Tag Archives: income

Dynegy: Too Early To Buy

Summary Dynegy shares have been cut in half in 2015 as investors run for the exits. While metrics are improving, the company still doesn’t generate significant operational cash flow. Additionally, I have concerns over whether cash flow problems have impacted the company’s ability to properly maintain its assets. It’s still to early to buy. If you really want a piece of this company, buy the preferred shares instead. Dynegy (NYSE: DYN ) is a holding company that owns a large portfolio of power generation assets throughout the United States, with a heavy concentration of these assets located in the Northeast and Midwest. The company operates regulated utility operations while also competing in the wholesale electric business, where it provides electricity to utilities, power marketers, and industrial customers. Unlike traditional regulated utilities that are the sole source of power for their customers, the wholesale market pits many players against each other in the name of driving down costs. Dynegy operates approximately 26GW of generation assets, with the vast majority of production evenly split between modern combined cycle natural gas plants and legacy coal plants. In acquiring and developing these assets, the company has had both an interesting and volatile past. Dynegy emerged from bankruptcy in 2012 with a little help from the renowned Carl Icahn , only to make a $6.25B acquisition (12.4GW) of coal and gas-fired assets from Duke Energy (NYSE: DUK ) and Energy Capital Partners just a few short years later in 2014. While the debt load may appear large given the company’s size and recent bankruptcy, the acquisition was viewed favorably by most ratings agencies in regards to improving earnings by acquiring some retail regulated business. However, this debt didn’t come cheap – weighted average interest rate of the debt was 7.18%, quite high given our current position in the interest rate cycle. Operating Results (click to enlarge) As one of the largest merchant energy providers using natural gas, you might expect operating results to have been a little bit more favorable than this post-bankruptcy. There are some sparks of improvement for investors to grab on to, such as improving gross margins. The retail Duke Energy/Energy Capital Partner assets have improved the company’s margin profile, and spark spread improvements due to collapsing natural gas prices have also boosted margins. SG&A expenses have also grown quite slowly, indicative of the scale that is present in many utilities. Bigger is generally better in this sector. Like the income statement, cash flow generation hasn’t been much better. Dynegy generated negative operational cash flow in 2013 and 2012, and was only generated marginal cash flow in 2014. 2015 is set to be a better year, but the company still struggles to generate enough cash to sustain itself. Through this point in 2015, the company has barely spent any money at all on capital expenditures ($500M over three and a half years). Even after taking into account the change in the business from the acquisition, this still seems woefully low. Great Plains Energy (NYSE: GXP ), another company with heavy coal exposure and nearly identical enterprise value, has averaged $600-800M in annual capital expenditures. I’m not sure I buy into just $130M in capex to support the company’s 16 power plants in 2014. This company is a long way away from supporting itself from a cash flow perspective, never mind instituting a dividend that can be healthily supported. I do like the company’s natural gas operations. Citing industry trends, management itself notes that it expects ~50GW of coal power plants to be phased out of markets that Dynegy competes in due to a variety of factors, such as falling natural gas prices, increased capital expenditure requirements, and burdensome regulatory costs. However, I can’t help but feel this leads to a negative in and of itself as well. This bullishness on natural gas generation seems to run contrary to the assets picked up from the Duke Energy deal, as a sizeable (roughly 40%) portion of those assets were coal-fired. Duke Energy has been reluctant and slow to shift generation away from coal, and while these were non-core assets for Duke Energy (the company has decided to focus on its East Coast operations), Duke Energy management wouldn’t have taken a poor deal just to dispose of these assets. Conclusion Dynegy is too early in the turnaround stage for me to recommend it, and it is too early to go bottom fishing, despite the stock getting halved in price in 2015. While I’m not going to call it a short (I would have six months ago), the company is still years away from being what investors want in a utility: consistent cash flows, a healthy dividend, and a fair valuation. The preferred issue is probably the better play here if you’re deeply interested in the company. The preferred currently yields 8.49%, and is convertible into 2.58 shares of Dynegy if you choose to later on. At $59.22/preferred share at this point, if this thing ever does recover, you’ll be sitting pretty and will have been paid a healthy dividend to boot while you wait.

