Like U.S. Master Limited Partnerships on Steroids: Higher Yields, USD Hedge
Part 10A of a Series
The High Dividend Investor’s Collapsing Dollar Survival Guide
1. EXECUTIVE SUMMARY FOR THIS SERIES
HIGH YIELD STOCKS ARE A FORM OF CASH. THUS INFLATION EATS AWAY AT BOTH YIELD AND PRINCIPLE. AS GOVERNMENTS INFLATE THEIR MONEY SUPPLY TO EASE CREDIT, MOST OBSERVERS BELIEVE INFLATION IS INEVITABLE.
THUS FAR IN THIS SERIES WE EXPLORED:
THE CURRENT STATE OF THE MARKET
THE CASE FOR AND AGAINST THE DOLLAR’S DEMISE
RECOMMENDED CRITERIA FOR SELECTING HIGH DIVIDEND STOCKS THAT ALSO GIVE A HEDGE AGAINST THE U.S. DOLLAR’S LIKELY IMPENDING DEPRECIATION.
SPECIFIC STOCK MARKET HEDGES AND HIGH DIVIDEND STOCKS THAT ARE INFLATION RESISTANT MENTIONED BELOW INCLUDE:
GENERAL MARKET HEDGES
UltraShort S & P 500 Proshares (SDS), UltraShort Financials ProShares (SKF), UltraShort QQQ ProShares (QID), UltraShort Real Estate ProShares (SRS), UltraShort Russell2000 ProShares (TWM)
BP, plc (BP), CNOOC Ltd. (CEO), Enid SpA (E), Total Fina Elf (TOT)
Veolia Environmental SA (VE), ENEL-SOCIETA PER AZI (ESOCF.PK or ENLAY.PK)
Cellcom Israel Ltd. (CEL), France Telecom (FTE) Telefonica (TEF)
Diana Shipping (DSX), Nordic American Tanker (NAT), Paragon Shipping (PRGN), Seaspan Corp (SSW)
Canadian Oil/Gas Energy Income Trusts
Advantage Energy Income Fund (AAV, TSX: AVN.UN), ARC Energy Trust (OTC: AETUF, TSX: AET-UN), Claymore/SWM Canadian Energy Income Fund (ENY), Enerplus Resources Fund (ERF), Peyto Energy Trust (OTC: PEYUF, TSX: PEY.UN), Provident Energy Trust (PVX, TSX: PVE.UN), Vermillion Energy Trust (OTC: VETMF, TSX: VET.UN)
Canadian Income Trust Tax Issues
IN PART 9 WE LOOKED AT BOTH
The recent uptrend in the stock markets and the U.S. dollar versus the Canadian dollar, and why they’re unlikely to mark the beginning of long term trends
Canadian Clean Energy Income Trusts
Atlantic Power Corporation (OTC: ATPWF, TSX: ATP.UN), Energy Savings Income Fund (OTC: ESIUF, TSX: SIF.UN), Great Lakes Hydro Income Fund (OTC: GLHIF, TSX: GLH.UN), Innergex Power Income Fund (OTC: INRGF, TSX: IEF.UN), Macquarie Power & Infrastructure (OTC: MCQPF, TSX: MPT.UN), Northland Power Income Fund (OTC: NPIFF, TSX: NPI-U)
HERE IN PART 10, WE’LL EXAMINE:
Canadian Energy Infrastructure Income Funds
Altagas Income Trust (OTC: ATGFF, TSX: ALA.UN), InterPipeline (OTC: IPPLF, TSX: IPL.UN), Keyera Facilities (OTC: KEYUF, TSX: KEY.UN), Pembina Pipeline Fund (OTC: PMBIF, TSX: PIF.UN)
IN COMING PARTS WE’LL EXPLORE:
Canadian Utility Income Trusts
Bell Aliant (OTC: BLIAF, TSX: BA.UN)
Canadian Health Care Income Trust
CML Healthcare Inc. Fund (OTC: CMHIF, TSX: CLC.UN)
Canadian Real Estate Income Trusts
Canadian Apartment Properties REIT (OTC: CDPYF, TSX: CAR.UN), Northern Property REIT (OTC: NPRUF, TSX: NPR.UN), RIOCAN REIT: (OTC: RIOCF, TSX: REI.UN
Canadian Misc Business Trusts
Yellow Pages Income Fund (OTC: YLWPF, TSX: YLO.UN)
AT &T Inc (T), Verizon (VZ), Otelco (OTT), Windstream Corp (WIN)
Energy Infrastructure Master Limited Partnerships (MLPs)
Buckeye Partners (BPL), El Paso Pipeline Partners (EPB), Enterprise Products Partners (EPD), Energy Transfer Partners (ETP), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), Nustar Energy (NS), ONEOK Partners (OKS), Sunoco Logistics Partners (SXL), TEPPCO Partners (TPP), Tortoise Energy Infrastructure Partners (TYG)
Alliance Resource Partners (ARLP), Northern Resource Partners (NRP), Penn Virginia Resources Partners (PVR)
Terra Nitrogen Company, L.P. (TNH), StoneMor Partners (STON)
Dominion Resources Inc. (D), Duke Energy Corp (DUK), Progress Energy (PGN), Southern Company (SO)
2. THE MARKET
Before ever considering investing in stocks, we must always first look at the overall market, since almost all stocks follow the major indices.
