Author Archives: Scalper1

VYM Is Still A Good Bet In The Short Term

Summary Rates will rise, but very slowly, so dividend funds are still in favor. As rates rise, high-yielding funds should generate more attention. Ultra-cheap way to own some of the world’s best companies. The purpose of this article is to discuss the attractiveness of the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) as an investment option. To do so, I will look at recent fund performance, its current holdings and allocation, and trends in the market to conclude if VYM will be a profitable investment going in to 2016. First, a little about VYM. The fund is designed to track the performance of the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields. Currently, the fund is trading at $68.52/share, and its most recent quarterly dividend is $.53/share. Since VYM’s dividend payment typically fluctuates throughout the year, I used Vanguard’s website directly to estimate its annual yield going forward, rather than relying on its most recent payment. Vanguard currently has its annual yield listed at 3.14%. With the Federal Reserve set to finally raise rates this month, (according to 81% of fund managers surveyed by Bank of America Merrill Lynch), it may seem to go against conventional wisdom to initiate positions in dividend funds at this time. However, there are a few reasons why I expect VYM to still outperform in this environment, which I will outline below. One, the market has been expecting rate hikes for some time, only to be continuously surprised by the Fed delays month after month. Funds such as VYM have been dropping prior to the Fed’s meetings, only to rebound sharply once the announcement of no increase is made. For example, in mid-August VYM dropped over 10% , partly on speculation that a September rate hike was evident. Since the Fed has delayed raising rates in the following two meetings, the fund has rebounded to the pre-drop levels. While VYM has not suffered a recent steep drop, it has traded cautiously over the last month, gaining under 1%. I view the potential upside to VYM, if the Fed delays yet again in December, as greatly outweighing any downside risk. In fact, while most traders are expecting a hike, they are still not completely sold on it. According to the same Bank of America Merrill Lynch survey , the possibility of a December rate hike after the release of last month’s Fed meeting minutes went down to 68%. Therefore, VYM could be a great hedge if the rate hike is delayed yet again, because the fund should rise swiftly as investors dive back in to capture the high yield. Two, I think VYM will outperform over the next six months even if rates do rise, because the increases are likely to be slow and small, meaning investors will have to wait a long time for yields to rise high enough on short-term bonds to seriously compete with the yield offered by the fund. The annual yield of over 3% will still be seen as “high” for a while, even when the Fed finally decides to begin increasing rates. Coupled with the possibility of capital appreciation, investors would be wise to stay the course with VYM, as I do not anticipate a massive correction in the fund on the first rate hike announcement. Additionally, if the Fed does decide to raise rates, the principal reason behind that decision is because they are beginning to feel more confident about the economy’s ability to stand on its own merits. Under such a scenario, I would expect the largest American companies to do well in this growing economy, and those are exactly the companies that make up the bulk of VYM’s portfolio. Below is a listing of the main holdings of VYM as of 10/31/2015: 1 Microsoft Corp. (NASDAQ: MSFT ) 2 Exxon Mobil Corp. (NYSE: XOM ) 3 General Electric Co. (NYSE: GE ) 4 Wells Fargo & Co. (NYSE: WFC ) 5 Johnson & Johnson (NYSE: JNJ ) 6 JPMorgan Chase & Co. (NYSE: JPM ) 7 Procter & Gamble Co. (NYSE: PG ) 8 Pfizer Inc. (NYSE: PFE ) 9 AT&T Inc. (NYSE: T ) 10 Verizon Communications Inc. (NYSE: VZ ) As you can see from the chart, VYM is made up of some of the biggest companies in the world, and these companies will perform strongly during periods of domestic growth. Therefore, the bulk holdings of the fund should continue to deliver returns, regardless of the Fed’s decision. Of course, investing in VYM is not without risk. While I have laid out a few reasons why I like the fund, it is certainly plausible that the Fed will raise rates more aggressively than anticipated. If rates are raised higher, or more quickly, than investors expect, the market will become more volatile and dividend funds will likely suffer as investors shift into bonds and other fixed income investments that begin to offer higher yields with less downside risks. Also, while I laid out why continued low rates will be beneficial overall for the fund, VYM does have about a 15% exposure to the financials sector. This is a sector that should actually outperform in a higher rate environment, since financial companies like banks are able to charge more for the loans they lend out, typically leading to a higher spread, and therefore profits, for the firm. If rates stay low, that sector could be a laggard, which will weigh on the overall performance of VYM. How much this will impact the fund is unclear, but it is a risk to be aware of. However, I do not expect either of these scenarios to play out. Fed chairwoman Janet Yellen has made it clear that the Fed will take a “gradual approach” to hikes to ensure the market is not disrupted. Also, I do not expect the financial sector to drag on VYM, as the sector has rallied, and all odds do point to a hike in the near future. Bottom line VYM provides investors with diversified exposure, access to some of the biggest companies in the world, all for an ultra-low fee of .10%, which, according to Vanguard’s website, is lower than that of 91% of comparable funds. With rates expected to stay at historically low levels, even after the Fed’s initial hikes, VYM’s yield of over 3% will continue to attract investor interest in 2016. The fund will also benefit from increased consumer spending, as it has a 20% weighting of direct exposure to the U.S. consumer. While recent consumer spending has not been strong , I see tremendous upside to that statistic, as hourly wages for Americans have finally started to rise . This will bode well for future consumer spending, especially going into the holiday season, and VYM will be a direct beneficiary of this trend. With a growing U.S. economy and wage growth, continued low rates, and low management fees, I would encourage investors to take a serious look at VYM.