Mixed Views On Emerging Markets: Funds To Buy And Sell

There are mixed views on emerging markets now. According to a report from Bank of America Merrill Lynch, fund managers have mostly been pessimistic about emerging-market equities since 2001. On the other hand, some strategists at leading banks and financial companies believe that securities from emerging markets may have hit their lowest point. Amid the contradictory opinions, certain market experts are of the view that investors often invest in emerging market funds too late or they stay invested for too long. So, while buying certain favourably ranked emerging market funds at a discount now should be a prudent move, investors may also dump certain Sell-rated funds that their portfolio will not miss. The Pessimism According to Bank of America Merrill Lynch’s monthly survey, fund managers are the most underweight on emerging-market equities against developed-market equities since the survey began in 2001. While post 2009, fund managers’ relative positioning had jumped and stayed mostly in the green till 2013, the sentiment soured after that. In 2014, the sentiment dropped to a new low before rebounding in late 2014 and early 2015. However, the sentiment is the most pessimistic now. The bearish outlook is concentrated mostly on Asia. Investors are apprehensive about the slowdown in China’s economy while the U.S. central bank may hike rates. The International Monetary Fund (IMF) meeting on Nov 30 is also crucial. Investors fear further devaluation in the Chinese currency but not before IMF adds the yuan to its Special Drawing Rights basket of currencies. And if this happens, Bank of America strategists fear that the markets will move even lower. Goldman Sachs projects that yuan traded at offshore rate may weaken by 2.5% to 3% against the dollar in the next 2 months. Eventually, the devaluation of yuan may impact other emerging-market currencies, as they are often influenced by the monetary policies in the world’s second-largest economy, China. The Contrarian View Meanwhile, market watchers at a number of leading banks and financial institutions have said that they believe asset values for emerging markets have hit a rock bottom. In fact, the views come from the likes of Bank of America, Goldman Sachs and Barclays PLC. Following three continuous years of losses, markets and assets from developing nations are poised for a rebound. According to Morningstar, in the 12 months ended October, emerging-market stock funds traded in the US dropped an average 13.4%. A major indicator of valuations for emerging markets is the MSCI Emerging Markets Index, which is down 30% from the high achieved in 2011. The index is currently trading at approximately 12x its earnings estimates. Additionally, the index’s valuation is nearly three times lower than the S&P 500’s current figure. This is why analysts at Barclays believe that prices of emerging market securities are significantly lower than their intrinsic value. Over the six-month period since the last three American market tightening cycles began, global markets have gained an average 15%. Strategists are also hopeful that emerging markets might rebound in 2016. They say that it might not mirror the “roaring”2000s, but 2016 might be the year the emerging markets “find their feet”. 2 Emerging Market Funds to Buy As mentioned earlier, investors should not miss the buying opportunity. An uptrend in emerging economies brings good tidings for investment instruments from these countries. Many of them currently have reasonable valuations compared to their historical averages. Below we present 2 International Bond – Emerging Market mutual funds that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Fidelity New Markets Income (MUTF: FNMIX ) fund invests the lion’s share of its assets in emerging markets or makes other investments that are economically linked to emerging markets that have stock markets as defined by MSCI. These emerging market countries also may also be the ones with low- to middle-income as classified by the World Bank. FNMIX currently carries a Zacks Mutual Fund Rank #1. FSRPX has gained respectively 3.7% and 0.2% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are 1.2% and 5.4%, respectively. Annual expense ratio of 0.84% is lower than the category average of 1.16%. Goldman Sachs Emerging Market Debt A (MUTF: GSDAX ) predominantly invests in emerging market debt securities. These instruments may be issued by governments as well as corporate entities. To gain exposure to certain emerging economies, GSDAX may use structured securities or derivatives among others. GSDAX currently carries a Zacks Mutual Fund Rank #2. GSDAX has gained respectively 2.8% and 0.5% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are 1.5% and 5.1%, respectively. Annual expense ratio of 1.24% is higher than the category average of 1.16%. 2 Emerging Market Funds to Sell It is also important to not stay invested in certain underperforming funds. For investors not ready to bet on the emerging markets now or for investors who have lost plenty staying invested in some emerging market funds, below we present 2 funds that either carry a Zacks Mutual Fund Rank #4 (Sell) or Zacks Mutual Fund Rank #5 (Strong Sell). Eaton Vance Emerging Markets Local Income A (MUTF: EEIAX ) gains exposure to the emerging economies by investing in securities and derivatives among other instruments. Bulk of EEIAX’s assets are invested in securities denominated in currencies of emerging market countries, fixed income instruments that are issued by emerging market entities, and in emerging-market denominated derivative instruments. EEIAX currently carries a Zacks Mutual Fund Rank #5. EEIAX has lost respectively 10.6% and 16.5% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are negative 7.2% and negative 2.5%, respectively. Annual expense ratio of 1.25% is higher than the category average of 1.16%. PIMCO Emerging Markets Currency A (MUTF: PLMAX ) invests most of its assets in currencies of emerging market countries or in fixed income instruments denominated by these currencies. PLMAX currently carries a Zacks Mutual Fund Rank #4. PLMAX has lost respectively 5.2% and 9.7% in the year-to-date and 1-year periods. The 3- and 5-year annualized returns are negative 4.7% and negative 2.4%, respectively. Annual expense ratio of 1.25% is lower than the category average of 1.58%. Original post

