Tag Archives: function

Cornerstone Total Return: Yield Illusion Creates Substantial Downside

Summary CRF trades at a ~40% premium to NAV. Rich valuation driven by retail investors’ perception of high dividend yield. However, the yield is predominately just a return of investors’ own capital. Background on Closed End Funds A closed-end fund is a publicly traded investment company that raises a fixed amount of capital, and is then structured, listed and traded like a stock on a stock exchange. Whereas conventional mutual funds and ETFs frequently redeem / issue new shares to ensure that the price per share remains in line with the net asset value of the underlying holdings in the funds, this is not the case for CEFs. Rather the share price of CEFs is driven by the market forces of supply and demand, and can at times trade at either large discounts or premiums to NAV of the funds’ actual holdings. This is particularly the case given that the natural investor base for CEFs tends to be small, retail investors that in some cases do not fully understand the products that they are investing in. The Cornerstone Total Return Fund (NYSEMKT: CRF ) is one extreme example, which currently trades at among the most significant premiums to NAV in the CEF universe. Overview of CRF CRF is managed by Cornerstone Advisors, and is composed of a broadly diversified portfolio of stocks, with the largest holdings being some U.S. blue chips. A more comprehensive overview can be viewed in the fund’s annual report : (click to enlarge) (click to enlarge) Source: CRF 2014 Annual Report CRF’s expense ratio (based on 2014 figures) has been just over 1.4% of NAV. Unsustainable Yield Despite the relatively traditional composition of the fund, CRF currently pays a monthly dividend of $0.332 (equating to an annual yield of ~16.6%, or ~23% of the fund’s NAV). You might be asking yourself how this could be possible. The answer is simply that the bulk of the dividend is coming from a return of capital rather than ordinary income/capital gains. In other words, investors are being returned their own money in the fund. (click to enlarge) Source: CRF 2014 Annual Report. Note that per share figures in the table above do not reflect the one-for-four reverse stock split in Dec 2014. Unsurprisingly, the fund’s NAV has declined in turn, as shown in the chart below. (click to enlarge) Source: Yahoo Finance Rich Premium to NAV So now the question is, what do you think is the fair value of this CEF? I certainly wouldn’t pay any premium to NAV for a vanilla portfolio of equities with a ~1.4% expense ratio. Rather, I would prefer to buy a much cheaper ETF like SPY and simply sell part of the holdings each year if I needed the income. But apparently many retail investors disagree (institutional holdings of CRF stand at ~1%, according to Nasdaq), and have been lured in by the siren’s song of this CEF’s “dividend.” In fact CRF is currently trading at a 40% premium to NAV (and has been even higher in some past years). In other words, investors are willing to pay more than $1.40 for each $1 of the fund’s net assets. (click to enlarge) Source: CEF Connect Conclusion Though I hold a small short position in CRF, this is admittedly somewhat speculative given that the fund has in the past traded at any even more extreme premium to NAV, and the borrow cost has been in the mid-single to double digits. However, retail investors should be mindful of the risks that come with owning CEFs trading far above NAV. Disclosure: The author is short CRF. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

