Tag Archives: financial

BUI: Thrown Out With The Bathwater?

Summary BUI is a closed end fund seeking total appreciation through capital gains and income, investing in utility and global infrastructure equities. BUI currently yields over 8% as its discount to NAV is near record highs. BUI is an atypical closed end mutual fund that has been discarded with the rest of the CEFS over the last 12 months. The BlackRock Utility & Infrastructure (NYSE: BUI ) closed end fund is an investment that I could of only wish for… on paper. BUI is an investment in one of my favorite asset classes (utilities and infrastructure), utilizing one of my favorite investment strategies (covered call writing), in one of my favorite investment fund structures (closed end fund). Unfortunately, since inception, it has been at best a mediocre investment, in particular over the last 12 months. Is the fund a bad fund? Or has the baby been thrown out with the bathwater? The Basics The BlackRock Utility & Infrastructure fund is a closed end mutual fund seeking income and capital appreciation by investing in equities of companies engaged in the utilities and infrastructure business. It carries a 1.1% expense ratio and invests in a portfolio of utility stocks that can be found in many other utility ETFs and mutual funds. What separates this fund from the competitors is the portfolio managers’ strategy of using/writing call options on the individual stocks in order to generate current income. In theory, this should reduce the overall volatility of the portfolio while providing current income. Currently it is paying a distribution rate of 8.57%. In rising markets, these types of portfolios tend to underperform the market as the upside is capped with the written call options. Let’s see how the portfolio has done. The Numbers Closed End Funds are a unique type of an investment that require extra care and attention. Unlike a traditional open end mutual fund that trades once a day, a closed end mutual fund trades like a stock and can be bought and sold throughout the day. Unlike traditional mutual funds which are priced once a day at the net asset value, closed end mutual funds trade a market prices, that may or may not be indicative of the true net asset value. For these reasons closed end mutual funds are typically more volatile compared to traditional funds, not because of the underlying performance, but rather on the reactions or over reactions in the market price. To understand this, you must also keep in mind that closed end funds, unlike their open ended siblings raise money once, and then they list on a public exchange and trade like a stock. If you as the investor want to invest money in the mutual fund strategy, you are buying someone else’s shares. The fund managers have that finite portfolio to work with and that is it, no new shares are created when you decide to invest your money. What this ends up translating into is most closed end funds trading at discounts below the actual value of the funds. That is why it is important to note the difference between the Market Price and the underlying Net Asset Value (NAV). In times of trouble, the market price may be significantly below the actual NAV, and may be a good opportunity to invest and buy assets on sale. Over the last 12 months, Closed End Funds have been hit quite hard with investors pulling out money. Typically, a closed end fund investor is looking for current income. The recent concerns about the health of the high yield markets as well as the interest rate hikes has caused fear and money flowing out of such investments. Unfortunately most people look at closed end funds as an asset class rather than as an investment vehicle with underlying investments. Has BUI been lumped in with other closed end funds? Let’s take a look. (click to enlarge) (Source: CEF Connect) As you can see, YTD BUI’s market price is down approximately 11%, however the underlying NAV is down only 6.99%. In essence, the investors were willing to accept less for the fund that what it was actually worth. In 2012 and 2013 you have had the same results. 2012 in particular resulted in a situation where the funds market price was down 3.51% for the year, yet the underlying net asset value was up 8.69%. 2014 showed what happens when people are chasing yield and were willing to pay more for the fund than what it earned where the market up was up 24.95%, yet the underlying NAV was up only 16.05%. An astute closed end fund investor looks for these opportunities to buy or to cash in their gains. On an annualized basis we have the following. (click to enlarge) (Source: CEF Connect) Since the fund launched in 2011, the total return including distributions averaged out to 3.43%. The fund has lost value, however it distributed a significant amount of dividends and income from the options. On a net asset value basis, the fund has performed respectably, earning an annualized 7.69%. Included are the performance numbers for the Closed End Fund Utilities category. What you can see is as expected, the fund has underperformed versus the peers, however during bad times, such as over the last year, BUI which uses no leverage and only generated income by writing call options was able to lower the volatility versus the peers as seen in the net asset value. Furthermore, while investors did notice this, you can still make the argument that this fund was hurt by the overall “dirty water” being thrown out as the market price did not hold up as well as the net asset value. The one place where this is evident is in the visualized chart of historical discounts and premiums to net asset value. (click to enlarge) (Source: CEF Connect) As of the time of writing, the fund is trading a discount of 13.24% to underlying net asset value. This has been historically a bigger discount than average, last seen late 2013 during the Fed’s Taper Tantrum. Conclusions and Final Thoughts Going through this analysis, it becomes more and more clear that unfortunately for this fund, it is lumped in with other closed end funds. Unlike other funds that employ leverage and invest in risky assets, BlackRock’s Utility & Infrastructure fund uses no leverage, buys globally listed equities, generates income with covered call options and has reasonable management fees. Unfortunately even though the underlying portfolio is seemingly performing as intended, the majority of investors are willing to overlook that and treat this as any other closed end fund. For a long term income investor looking for utility and infrastructure exposure, this fund at the current prices may be worthy of a look, at the very least put on your watch list.

