Morningstar Wide Moat Total Return ETF Offers an Interesting Conglomeration of Stocks

Morningstar Wide Moat Total Return ETF (MOAT) offers an interesting conglomeration of stocks.   All the companies have one common attribute – a high barrier to entry for competitors and an undervalued stock price. MOAT offers exposure to the top 20 companies identified by Morningstar as having a “wide moat”. Below is the current list of stocks:

80% of assets are large cap stocks and 20% are mid-caps.  40% are considered Value, 49% considered Growth and the balance 11% a Blend.  Sector allocations of these holdings are:

MOAT offers a 1.2% yield and charges a 0.45% fee. 

While the underlying Index has been around since 2007, the ETF was established in early 2012 and MOAT has about mirrored the S&P 500 return. Van Gleck ETF database offers this review: 

Moat = Sustainable Competitive Advantage
Morningstar equity analysts use a time-tested proprietary process to determine if a company has an economic moat.  The Index Favors Undervalued Stocks.  Of the broad equity universe analyzed by Morningstar, currently about 10% receive a wide moat categorization; the 20 stocks with the most attractive valuations are selected for its Index.  Proven Index Track Record.  Index has generated significant excess returns relative to the overall market since inception in 2/07. 

 According to Morningstar,

“only companies with an economic moat — a structural competitive advantage that allows a firm to earn above-average returns on capital over a long period of time — are able to hold competitors at bay.” 

In addition to offering a wide moat, the Index identifies the most undervalued of these companies and incorporated the top 20 most undervalued stocks. 

An informative SeekingAlpha article written by Morningstar concerning their Wide Moat Index can be found here:

Morningstar adjusts the Index portfolio once a quarter to reflect new names that are upgraded and deletions to Wide Moat Index status.  Most of the deletions are triggered by better value elsewhere.    The latest adjustments are below:

 From its founding in 2007 to the bottom of the market crash in 2009, the Index mirrored the S&P 500 return.  However, since 2009, the Index has substantially outperformed the S&P, as shown in the graph below:

The blue line is the performance of the Wide Moat Index and the red line is the SPX. 


From the graph, long-term investors in the Index have generated more than 50% greater returns than the market. 

MOAT is an easy method of gaining portfolio exposure to both the specific companies and to the investing philosophy of Morningstar.  Long-term investors should review MOAT as a core holding.    

Thanks for reading.  This  article first appeared in the December issue of My Investment Navigator newsletter,
George Fisher

BlackRock - Neutral Rated But Long-Term Core Financial Holding

BlackRock (BLK) is the largest asset manager in the world, with $4.525 trillion in total assets under management AUM and clients in more than 100 countries.  The AUM generates Fee Revenues of around $5.5 billion a year.   Product diversity and a heavier concentration in the institutional channel have traditionally provided BlackRock with a much “stickier” set of assets, or a propensity not to migrate to competitors, than its peers.  BlackRock's well diversified product mix makes it neutral to shifts among asset classes and investment strategies, limiting the impact that market swings and/or withdrawals from individual asset classes or investment styles can have on its AUM.  For example, BLK offers the iShare brand ETFs in Equity, Fixed Income, International and Multi-Asset allocations. 

Many think BLK is mainly a retail-focused firm, but they offer specialized services for the following categories of customers:

  •  Investment Professionals Advisors and RIAs
  • Asset Managers
  • Fixed Income Professionals
  • Broker Dealers
  • ETF Investment Strategists
  • Institutional Consultants
  • Insurance
  • Pensions, Foundations and Endowments

In its most recent investor’s presentation, the company offers an interesting breakdown of its client base:


The company outlines its philosophy on its website:

“BlackRock is the world’s largest asset manager, and our business is investing on behalf of our clients, from large institutions to the parents and grandparents, the doctors and teachers who entrust their savings to us.
We work only for our clients—period. Our promise is to offer them the clearest thinking about what to do with their money and the products and services they need to secure a better financial future.
That is why investors of all kinds entrust us with trillions of dollars, and it is why companies, institutions and global governments come to us for help meeting their biggest financial challenges.”     

Retail investors represent only about 12% of assets but generate 35% of base fee revenues.  iShares represent 23% of assets and also 35% of revenue,  The bulk of assets and fees are generated in the instructional sector with 65% of assets and 30% of fees. As shown, growth in the retail segment will drive earnings higher over time.   Management believes overall AUM can organically grow by 5% a year, driven by retail growth in the high single digits.

 Retail asset expansion is slowing from its 5-yr average growth of 11%.  iShares assets are expected to maintain its 5-yr average of 16% with mid-double digits growth projections.  Institutional assets are expected to maintain its 5-yr average growth in the low single digits. The firm also sees growth potential in its BlackRock Solutions, which is a complete risk assessment and portfolio management service for institutional investors.

Earnings per share have been growing at a 15% annual rate since 2010 and have driven dividend growth of 19% over the same timeframe.  Consensus EPS is for $18.50 in 2014, $20.60 in 2015 and $23.60 in 2016. At a PE of 15, or its EPS growth rate, share prices could reach $430. 

