Roger Conrad reviews his 10% Club, which is made up of essential service stocks offering both current yields as well as anticipated dividend growth. Here, the editor of Conrad's Utility Investor explains the background of the list, his contrarian investment strategy, and highlights four stocks that currently earn a spot on this list.
Steven Halpern: Joining us today is Roger Conrad, income investing expert and editor of Conrad's Utility Investor. How are you doing today, Roger?
Roger Conrad: I'm great Steve, how are you?
Steven Halpern: Very good, thanks for taking the time. Today we're going to discuss your 10% Club, a special group of essential services stocks whose yield plus anticipated dividend growth could potentially exceed 10%. First, before we look at the portfolio with some of the stocks themselves, could you explain what makes up that category essential services?
Roger Conrad: We'll, we're talking about anything that people need, you know, and that is essential for the economy, so we're talking about electricity providers, heating and gas providers, communications, water and energy pipeline, those types of infrastructure investments where demand is always pretty constant, regardless of whether we're in a bear market or a weak economy, and as a result, investors can really look forward to some pretty steady earnings.
They tend to pay pretty nice dividends and there is, at least for regulated utilities, an unblemished record of always coming back from any disaster, so they're really kind of bedrock for the economy, for the markets, and very, very good stocks to own.
Steven Halpern: So, to find these long-term opportunities, you take a contrarian approach, noting that the idea of buying low and selling high can be much more difficult than it might appear on the surface. Can you expand on that?
Roger Conrad: Absolutely. You know, I think all of us are creatures of emotion to some extent—investors—and when we talk about our money, it's a personal matter, so it's very hard to hold a stock—or particularly to buy a stock—that other people are selling, that the momentum has moved against.
But that's precisely the time when you do have best-in-class companies and industries like essential services that have that really strong record of rebounding from any disaster, that's when you find these companies at good prices, so that's when you want to be buying them. I think that's what makes things difficult.
It's also something that we were able to do last year a lot and that is to make sales of stocks that have become very, very popular, and even in the essential service space, so even in companies that people have thought about holding forever, there's still a time—sometimes—to take a profit, and, of course, a lot of these stocks have come down pretty heavily since then, so that has given us another opportunity to get back in.
You really do want, particularly here in—what I would call—the later stage full market, you really do want to take advantage of these emotional shifts because there are stocks that become undervalued and overvalued pretty quickly, and by taking advantage by betting against the crowd, you can really buy low, and again, sell high.
Steven Halpern: So, expanding on this contrarian style, you point out that concerns over higher interest rates have given many investors an excuse to just sell, but you point out that returns generated by these essential services stocks aren't necessarily tied to interest rates, and as such, those who are selling might be making a mistake. Could you explain that?
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Roger Conrad: Well, that's absolutely right. In fact, if you just look at annual returns on some of these indexes—the utility index for example—you find that it goes up years when interest rates have risen and you find that it goes down years when interest rates have fallen, 2008 being a prime example of a time when interest rates really dropped like a stone, but yet, utilities had their worst year, really going back to, certainly, a decade.
The key, if you look at it, is what kind of earnings were these companies having? What sort of economy did we have that enabled them to do well to increase dividends? That was really the driver for these stocks in all these various years.
Now, people are sort of trained to sell when they see interest rates rising, or more importantly, when the perception is that interest rates are going to rise and we'd seen that happen several times over the past few years, but each time it's been a great opportunity to pick up good stocks and that's really the point I think of this 10% Club is we're looking at companies that are growing their businesses.
They certainly are not slowing down to any extent with the economy doing well.
And yet, because of this misconception about interest rates really almost moving like a bond substitute, which they're not, because of that you do get these big momentum swings in buying and selling.
So again, it gets back to that buy low, sell high and this gives us, again, this interest rate misconception and gives us an opportunity to buy these stocks at very good prices.
Steven Halpern: So, let's look at a handful of individual stock that make this elite list of your 10% Club and one stock on the list is a water sector utility, Aqua America (WTR). What's the attraction here?
Roger Conrad: Well, this is a utility that has basically grown very rapidly over the past 20 years by simply buying smaller water systems, integrating them into their own system, cutting costs, and thereby, making upgrades.
One thing about our water system in the United States, it's very diffuse, the ownership of it, and this gives companies like Aqua a lot of opportunities to make those acquisitions.
Of course, the big news in water, and we've just written about it in Conrad's Utility Investor, is the big draught has taken place in the Western part of the country and in California where we've seen water rationing. Well, you know, Aqua has that advantage of not operating in those states.
I do think there's some opportunities there, but Aqua, if someone's worried about the impact of the draught on utility earnings on water utility earnings, they don't have to worry about it with Aqua.
I think that actually is helping this stock trade at an even larger premium, but the main attraction to me is just steady dividend growth, because they're adding more customers, they're adding more systems, and in a very, very low risk way, because again water is one of those essential services, and you need it no matter what.
Steven Halpern: Now another stock in the 10% Club is Brookfield Renewable Energy Partners (BEP), which is a limited partnership. Could you tell us about this play on renewable power?
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Roger Conrad: Well, this is primarily a hydro play, hydro water power play. They have operations in Canada, United States, but also in Brazil and in Ireland.
They're backed by Brookfield Asset Management, that's their parent company, so they have a lot of financial resources to draw on to make acquisitions and that's basically how they grow their dividends is by acquiring new plants.
They lock in customers over long periods of time, and therefore, produce very, very steady reliable cash flow, so it may be a stock some people would consider to be boring but I like that kind of boring.
Again, the company is yielding well over 5%. And, as you say, its limited partnership, so that's partly tax advantaged, but more importantly, it's growing that distribution by 7% to 8% a year, which adds up to well over 10%, which is the criteria for the 10% Club.
This is just a really nice one and it's one of those very few Canadian stocks that has actually produced very strong returns, even with a Canadian dollar weakening against the US dollar.
So the Canadian dollar stabilizing—and possibly appreciating over time—is an added bonus for owning a company that's very, very safe and again has just a very steady, reliable path towards what's quite robust growth.
Steven Halpern: Now your 10% Club list also includes two leaders in energy infrastructure, Kinder Morgan (KMI) and Plains All American Pipeline (PAA); what are your thoughts here?
Roger Conrad: Well, I like both of these, and of course, you know, we've seen a real slow down in the energy patch. These are midstream companies that own pipelines, and so forth, that are based on fees, so they're not directly affected by energy prices.
But this industry is affected by the financial health of producers, which are really stressed now with lower energy prices, so a number of weaker midstream companies out there, we think, are in danger of suffering from contract defaults and sharply lower earnings, and thereby, even dividend cuts with some of these.
That's not true of Kinder Morgan or Plains All American. These companies have been around a long time. They have good contracts with very credit worthy partners.
A lot of the newer entrants don't have those same strengths because they simply were late to the party, so they've had to take whatever they can get, in terms of contracts and customers, but these companies have—again—a clear path towards actually adding more assets over the next several years and thereby increasing their distributions.
Kinder Morgan is no longer a limited partnership, that's a corporation. Plains All American is a limited partnership, so there are some tax advantages there as well.
For both of these, the most important thing is that they're growing their distributions very reliably in an industry that has become rocky for a lot of their competitors, but for them, again, they have a very clear path towards a quite robust growth.
Steven Halpern: Again, our guest is Roger Conrad, editor of the industry leading Conrad's Utility Investor. Thanks so much for taking the time today.
Roger Conrad: Thanks Steve.