Go For Birchcliff’s Preferred Shares Instead Of The Common Stock

Summary Birchcliff enjoys an ultra-low production cost for its natural gas, thanks in part to processing the majority at its own processing plant. I’m curious to see Birchcliff’s plan for 2016 as, despite the $120M price tag, it would make sense to expand the gas processing plant. The IRR is positive and will be 22% at a 10% higher gas price, so technically and theoretically Birchcliff should be going ahead with the expansion plans. But everything will depend on the company’s plans to achieve production growth, and I think Birchcliff will have to choose between the gas plant and a higher gross production rate. It’s pretty obvious the vast majority of the oil and gas producers are bleeding in the current price environment. That’s particularly true for Birchcliff Energy ( OTCPK:BIREF ) where the majority of the annual production consists of natural gas, which has been hit pretty hard. In fact, the gas price in North America has even dropped to less than $2. BIR data by YCharts Birchcliff is a Canadian company and I think it would be a better idea to trade the shares through the facilities of the Toronto Stock Exchange, where Birchchliff is listed on the main board with BIR as its ticker symbol . The average daily volume is much better in Canada as approximately 660,000 shares are changing hands on a daily basis for a daily dollar volume of $2M. El Nino Is Hurting the Company’s Top and Bottom Lines Let’s start with the good news: Birchcliff Energy was able to keep its production rate stable at a total of 38,400 barrels of oil-equivalent per day. As I said, the vast majority of this comes from natural gas sales and the revenue from natural gas was approximately 3.25 times higher than the revenue generated from selling the attributable oil output. As the average production rate in the same quarter of last year was just over 34,000 boe/day and as the average in the first nine months of the current financial year was approximately 38,400 barrels per day, Birchcliff has done a pretty good job at keeping its production rates pretty consistent despite the worsening climate on the oil and gas front. (click to enlarge) Source: Financial statements. The total revenue in the third quarter of the financial year was almost C$79M ($57M) , which is more than 25% lower compared to the same quarter last year, so the higher output didn’t compensate for the lower oil and gas prices. The operating costs also increased a bit, due to increased marketing and transportation expenses. Nonetheless, Birchcliff was able to write black numbers on its bottom line, and the company generated a net profit of C$4.8M ($3.65M) in the third quarter of 2015. Keep in mind that Birchcliff hasn’t hedged any of its gas and oil production, so “what you see is what you get.” The revenue has not been boosted by one-time events, such as the gain on derivative instruments. Source: Financial statements. The operating cash flow on an adjusted basis was C$44.3M ($32M), which is pretty good considering the circumstances and the shortfall to cover the capital expenditures. The investing part of the working capital position was limited to just C$20M ($14.5M). This could be better, but it could also have been a lot worse. This is where Birchcliff’s low-cost gas production at Montney comes in handy. Will Birchcliff Generate a Sufficient Amount of Cash Flow to Cover Its 2016 Capital Expenditures? My main test for Birchcliff will be in seeing what the company is planning to do next year. The original plan called for another 10%-12% production increase to 42,000-45,000 barrels of oil-equivalent per day, but I can imagine the company is currently developing a revised capital plan that will forego any production expansion while waiting for a higher gas price. This might probably be the smartest decision because even though the production costs at Montney are quite low, it might not be sufficient to cover the additional capital expenditures to indeed break even on the cash flow front. Source: Company presentation. It’s encouraging to see that even in the current gas price environment, the annualized operating cash flow will be roughly C$160M ($116M) and Birchcliff will have to try to keep the capital expenditures limited to approximately this level. Fortunately, the Canadian Dollar continued to weaken. This basically means that the lower natural gas price expressed in USD is partly compensated by the weaker CAD, which is also the currency Birchcliff is reporting its financial statements in. (click to enlarge) Fortunately, Birchcliff Energy still has ample access to liquidity as its bank has confirmed and increased an existing credit facility. Birchcliff can still draw approximately US$120M from this credit facility, and that should be sufficient to cover the capital shortfalls for the next two to three years. The Preferred Shares Could Be a Solution to Raise More Cash No company likes to issue new shares at the bottom of a cycle, but Birchcliff has an attractive Plan B. Birchcliff has two series of preferred shares in the market, and both the A-series and C-series have 2 million outstanding shares. The A-shares have a fixed 8% yield (payable quarterly) and are currently trading at 70% of par (and can be reset in 2017 based on the five-year yield on Canadian government bonds with a mark-up of 6.83%). The C-series have a fixed 7% yield . Both preferred share issues are perpetual, so Birchcliff can decide whether or not it wants to retire these preferred shares in the future. Should Birchcliff double the preferred share issue, it could raise C$70M ($50M) in a heartbeat, further reducing the pressure on its balance sheet. This could cover almost two years of capex funding shortfall. The additional cost of raising this C$70M? Just C$7.5M ($5.5M) per year. That’s not cheap, but it would provide an easy way to fund the ongoing activities. Once Birchcliff’s cash flows increase, the company can easily repurchase the preferred shares. Investment Thesis Birchcliff Energy is definitely hoping for a harsh winter to see a boost in the average gas price. The cash flow situation remains under control, but I think I would prefer the additional layer of safety and purchase the preferred shares. Yes, the upside is a bit more limited, but the series-C preferred share now yields almost 9%. That excludes any potential capital gains if Birchcliff decides to repurchase the preferred shares at par value sometime in the future. It will be very interesting to see what kind of capital investment plan Birchcliff has been preparing for 2016, and what it will do with the PCS gas plant, which was expected to see its throughput increase by 30% by the end of 2016. I think holding off on the expansion is the wisest decision, considering the IRR is just 22% at an AECO gas price of $2.5/GJ (currently at $2.25) and the initial capex is budgeted at US$120M. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Peer Inside The iShares S&P 500 Value ETF