NextEra Energy’s Valuation Still Too Rich, Catalysts For Long-Term Growth Strong

Summary Our pricing has moved up, but we are still looking at a $96 price tag. NextEra’s strong quarter in the latest earnings show great strength in renewable energy but comps were weak. Hawaiian Electric deal is moving along well, but it will still take another 9-12 months to finalize. Today, we are going to take a refreshed look at NextEra Energy (NYSE: NEE ). We first looked at the company in late February. At that time, we thought the company was fairly priced with potentially some room for a pullback. The reason was that we believed that the market was slightly overvaluing the utility space, and a correction was due. Since that report, the stock has dropped over 5% to the upper-90s. We noted we would be interested at the 90-level. Our main thesis was that, while the company’s health and catalysts were strong, valuations were pricing in a best-case scenario of 6% revenue growth and 22% operating margins consistently moving forward. We worried that was too aggressive perhaps, and even if not, an even better scenario would be needed to see upside. Today, we want to revisit our catalysts in the wake of the last set of earnings as well as other developments that have occurred. Additionally, we will take another look at our pricing model to update that given this analysis. 2015 Catalysts Revisited Economic Moat Strength What we saw as really the overall #1 strength of NEE was its dominant economic moat that it was able to have due its non-competitive arrangements with municipalities. What that means is that the company negotiates a “fair price” for a certain area if the municipality agrees to limit competition. Most areas of the country have similar agreements, and it helps to establish infrastructure and investment from utilities, while guaranteeing power, service, and price to end customers. As we noted before, NEE is very attractive because about 80% of its business is in the regulated arena, where profitability is strongest. This image from Market Realist tells the tale: (click to enlarge) The company maintains one of the highest margins in the industry with this strong mix, and there is little threat to a major push down. As long as the company can maintain this strong mix, it will be attractive for income, long-term investors. The real benefit or issue that could move the needle, though, was the company’s work in Hawaii… Hawaii – Another Regulated Market to Add Shareholder Value In 2014, NEE bought Hawaiian Electric (NYSE: HE ) for north of $4B. The move was a chance to come into a new market that was in need of cost savings and be able to combine a regulated market with the company’s practice of making efficient utility deliveries. Additionally, the company will bring its penchant for renewable energy to help build a better “mousetrap” in the state. The company had plans to revolutionize the space with solar energy. The state is one of the best for solar energy. So, how have things been moving since the last time we looked at the company. There have been quite a few developments. Right now, the main aspect of the deal is just to get it done and approved. In April, HE’s CEO came out saying he was confident that the deal would be completed within a year, and the Hawaiian House of Representatives put a resolution in place to complete the deal by June 2016. Given the market is regulated, it is a major decision for Hawaii, consumers, etc. In the latest earnings transcripts , when CEO James Robo was asked about approval, he stressed that he still believes it will be done by the end of the year: Steven Isaac Fleishman – Wolfe Research LLC Yeah. Hi, everyone. Just further on the Hawaiian deal, what’s the latest in terms of timelines for approval? James L. Robo – Chairman, President & Chief Executive Officer Steve, we’re still hopeful that we’re going to be able to get all regulatory approvals by the end of the year and that’s the target that we’re working towards. Steven Isaac Fleishman – Wolfe Research LLC Okay. Is there any movement toward like settlement discussions or still more formal process? James L. Robo – Chairman, President & Chief Executive Officer I think, Steve, that we’re very early in the process right now and discovery will be ongoing through the summer. And we expect all of the filings to be done by the end of August and so, anything on the settlement front would be very premature. Moray P. Dewhurst – Vice Chairman & Chief Financial Officer Steve, just data; we filed formal testimony. I think we’ve had some 300 interrogatories or data requests so far. We can expect to have a lot more over the coming months. That’s good. We want to make sure that all legitimate questions are appropriately aired and that people get the answers to the questions they have because we firmly believe this is fundamentally a good deal for folks in Hawaii, customers, as well as for shareholders. So we want to make sure that all the facts come out, but it will take a while and the schedule calls for that to go through the summer. It looks like this summer will be key to briefing the necessary parties, filing all the necessary paperwork, and completing the process. Overall, the process is moving along like most deals with some hiccups but generally fine. One item that did come up was that HE had to extend the shareholder vote to get the majority they needed for the acquisition, which does not necessarily mean that it wasn’t liked by shareholders. Overall, though, we believe this deal is very important to NextEra Energy. As we noted previously: The company brings the expertise of how to apply a mix of renewable energy and create consistent returns. With the prices that Hawaii is used to paying, the company should reduce costs for Hawaiians yet also make a strong profit. The company’s mix, though, of more green energy plays has not been as profitable. The company still makes its bread and butter in Florida where it uses a majority natural gas. So, the question will be if they can return the type of 20% operating margin in Hawaii? The nice thing that is baked into the cake for them is that Hawaiians are used to paying more than most Americans, so they will be able to invest more easily. We will continue to monitor this situation, but for now, the company looks like they are still on track. Current Pricing The latest earnings for NEE were pretty solid in the latest quarter. EPS came in at 1.41 versus 1.28 expectations as well as a beat for revenue as well. The company’s results were helped by an improving Florida economy that led to more additions as well as a lot of strength in NextEra Energy Resources, which saw a 41% increase in revenue. The NEER division is the renewable contracted part of the business, and that type of growth shows just how in demand renewable energy is becoming. In this section, we will want to take a look at our last pricing analysis, update it, and determine what we believe is a fair value price for NEE. In order to price the company, we need to make certain assumptions. In our last article, we modeled revenue growth will continue at a clip of 4-5% per year, and we believe that level will maintain for the next several years. The gains in NEER are not sustainable, and a lot of the gains were going up against the very adverse weather conditions one year prior. Most analysts are only modeling for 1% growth still for this year, but we are using an annualized figure. Utility revenue is fairly consistent. The key to the company is definitely margins. Operating margins are key to our DCF analysis. The coming has forecast that they will come in at the 22-23% in 2015, but I imagine this number will dip some with the onslaught of Hawaiian Electric when it is approved. In Q1, the company’s operating margins were strong at 28%. Again, the 42% operating cash flow return at NEER buoyed this higher, and the company stated they see a 20-25% overall operating cash flow return in that division for the full year. For 2015, we believe 22-23% is a bit light, and we will increase our expectation to 25%. As for the HE deal, it should add roughly $4.5B in sales in 2016, but the company operates with a 10% operating margin. The deal is really essentially to take what is a tough market for making money, revolutionize it, and improve it. This plan, though, will take several years. Therefore, margins will drop in 2016 but gradually improve again through 2020. Taxes have averaged roughly 25% for the past five years, and it’s likely this will stay around 28%-30% over the next several years. We may see it jump even a bit more beyond 2016 when more solar credits are expected to expire. Depreciation will continue to grow at about the same rate as revenue growth. Capex should come down in 2015 to around $6B and again in 2016 to $4B.The $4B rate, though, is pretty standard for the company. Our WACC rate is 5% for discounting. When we use this math in our five-year DCF analysis, we were looking at a low-90s number. We have made some positive adjustments, and here is our projections:   PROJECTIONS   1 2 3 4 5   2015 2016 2017 2018 2019 Income from Operations 4350 3654 3990 4347.2 4726.73 Income Taxes 1218 1023.1 1117.2 1217.2 1323.48 Net Op. Profit After Taxes 3132 2630.9 2872.8 3130 3403.25             Plus: Depreciation 2600 2700 2800 2900 3000 Less: Capex -3600 -3900 -4000 -4100 -4200 Less: Increase in W/C -100 -100 -100 -100 -100 Available Cash Flow 2,232 1,531 1,773 2,030 2,303 When we complete the math here, we are now looking at a $96 price tag. The key areas to contemplate are how much will margins drop when HE comes online and how much growth will it bring about. Further, will CapEx be drastically higher in 2016 as the company invests into the infrastructure? These questions are tough to model, but this model appears to be friendly and mid-to-best-case. Thus, we are still coming in around where NEE is performing today. Conclusion NextEra has interesting catalysts to 2015, but after a tremendous run in 2014, the company looks like its upside may be limited in the near-term. The recent pullback is a sign that the stock has gotten ahead of itself, and valuations are still rich. Right now, we like the stock as a long-term play in safety, but it will only be an income play with limited value upside. Yet, for its socially responsible model, the company presents another interesting dynamic. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Will The Fed Push Back Down GLD?

