite for nibbles if you can get it under $15, there remains some potential for capital gains if investors grow more confident that MPW will be a solid dividend grower and has its balance sheet challenges behind it (as I think is the case now) — if they get priced at just a small premium to bigger, more established healthcare REITs like HCN or VTR with, say, a 4.75% yield (that would still be the highest yield in the group by a substantial margin) that would mean, at the current just-raised dividend, a share price of $18.50.
Coresite (COR) is still my favorite rapid-dividend-growth name, and a fantastic small company (it’s a data center REIT), but it’s hard to see it growing super-rapidly forever and it has been quite volatile in the past — their dividend growth in the past three years has slowed, from 50% to 30% to 20% this year, so they still hike dividends more aggressively than almost anyone else but the sector remains competitive (and now counts the far larger Equinix, EQIX, among the REIT competitors with a 3%ish yield) so it will probably be volatile with or without interest rate panics. Their earnings report a couple weeks ago was fantastic, REITs just don’t grow this fast (FFO at 25%, revenues at 18%), but it’s a small player in a competitive field and it has performed dramatically better than its big competitors in the last year (and especially in the last couple months) so I hate to chase it even with their fantastic growth — momentum investing in REITs seems like it’s probably a bad idea given the non-compounding nature of these companies (they have to raise capital to grow, they can’t reinvest earnings), there seem always to be moments for the patient investor when they come back to earth on bad news or macroeconomic panics, drive the dividend yield up, and get to be plump, enticing buying opportunities.
Retail Opportunities Investment Corp (ROIC) reported this week, too, and it was more nice, boring performance — this is the stable one in the bunch now that they’ve gradually levered up over the years and expanded the portfolio of shopping centers, and it’s priced just about the same as its peers and isn’t growing fast. The very definition of a nicely yielding REIT with good management — better to buy when people start to irrationally hate it because they think interest rates are going from zero to 1.5%, so at these prices it’s a hold for me still.
Our hedge fund reinsurance folks reported recently, too — Greenlight Re (GLRE) didn’t do well enough on underwriting to fully capitalize on their great fourth quarter of investing performance by David Einhorn, so the book value rose only to $30.76, a bit lower than I expected. It tends to drift down to very close to (sometimes slightly under) book value from time to time, so although I think buying at 1.2X book should work out well for very long-term holders (that’s a far higher $36+, the shares are at $32.50 now), the more opportunistic might wait until it drops to $31 or so.
Third Point Re (TPRE), on the flip side, continued their dramatic improvement in underwriting over the course of the last year and they are now at break-even on their combined ratio (within a whisker of 100). That was expected given that all new insurers (they’re only about three years old) have to “grow into” their operating costs, but it’s good that they got there in a tough pricing environment and had a good operational quarter… but, unlike Einhorn, Daniel Loeb had a bad quarter investing so the book value fell. That’s not going to continue forever, Dan Loeb’s two decades of compounding at 18% a year seem very unlikely to me to have been a mirage, but I’m sure they’ll have worse quarters than that, too.
With the insurance operation doing well at starting up in a very tough pricing environment, and the float having grown nicely to close to $400 million now (growing float and a growing investment portfolio provide free leverage for the investment manager… as long as the insurance side doesn’t lose money) I’m more confident than ever in TPRE because their edge will continue to be Third Point’s ability to invest better than the other reinsurance companies — that might not be enough to overcome a long-term challenging insurance pricing environment where the consensus seems to be that small reinsurers must merge and get scale in order to compete, but so far they’re on the right track so I’m sticking with them and think it’s still a good buy, like GLRE, up to 1.2X book for patient investors (that would be $16+, it’s at about $14 now) or an opportunistic buy at book value if you can get it. Right now book value is $13.55.
You might note that I’m being very patient with my long-term thesis that hard insurance market + insurance companies who invest better (or underwrite much better) than their peers = opportunity… the thesis was built on the fact that rising rates are terrible for insurance companies in the short term because their portfolios are usually dominated by bonds, and equities do far better than bonds in rising rate environments, so insurance companies who invest well in equities should benefit both from the fact that their competitors will have to tighten prices to make a profit and from the fact that their portfolios will outperform. That’s been negated to some degree because interest rates kept falling, helping out portfolios at most insurers, and more importantly it’s been countered by the fact that outside capital has been flowing into the insurance business (from hedge funds and other alternative investors) and the excess capital in the system has been keeping price competition tight and extending the “hard market.”
So far, BRK-B, MKL, GLRE, TPRE and LRE.L have done well, in some cases very well, but have — on average — not been dramatically better than the S&P over two years (Markel and Berkshire have done much better, Greenlight about the same, Lancashire and Third Point were added a bit later but have underperformed the market). Perhaps I should have just stuck with the big, established guys in MKL and BRK.B, time will tell, but I remain pleased that those two are both in my top five personal individual equity holdings (GLRE is also in the top ten, for whatever that’s worth — that doesn’t include funds and ETFs that I use to diversify away from the stupid decisions I sometimes make, by the way, just the stocks I own). And yes, Warren Buffett’s annual letter to investors will come out tomorrow and everyone should read it — this will be a long one looking at Berkshire’s 50-year history under his control, should be an even better read than usual… and I’ll be at the Berkshire Annual Meeting in Omaha in two months and will share any new perspective I might gain there with you. (If you want a little perspective on what Buffett is going to say, he let the FT republish his 1965 investor letter here — he thought the fund might be getting too big to generate big returns back then.)
And Sandstorm Gold (SAND), which is enduring despite hardships, also reported recently. They bought more royalties this month at very low cost (may not be cheap, because if the mines don’t get built or produce they’re worthless — but it was a small cost), reported what they called “in line” production of gold for the year and anticipated drop in production this year, and updated on Metanor and Luna. Luna continues to be the huge issue, a big part of the reason that their gold received might be at 40,000 ounces a year instead of 50-60,000+ in their past projections. Still levered to gold pretty aggressively, still riskier than the big gold royalty companies… but also still cheaper than those big competitors, I give this one a lot of leeway as an equity exposure to precious metals (balanced by holding some physical gold and silver as well, all as a hedge against currency depreciation over time, though total exposure to gold and silver for me is only about 5% of my portfolio and savings).
That’s it for this week’s Friday File, folks — more fun to come next week, I’m sure, and I look forward to seeing what bubbles up from the teaser pits to share with you. Have a great weekend!