A. Just a Bear Rally
Over the past month we’ve seen what still appears to be a nothing more than a bear market rally, because:
Overall market fundamentals still declining: Some are dropping at a slower rate, and this has been the “good news” that bulls have used to support their optimism. Some continue to drop faster. I don’t see any cause for near term optimism in the usual leading indicators? Do you, dear readers? Please enlighten me via your often superb comments
Questionable improvements in the financial sector: The other big source of optimism, improvements in the financial sector, are, ahem, suspicious. Funds funneled via AIG, and “resulting profits from operations” (ignoring asset write downs completely), suspension of mark-to-market, etc. Drastic as these are, they more ominously hint at what else might me going on behind the scenes as the government aggressively manages a façade of improvement. I can’t blame Obama, what choice does he have? Let the banking system sink? But can he really sustain this “confidence” game (pun intended)? I hope so, but I’m not placing money on it.
All this is before we even consider the ramifications of the recent bankruptcy of the largest mall operator, General Growth Partners, which suggests that other overly leveraged retail and other REITs may be forced to sell properties into a saturated market, further lowering valuations on these assets and the actual values of the banks’ commercial real estate mortgage portfolios.
Auto industry bankruptcies: So far still a massive game of chicken to scare unions, debt holders, and government into further concessions. All face disaster in one form or another. One bond dealer I spoke with thinks the bondholders may push the companies over the edge, given the especially poor deal they’re being offered. Regardless of what happens, the mere increasing threat to so many jobs will be another shock to the economy.
In sum, I don’t understand the basis for this rally other than perhaps a purely technical or program driven buying, which in turn caused large short positions to unwind. These could feed on each other for a bit, but how long can the market rally without the support of actual evidence of real improvement?
Looking at a chart of the S&P 500, April 20th may be the key reversal that signals the end of this rally, just as this level proved to be the peak on February 10th. Failure to crack the 850 level decisively on high volume over the next week would likely end this rally.
Figure 1: Was April 20th the end of this rally? Note the similarity to February 10th.
In sum, consider:
· Using the rally to sell at least some partial positions taken since mid March
· Taking small hedges in Ultrashorts mentioned earlier like SDS, SKF, TWM
· Deferring new purchases until either
Ø The rally decisively breaks through 850 on the S&P, then consider limited buying, OR
Ø The rally fails to remain above it over the next week, then wait for prices to test lows before buying more
· Placing sell stops just below support to limit further losses or protect profits on positions
See Part 3 for the full details, but here’s the summary.
We’re seeking stocks of strong companies that mostly earn and distribute a high dividend in a non-USD currency and have a dominant position in a market for an essential product or service.
Here in Part 10, we examine an elite group of stocks which offer one of the most ideal combinations of reliable high yield and USD hedge, the best of the Canadian energy infrastructure income trusts.
4. CANADIAN ENERGY INFRASTRUCTURE INCOME TRUSTS - The Big Picture
A. Comparison to U.S. Energy Infrastructure Master Limited Partnerships (MLPs) – Similarities and Differences
These are similar in a number of ways to their U.S. version, the Energy Infrastructure Master Limited Partnerships. Those U.S. MLPs that we’ve recommended offer yields around 9% that are very reliable. Because they operate almost exclusively in the US, they don’t offer a USD hedge, however their monopoly supplier status for vital oil and gas in their areas of operation gives them pricing power (tempered by regulators) to pass along cost increases, thus providing a considerable degree of inflation protection. Significantly, they don’t have the uncertainty of the Canadian 2011 tax changes. They will continue to be tax free at the entity level, passing along both income and expenses to share holders.