Microsoft Surface gaining on Apple iPad in tablet market

Microsoft’s (MSFT) Surface tablets are seen closing the gap with Apple’s (AAPL) iPads over the next few years, according to a forecast released Tuesday by research firm IDC. Tablets running Alphabet’s (GOOGL) Google Android operating system are expected to grab 67% of the market in 2015, followed by Apple’s iPad with 24.5% and Microsoft’s Surface with 8.5%, IDC said. IDC predicts that Microsoft’s share of the tablet market will gradually increase

OGE Energy – Should Investors Buy The Dip?

Summary OGE Energy has suffered lately due to its ownership interest in Enable Midstream Partners. This weakness is likely to remain in place in the short term, but the regulated utility business will bolster earnings. Compared to partner CenterPoint Energy, OGE Energy looks to be the more attractive deal currently. OGE Energy (NYSE: OGE ) is another pseudo-utility option for investors, with both a regulated electric business and an equity ownership interest in master limited partnership Enable Midstream Partners (NYSE: ENBL ). The regulated business does substantially most of its business in Oklahoma, serving nearly one million customers throughout the state (including Oklahoma City). Power is provided through the company’s ownership of 6.8GW of mixed electric generation. By peak capacity, OGE Energy has more production available at its natural gas facilities, however in general the company has relied on its coal-fired units for baseload generation due to cost advantages. The equity ownership in Enable and how it came to be is an interesting one. Enable was founded by OGE Energy, ArcLight Capital Partners, and CenterPoint Energy (NYSE: CNP ) ( prior research by myself on CenterPoint is available here on SeekingAlpha ) in 2013. CenterPoint has a majority interest through the limited partner units, but both parties have equal management ownership rights. CenterPoint and OGE Energy elected to spin-off Enable from Centerpoint in April of 2014 to raise capital, while also swapping their common stock ownership to subordinated to appease prospective investors. As I cautioned investors in October when I wrote on CenterPoint, while exposure to midstream operations has been a trend in many utilities lately and can boost the earnings growth, such operations can also bring volatility to the stock price. In the time since that research was published under two months ago, Enable has fallen over 30%, now down 45% over the past six months. This has dragged both CenterPoint and OGE Energy down along with it, compared to a relatively boring performance for the utility sector as a whole over the same timeframe. Is it time to go bottom fishing for a deal in either of these two names? Historical Results For The Utility Business (click to enlarge) I’ve stripped out the results for OGE Energy’s utility assets above, so this is purely the results from the regulated utility segment. Revenue growth has been solid for the company, primarily due to Oklahoma’s relatively favorable economic profile compared to the rest of the country. Oklahoma City and other large cities have seen sizeable inflows of interstate migration, and charge-offs have been low due to below average unemployment and better than average median household incomes. Operating margins, however, have contracted. This is primarily due to increased depreciation and amortization expenses, stemming from additional assets being placed into service throughout the period. Capital expenditures have been quite high, even excluding the midstream pipeline infrastructure, from 2011-2013. This has moderated somewhat in 2014/2015, but further ramp-up is likely in the coming years. The reason for that is the company’s coal power plant exposure. From 2015-2019, the company estimates it has over $1B in capex costs directly related to bringing these coal power plants into emissions and regulatory compliance, while also converting two to natural gas where it deemed upgrades unfeasible. (click to enlarge) * OGE Energy Investor Presentation, EEI 2015 Like many Midwestern utilities that have traditionally used coal as a primary source of power generation, OGE Energy has been engaged in a lengthy dance with federal and state regulators. It recently won a one year extension for compliance for Mercury Air Toxic Rules (through April 2016) and lost many filings and appeals over the EPA’ Federal Implementation Plan, which it tried to push all the way to the U.S. Supreme Court. While these costs will be eventually passed along to utility customers and likely recovered, this recovery will take time and the burden of the costs over the next several years will likely dent short-term cash flow. The likely cash flow shortfalls in the coming years will be a continuation of recent trends. OGE Energy has raised $1B in net debt since 2011, but managed to minimize the impact of this by using proceeds from the spin-off of Enable as an offset. Given the current market appetite for Enable common units being weak at best, it is unlikely management will elect to sell any of its currently held units to the public to raise cash. To pay for 2016-2019 capex, investors should expect the company to turn back to the credit markets again, making good use of its solid credit ratings. While OGE Energy is already paying $150M in annual interest expense, its leverage ratios remain low (roughly 2.7x net debt/EBITDA on 2015 full year expectations). Conclusion Enable’s results are the wildcard here. In my opinion, if you’re willing to shop for or own OGE Energy, you should also be willing to buy CenterPoint Energy, and vice versa. While CenterPoint trades cheaper at 7.9x ttm EV/EBITDA compared to OGE Energy’s 9.7x, I think the risk/reward favors OGE Energy still. You’re getting a lower levered player with a higher quality regulated business. However, in the end, you might end up with both company’s assets anyway as I think OGE Energy and CenterPoint are ripe for a merger. Both management teams already work closely together due to their interests in the Enable entity, and tying the companies’ fates together makes economic sense. The joined company would enjoy further diversification and the companies operate right next door to one another geographically. Utility consolidation has been an ongoing trend, and a merger here is one of the more obvious remaining moves among smaller utility names in my opinion.