Tag Archives: income

CenterPoint Energy: Be Sure To Understand What You Own

Summary CenterPoint currently yields nearly 5.35% and has $1.2B in cash reserves. Transmission and distribution income – nearly 50% of operating income – is geographically concentrated. It is largely considered to be a utility – however, a quarter of the income is derived from the MLP equity interest, which has been historically volatile. CenterPoint Energy (NYSE: CNP ) is a diversified pseudo-utility with a wide range of operations. The company operates a regulated natural gas utility business, a transmission and distribution arm, and retains ownership of substantial equity interest in Enable Midstream Partners (NYSE: ENBL ). CNP has been a favorite of investors chasing yield, but the shares have had trouble keeping up with the utility index over the past two years. Unfortunately for shareholders, the shares are down 20%, compared to a 20% gain for the broader utilities index. Contrary to what you might think, the dividend has actually been growing measurably the past two years, and the company now yields over 5.49%, well above historical averages. Is there an opportunity here for shareholders for both solid yield and capital appreciation? Business Operations CenterPoint’s strongest business unit in regards to operating income is its electric transmission and distribution business. This segment provides the infrastructure to connect power plants to substations which connect to the retail customer. This is a low-business risk, high-value business. Because the infrastructure is entirely pole/wire assets, there is significantly less regulatory and environmental risk compared to actual power generation. While this is a monopolistic business with very little risk, CenterPoint’s operations do have geographic risk in that the company only owns assets located in and around the House/Galveston metropolitan area. While this area has retained its strong growth even with the fallout of plummeting energy prices, there is no guarantee that this trend will continue. A reversal in the area’s fortune would result in a slowdown in demand for electricity, driving earnings down in this segment. The most stable and consistent business unit is CenterPoint’s intrastate natural gas distribution business. Compared to the transmission and distribution business that is concentrated in one area, this segment provides natural gas to more than three million customers in six states. Like other gas utilities, the company passes along the cost of the gas to customers, so there is little effect of gas price fluctuations on CenterPoint’s profitability aside from revenue numbers. Further cementing operating results, the company has weather normalization and decoupling mechanisms in place to limit the effects of seasonality and variations in customer demand in five of six states. This portion of CenterPoint is extremely well run, and earnings consistently bump up against the maximum allowed rate of return that the public utility commissions have set for the company (authorized return on equity in the 10% range). As mentioned, CenterPoint owns 55.4% of the limited partner units of Enable Midstream Partners, receiving 40% of the distribution rights. Operational control is split 50/50 between CenterPoint and OGE Energy (NYSE: OGE ). The reason for CenterPoint’s underperformance may largely lie with poor results from Enable. Enable’s first half of the year has been poor when compared to the 2014 results ($93M in operating income for Enable in 1H 2015, compared to $138M in 1H 2014). The downside action in Enable may have been overdone. Compared to many midstream companies like Kinder Morgan (NYSE: KMI ), the company is much less levered (2.6x net debt/EBITDA), making it better positioned to handle any long downturn in U.S. energy midstream operations. I think the weak recent share price performance is primarily related to the company’s short public history and heavy insider ownership. With very little track record and such a small percentage of the float open for trading, the shares have been volatile, scaring many retail and institutional investors away. Operating Results (click to enlarge) Revenue can vary widely year to year, especially within the natural gas distribution segment. As an example, revenue grew 40% from 2012 to 2014 ($959M), but operating income only grew 26% ($60M). This can cause operating margin decreases through no fault of the company as these operating margins decrease as the fixed cost of the natural gas being provided rises. Meanwhile, further putting pressure on operating margins has been a steady increase in operations and maintenance costs within the electric transmission and distribution segment. Between 2012 and 2014, revenue grew 12%. Regrettably, operations and maintenance costs grew 32%. While its maintenance capital expenditures will be recovered as part of capital plans eventually, these recoveries may not be as timely as investors might expect. (click to enlarge) 2014 was a concerning time for the company from a cash flow perspective. Cash from operations had fallen nearly $500M from 2012 levels, and capital expenditures were up tremendously. CenterPoint had to plug the hole with the $600M in proceeds from long-term debt it had raised late in the year prior. With $6.4B in net debt, the company is only moderately leveraged at 3.2x net debt/EBITDA. However, with CenterPoint keeping $1.2B in cash and cash equivalents on the balance sheet, it is prepared to weather any mild operational issues quite well. Conclusion When investing in CenterPoint, investors need to be aware they aren’t buying a company with 100% regulated utility operations. The higher dividend yield here is likely justified, given the volatility present in the Enable ownership. On the plus side, the natural gas operations are very well run, and the electric transmission business, while experiencing headwinds currently, is also solid. In my opinion, the shares likely trade around their fair value. Investors looking for yield can likely comfortably add some exposure to the company in the $17-18/share range.