We will deal with these U.S. MLPs in depth in future articles. However, for now, here’s a list of our favorites:
· Buckeye Partners (BPL)
· El Paso Pipeline Partners (EPB)
· Enterprise Products Partners (EPD)
· Energy Transfer Partners (ETP)
· Kinder Morgan Energy Partners (KMP)
· Magellan Midstream Partners (MMP)
· Nustar Energy (NS) – also has an asphalt production arm that will benefit from both a shrinking number of suppliers and the Obama administration’s push for infrastructure projects like roads.
· ONEOK Partners (OKS)
· Sunoco Logistics Partners (SXL)
· TEPPCO Partners (TPP)
· Tortoise Energy Infrastructure Partners (TYG) – actually a fund that serves as a basket of these kinds of businesses
Like the U.S. MLPs, these Canadian midstream (pipelines and storage) firms:
· Must distribute most of their available cash (90% for the U.S. MLPs in most cases) after that needed for maintenance and of current projects and new ones needed to maintain or grow revenues.
· Don’t pay tax at the entity level. Until Canadian tax law changes in 2011, those that don’t elect early conversion to corporations are not taxed at the entity level, allowing higher yields. While there is some uncertainty about how 2011 driven conversions to corporations will affect these trusts, the bottom line is that our selections’ distributions should not be significantly impaired due to various factors discussed below.
· Their revenues are generally based on capacity sold in advance to energy producers regardless of whether that oil or gas is actually moved through their pipelines or not.
Thus like their U.S. counterparts, they offer reliable, high yields. However, they offer some intriguing advantages.
· Higher Yields: Their yields are generally a bit higher than the approximately 9% average of the U.S. MLPs.
· USD hedge: They all pay distributions in CAD (usually converted to USD by brokers in the U.S.), thus offering a USD hedge.
· Monthly distributions: Most pay each month, not quarterly like their U.S. counterparts.
· 2011 Canadian tax changes may adversely affect yield: Yes, the 2011 driven conversion to corporations with an additional layer of tax at entity level raises questions about how well each firm will be able to maintain its yield. As a group, energy infrastructure companies have relatively high depreciation expenses that can offset taxes.
For example, those who own U.S. MLPs will often notice that they receive returns of capital in addition to income. This means that some of the distributable cash exceeds net income because these firms have high non cash expenses like depreciation of expensive pipelines, ships, storage tanks, and other related high capex facilities.
Also, our specific picks are growing their businesses and can be expected to ultimately increase funds from operations and thus distributions to make up for funds lost to taxes. Note that most Canadian companies do not pay full theoretical taxes due to careful tax planning.
· Currency Risk: Distributions and share prices in CAD can be a dual edged sword. There will be periodic declines in the value of the CAD against the USD.
See Part 9A for full details on why we believe the CAD will appreciate over the coming years against the USD. In short, a more conservative, healthier banking and housing sector that did not indulge in subprime lending has meant that the CAD supply is not expanding on anything close to the scale of the USD. While that isn’t the only factor to consider, it’s a big one.
· Market Risk. Like virtually all shares, they will move with the overall market. Note that all of these are relatively thinly traded, and thus volatile, since little selling or buying can really move their share prices.
Given the market and currency risk that remains, it’s very possible these will yet again power dive with the market. Pray that they do. That’s the best time to add as long as these businesses continue to perform.
Remember: energy transport and storage is one of the most recession resistant industries. Thus these are great defensive plays that pay you very well while you wait for recovery.
5. Conclusion, Disclosure & More Info
Here in Part 10A we presented current market and background information as the first part of our Part 10’s examination of the best of the Canadian energy infrastructure income trusts.
In sum, they provide among the best risk/reward available for high dividend investors. They are similar in many ways to U.S. Energy Infrastructure MLPs, with the added advantage of generally higher yields and a valuable USD hedge. While the 2011 tax changes will cause these to convert to corporations theoretically taxed at higher rates, we will show in part 10B that the effects on our recommendations’ distributions should not be significant and may well be nil.
Part 10B will look at specific recommendations in this sector
Part 11 will deal with another superb Canadian income trust sector.
Disclosure: I have positions in most of the above mentioned investments.
Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendstocksguide.blogspot.com