Why I Sold Pimco High Income Fund

Summary PHK has managed to attract a premium near its historical average before its dividend cut. Although another cut is unlikely in the near term, the current premium is overly generous. Historical price trends have created clear buy and sell signals which indicate PHK is too pricey at its current premium. However, if PHK can continue its recent and opaque increase to NAV, a new higher price target may be in order. Pimco High Income Fund (NYSE: PHK ) consistently paid out the same dividend for over a decade, until a 15% cut that management insisted was reflective of the secular stagnation argument for lower global growth that has come to quietly dominate many economists’ thinking. In management’s words: “Generally, the changes in distributions for PHK, PCI and PDI take into account many factors, including but not limited to, each such Fund’s current and expected earnings, the overall market environment and Pimco’s current economic and market outlook.” The market’s response was unsurprising – the fund reached a 52-week low of 6.87 and saw its premium to NAV – once the highest in the CEF universe – fall to zero. This was a tremendous buying opportunity and I heavily added to my position before encouraging investors to not worry about a dividend cut anytime soon . A dividend cut remains unlikely. Since October, the new payout has remained steady. In November, NII covered distributions by 92%, and NII has remained just a hair under 10 cents since April, when NII fell precipitously to about 7.2 cents per share, as it also was in March and January. 92% is still not full coverage, leaving some investors concerned about PHK’s future payouts. However, PHK is preparing for an interest rate hike and the ability to buy new issues at new, higher rates. Prepping for the Rate Hike The duration of PHK’s holdings has fallen to 4.7 years as of the end of September, down from over five years earlier in 2015. The fund has been cutting the duration of its holdings for a long time in anticipation of raising rates, which actually hurt performance in 2014, as management acknowledged in its semi-annual report from September 2014 – and which management attempted to rectify by buying swaps: “Despite the Fund’s short exposure to the long end part of the curve, which has hurt the performance, overall increased duration exposure with interest rate swaps contributed positively to performance as Treasury rates declined.” Now the fund seems to be doubling down on its expectation of an interest rate hike. If Yellen does raise rates in December or early 2016 and high yield issues offer higher yields as a result, PHK will be able to churn into higher yielding debts and fully cover dividends more easily. (For more on how higher rates can be good for PHK, please see my two earlier pieces on the subject: Part 1 and Part 2 ). A Safe Payout – So Why Sell? The market seems to have accepted that PHK’s new distribution is about as safe as the old one, and may last just as long before being cut again. Yet I sold the fund because the market has overpriced the value of PHK’s new payout. As of November 25th, the fund’s premium over NAV was 24.65%, almost at the average premium the fund enjoyed over its lifetime before the dividend cut: In other words, the market is roughly pricing the fund’s ability to fund future payouts at the same premium as it has priced that fund’s future payouts before the dividend cut. At best, the market is punishing PHK with a premium that is 5% below its historical average. Is that sufficient for a 15% dividend cut? The Technical Concern There also is a technical argument to be made against buying PHK now – but keeping it on a watch list in the future. Since 2010, when the fund’s premium to NAV remained sustainably high, PHK has followed a steady pattern of slow appreciation to a peak, followed by a decline, and then a steady appreciation again: (click to enlarge) This pattern held for most of 2014 until the high yield market began to see serious risk aversion and a tightening of credit spreads at the end of the year, partly due to the strong dollar, partly due to rising oil prices, partly due to fears of collapsing liquidity, and partly due to fears of higher defaults resulting in an increase in interest rates: (click to enlarge) While I believe short-term speculation on asset prices is almost always a losing game, in the case of PHK the return to form seems to be congealing, and since the dividend cut the slow appreciation followed by a steep drop-off seems to be coming back to the name: (click to enlarge) However, we are currently not seeing a steep sell off as we did in the middle of September and earlier in November. This trendline, its historical performance, and its new payouts have all given me clear price targets to buy, sell and hold this stock which are currently telling me to wait until returning to the name. A Silver Lining? There is hope for PHK, however, which may help it close the gap on its current premium. In the last few days the fund’s NAV has shot up to its highest point since its dividend cut and the first sign of an increase in NAV since the beginning of 2015: (click to enlarge) It’s unclear how the NAV for PHK shot up so quickly in such a short period of time. Because bonds, especially high-yield bonds, are particularly illiquid, this could be the result of a new mark-to-market for a holding that was temporarily mis-priced due to thin trading. Alternatively, it could be a result of a cumulative appreciation of the high yield market as the fears of earlier in the year briefly fade. A third option is that the fund made a new purchase that was particularly undervalued by the market. In any case, the fund’s NAV shot up after the spread between high yield and U.S. Treasuries widened, giving more opportunities for fund managers to find high-yielding assets to fund distributions: (click to enlarge) This could mean PHK will find more ways to increase its NAV and close that gap between its current premium and the premium that it deserves after a dividend cut. I will continue to watch PHK closely to see if its ability to increase NAV is sustainable, or if the market decides to under-price the fund again. Until then, I’m waiting on the sidelines.