Aberdeen Asia-Pacific Income: Emerging Markets Bonds At A 17% Discount

Summary Example of one Asian baby thrown out with the bathwater by retail investors. Relatively safe portfolio of bonds, overseen by a reputable manager, with a yield in the high single digits. High potential for alpha through eventual compression of high-teens discount to NAV. Background on Closed-End Funds For those who want exposure to a particular sector or asset class, closed-end funds sometimes represent a cheaper vehicle than alternatives like ETFs and traditional mutual funds. This is because ETFs and conventional mutual funds 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 closed-end funds. Rather, the share price of closed-end funds is driven by the market forces of supply and demand, which sometimes creates attractive opportunities to buy stakes at big discounts to NAV. This tends to happen when sentiment for the particular sector on which a closed-end fund focuses becomes negative, causing some investors to sell irrespective of price. This is currently the case for several Asia-focused closed-end funds. I previously wrote about one such opportunity to obtain Chinese equity exposure at a 20%-plus discount. Here, I’ll cover another opportunity to buy debt exposure at a discount. Aberdeen Asia-Pacific Income Fund Overview The Aberdeen Asia-Pacific Income Fund (NYSEMKT: FAX ) was established in 1986 with an investment objective to seek current income through investment in Australian and Asian debt securities. Aberdeen is a reputable closed-end fund manager, which has conducted share buybacks through tender offers for several of their other funds (such as The India Fund, Inc, Aberdeen Chile Fund, Inc, and Aberdeen Greater China Fund, Inc) when they have traded at significant discounts to NAV. The fund currently pays a monthly dividend of 3.5 cents (equating to a ~9.3% yield), and its expense ratio is moderate at 1.09%, excluding interest expense and based on the fiscal year ending October 31, 2014. The fund makes moderate use of leverage, which stood at approximately 22% of gross assets at August 31, 2015. Leverage is of course a double edged sword and could magnify any gains or losses experienced by the underlying assets. As can be seen below, although the fund’s longer term returns have been reasonable, performance has suffered recently amidst general market turbulence in the sector. Source: Aberdeen Asia-Pacific Income Fund Performance Report This lackluster recent performance has spurred investor outflows that have caused FAX to now trade at a ~17% discount to NAV. As shown below, this has happened numerous times in the past when Asian market sentiment turned negative (e.g., 2008, 2000, 1998), but in all cases the discount eventually collapsed when sentiment stabilized. (click to enlarge) Source: CEFConnect Portfolio Composition Based on reported holdings at August 31, 2015, the FAX portfolio is composed of ~44% corporate bonds, ~53% sovereign and supranational bonds, and ~2.6% cash. The vast majority of the portfolio is made up of investment grade (BBB- or higher rated) bonds. To put this in a little perspective, the average annual historical default rate of bonds rated IG by S&P over the past few decades is well-under 0.5%. Source: Aberdeen Asia-Pacific Income Fund Fact Sheet The portfolio is diversified geographically as summarized below, though Australia, China, India and South Korea are the largest constituents. Source: Aberdeen Asia-Pacific Income Fund Fact Sheet Conclusion Due to the Aberdeen Asia-Pacific Income Fund’s current large discount to NAV, investors now have the ability to own a relatively safe portfolio of Asian bonds, overseen by a reputable manager, for ~83 cents on the dollar.

Utilities Specialist Reaves Launches Its 1st Actively Managed Utilities ETF

Summary Reaves Asset Management – a company with 50 years researching and investing in utility assets – recently launched the Reaves Utilities ETF. It joins the relatively small list of actively managed ETFs but carries an expense ratio that would place it among the most expensive in the utilities ETF space. The fund’s managers believe that actively managing the inherent complexities of the utilities sector can unlock additional value for shareholders that a passive index can not. Reaves Asset Management – an investment management firm that specializes in the utilities and energy sectors – has been investing on the behalf of its clients for the past 3+ decades. Recently, the company entered the ETF space for the first time with the Reaves Utilities ETF (NASDAQ: UTES ). Reaves, however, is not new to the fund game. It also offers the open-end mutual fund Reaves Utilities and Energy Infrastructure Fund (MUTF: RSRAX ) and the closed-end fund Reaves Utility Income Fund (NYSEMKT: UTG ). Not only is Reaves entering the ETF space for the first time but it’s doing so with one of the few actively managed ETFs out there. Manager The Reaves company has been around for over 50 years and has been managing investor money for around 37. The company now manages a total of roughly $3B in a combination of its mutual funds, ETF and separately managed accounts. The ETF is managed by Louis Cimino, John Bartlett and Jay Rhame. Bartlett has been with the company for 20 years, Cimino 18 and Rhame 10. The research team at Reaves, according to the fund’s fact sheet, “averages over 20 years of experience.” Investment Process The management team uses a combination quantitative and qualitative approach in order to make investment decisions and, according to the fact sheet , uses the following criteria. Where this product differs from most other ETFs is that it’s actively managed. Betting that the fund’s active management can outperform a passive index may prove to be a risky proposition. In most cases, actively managed funds cost more to operate to than passive index funds due to the extra involvement necessary to manage the fund. According to ETFDB.com, this ETF’s 0.95% expense ratio would rank it as the highest annual expense ratio among the roughly two dozen utility-focused ETFs in the marketplace. The Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) charges just 0.15% a year which means the Reaves ETF will need outperform by nearly a full percent per year just to come out ahead. That’ll be a tall order to fill regardless of who’s managing the fund. Holdings As of October 9, the fund has 21 holdings total. The top 10 holdings listed below account for 67% of fund assets currently. Prospects The ETF is debuting at a potentially advantageous time. Utilities as a whole have struggled this year – the Utilities Select Sector SDPR is down 4.8% year to date versus a 2.1% loss for the S&P 500. Investors had been anticipating a rate hike from the Fed and yields on the 10 year Treasury hit 2.5% earlier this year which made fixed income securities look more attractive and began rotating cash out of equities. As the prospect of a Fed rate hike looks to be getting pushed further out on the horizon and Treasury yields begin coming back down, the 3-4% yields offered by utilities began to look more and more attractive. While Reaves has been studying and managing utility assets for decades I still believe it’s going to have a difficult time overcoming the expense ratio over time. The fund currently has about $2.6M in assets and trades just a few hundred shares a day so bid-ask spreads could be large until the fund is able to operate a little more efficiently. All in all, due to the fund manager’s wealth of utility sector experience I would continue keeping an eye on this fund.