Summary The FOMC will convene again next week. If the FOMC hints about raising rates anytime soon, this could drag down GLD. The recovery of the U.S. dollar and rise in long-term treasury yields will keep pressuring down GLD. The recent strong labor report brought up the odds of the FOMC coming closer towards raising rates. It also cooled down the gold market. Nonetheless, the SPDR Gold Trust ETF (NYSEARCA: GLD ) is still flat for the year even though the U.S. dollar and long-term yields have picked up again in recent weeks. The FOMC isn’t expected to make any big changes in the upcoming meeting. But the price of GLD could start coming down again if the FOMC even drops a hint about raising rates in its upcoming meeting. The better-than-expected non-farm payroll report along with the sharp rise in JOLTS – number of job openings reached 5.38 million while market expectations were set at 5.03 million – have both driven a bit higher the implied probabilities of a rate hike in September to 33% and for December to 70%. The FOMC will convene on June 16-17 and release the press statement on June 17 accompanied with a press conference and release updated economic outlook. On the one hand, the GDP contracted back in Q1 and inflation is still contained below 2%. On the other hand, the U.S. labor market continues to show recovery, and there are possible speculative bubbles in the housing and stock markets, which could be popped once interest rates start to rise again. In the meantime, even though the FOMC is considering normalizing its monetary policy, this doesn’t mean the M2 isn’t growing – as of May, M2 is up by 5.3% year on year. This higher M2 comes despite the tumble in oil prices in the past few months. But the rise in M2, which is another indication for the changes in U.S. inflation, hasn’t driven up the price of GLD in recent years, as presented in the chart below. Moreover, the core PCE , which is the indicator the FOMC follows, has gone down to 1.2% – the lowest level in over a year. This low level doesn’t vote well for the FOMC to turn hawkish in the coming meeting. (click to enlarge) Source: FRED, Google Finance Despite the rise in M2, the U.S. money base remained relatively flat and rose by only 0.7% year over year. But this hasn’t resulted in a sharp rise in the money base as it was the case back when the FOMC implemented QE1, QE2, and QE3. After ending QE3, the FOMC only continued purchasing new bonds to substitute expiring bonds in order to maintain its big balance sheet. Thus, it would take a 180-degree change in the FOMC’s policy for the gold market to heat up again. The weakness of the Euro and other major currencies mainly due to ECB’s QE program, the Greek bailout talks also play a minor role in keeping the Euro weak, is likely to further drive up the U.S. dollar, which doesn’t help the price of gold or the price of GLD. Another factor that could keep slowly bringing down GLD is the recovery of long-term treasury yields, which have picked up in recent weeks. The correlations among GLD and long-term yields, as seen below, are negative and strong and suggest that if yields keep rising, GLD could also start to come down. (click to enlarge) Source: U.S Department of Treasury and Bloomberg Final note The upcoming FOMC meeting could be another nail in the gold market’s coffin – especially if the FOMC turns more hawkish by improving its outlook and providing a clearer picture about raising rates. Currently, the market doesn’t expect the FOMC to make any major changes to the policy and the Fed could remain dovish, which helps to keep GLD from tumbling. The major shift is only likely to occur closer to the end of the year – when the FOMC is more likely to raise rate, assuming the U.S. economy continues to progress in its current pace. Until then, the stronger U.S. dollar and higher long-term treasury yields are likely to keep GLD slowly dwindling. For more, please see: 3 Questions About Gold Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.