Summary The individual holdings look fairly solid with a heavy exposure to XOM. The sector allocations are going heavy on the financial sector. While those financial firms may benefit from raising short term rates, I’d rather hedge rate risk and add more exposure to utilities. The iShares S&P 500 Value ETF (NYSEARCA: IVE ) is one way to get the value exposure for your portfolio. On the other hand, if you prefer to look at individual sectors you may find the holdings a little more concerning as 25% of the equity is invested in the financial sector. Generally I have tendency to prefer the value side of the index, but going so overweight on financials is an interesting aspect of the fund. Quick Facts The expense ratio is .18%. I have a strong preference for very low expense ratios, so this is a bit higher than I like to see. With over $8 billion in assets under management, it seems better economies of scale could be achieved, but the higher expense ratio may simply reflect more profits to the sponsor of the fund. Holdings I put together the following chart to demonstrate the weight of the top 10 holdings: (click to enlarge) I love seeing Exxon Mobil (NYSE: XOM ) as a top holding. Investors may be concerned about cheap gas being here to stay, but I think money in politics will be around decades (centuries?) longer than cheap gas. Bet against big oil at your own peril. I find the exposure to AT&T (NYSE: T ) interesting simply because the 2.4% weighting is almost twice that of Verizon (NYSE: VZ ). I find the telecommunications sector a little risky because of the intense price based competition brought by Sprint (NYSE: S ). The sector will probably find a solution to the intense competition, but I’ve gotten burned pretty badly by the mining sector where industry competition reached absurd levels and companies opted to focus on lowering their own costs by increasing production and driving down prices. Declining prices for the product combined with increased production and intense capital expenditures is a pretty ugly situation. Outside the Top 10 Outside of the top 10 you’ll find Johnson & Johnson (NYSE: JNJ ) as 1.64% of the portfolio. This is another great dividend company to hold. They have an effective R&D team and a global market presence. Just look at their dividend history and try to come up with a reason that this company shouldn’t be in a dividend growth portfolio: (click to enlarge) Beyond JNJ you’ll also see other dividend champions like Wal-Mart (NYSE: WMT ) and Pepsi (NYSE: PEP ). The heavy exposure to dividend champions is one reason for investors to appreciate the value side of the index. Wal-Mart has been on a massive slide lately but I don’t see it getting much worse before it gets better. The market for equity can be a little too short sighted in valuations. While Wal-Mart is seeing their already thin operating margins get pressed even thinner amid higher wages, they are also the low cost leader. When Wal-Mart raises prices, the rest of the industry should follow. Who will undercut Wal-Mart? Will it be Target (NYSE: TGT )? I doubt Target really wants to do that since they raised wages also and have the same challenge. Sectors Going heavy on financials hasn’t been my style, but increasing interest rates may benefit them more than the rest of the economy. It’ll be interesting to see how much higher the Federal Reserve can push interest rates without crashing the economy. What to Add The biggest weakness here in my opinion is the relatively small position in utilities. Since utilities often have a material correlation with bonds, I’d like to see a little more utility exposure in the portfolio. An investor could modify the exposure by simply adding the Vanguard Utilities ETF (NYSEARCA: VPU ) to their portfolio when using IVE as a substantial holding. Conclusion The expense ratio is a bit high and the concentration in the financial sector is a little higher than I’d like to see. However, the rest of the portfolio exhibits some great traits with a focus on established dividend growth champions that have the size and experience to whether difficult market environments. All things considered, I think there is more to like than to dislike in this portfolio. Some investors with a very long holding period may want to look for options with slightly lower expense ratios. If investors have a shorter time frame or intend to move their positions more frequently the healthy liquidity on IVE should be attractive for creating a smaller bid-ask spread.