At a constant 44% payout ratio, the dividend could grow to $10.50 from its current $7.72.   However, if global markets do not return 6% to 7% annually and AUM growth falls below 5%, these estimates will be reduced.

Morningstar analysis offers the following observations:

Bulls Say: BlackRock is the largest asset manager in the world, with $4.525 trillion in total AUM and clients in more than 100 countries.  Product diversity and a heavier concentration in the institutional channel have traditionally provided BlackRock with a much stickier set of assets than its peers.  BlackRock's well diversified product mix makes it agnostic to shifts among asset classes and investment strategies, limiting the impact that market swings and/or withdrawals from individual asset classes or investment styles can have on its AUM.
Bears Say:  The sheer size and scale of BlackRock's operations could end up being the biggest impediment to the firm's AUM growth longer term.  Despite accounting for two thirds of total long-term AUM, institutional clients generate less than one third of BlackRock's long-term base fees given the lower fee structure attached to these large investment mandates.  While actively managed funds account for just over one third of total long-term AUM, they account for more than half of long-term base fees, increasing the pressure on BlackRock to fix its active equity and fixed-income offerings.

In addition, Morningstar offers this recent opinion:

BlackRock's $15.2B purchase of iShares from Barclays at the depths of the financial crisis could go down as the financial services equivalent of the Yankees' purchase of Babe Ruth from the Red Sox, says ETF Trends, noting iShares now offers more than 700 ETFs and is closing in on $200B in AUM.  The top three ETF providers (iShares, Vanguard, State Street) "have effectively maintained a triumvirate," says Morningstar, with 82% of the U.S. market and 70% of the global market - figures that aren't likely to change a lot in the near-to-medium term. "We expect iShares to continue to be the biggest growth driver for BlackRock in the near-to-medium term," says Morningstar, noting the unit in 2014 is expected to surpass last year's $62.2B in inflows (accounting for 56% of BlackRock's long-term flows).

Over the past 15 years, BLK has generated a 17.5% total annual return compared to the S&P 500 of a mere 4.3% return.  Going forward, BLK has a realistic potential to generate 10% annual total return for long-term investors. 

Although BLK has seen a huge run from its low of $308 just a few months ago to its current $356, the future looks bright for the firm.  Investors seeking a top-quality financial firm should consider making an initial position here and add on weakness over the next few months.

Fluor - Industrial Construction Company Getting Rave Reviews

Fluor (FLR) is an engineering and construction company focused on power plants, chemical and drug factories, bridges and other big structures.  Their boilerplate description is a great recap of FLR :

Fluor Corporation (NYSE: FLR) is a global engineering and construction firm that designs and builds some of the world's most complex projects. The company creates and delivers innovative solutions for its clients in engineering, procurement, fabrication, construction, maintenance and project management on a global basis. For more than a century, Fluor has served clients in the energy, chemicals, government, industrial, infrastructure, mining and power market sectors. Headquartered in Irving, Texas, Fluor ranks 109 on the FORTUNE 500 list. With more than 40,000 employees worldwide, the company's revenue for 2013 was $27.4 billion

 Like many large project construction companies, such as Netherland-based Chicago Bridge and Iron (CBI) and London-based AMEC (AMCBF), FLR has a substantial backlog of work.  With a backlog of over $40 billion, the company has about two years of work under contract.  Below is a recap of the backlog by operating segment:

Government                $5.2 billion 13% of backlog

Power                          $1.7 billion 4%

Industrial and Infrastructure   $9.2 billion 23%

Oil and Gas                 $24.4 billion 60%

The company’s recent awards include a multi-year contract to decommission a nuclear power plant in the UK and a gas pipeline in Mexico.  One of FLR-designed and constructed complex medical projects was named the International Society for Pharmaceutical Engineering 2014 Facility of the Year for Project Execution.   As the conversion from coal-fired power generation to natural gas marches on, the construction budgets of power companies globally will continue to be strong.  However, two sectors are dragging down investor’s interest – mining and energy. 

Investors should continue to watch the spread between new awards and revenues on a quarterly basis.  For example, during the second quarter, the company booked $5.9 billion in new business while billing $5.3 in revenue, increasing the backlog by $600 million – a positive sign for future revenues.

Morningstar offers an interesting recap of FLR’s strengths and weaknesses:

Bulls Say: Much of the world's easily accessible natural resources have already been harvested, meaning future mining and extraction projects will increasingly take place in remote areas. Fewer companies can service these types of projects, which should benefit Fluor. Fluor has a solid balance sheet with plenty of cash to spare for buybacks and making strategic bolt-on acquisitions where necessary.  Major multiyear project awards will provide top-line stability over a number of years.
Bears Say:  Fixed-price contracts will become more common in the coming years. Though they can carry higher margins than cost-plus contracts, fixed-price contracts are also riskier as they put more of the burden on the contractor to control costs and manage unforeseen circumstances like poor weather.  With more than 40,000 employees around the world, rising labor costs in emerging markets could keep pressure on Fluor's margins.  Working on large projects in remote areas of the world may create a greater chance of cost overruns and geopolitical risks. 

 With the current decline in most energy related stocks, Fluor offers interesting opportunities at its current price.  Shares have dropped about 15% since the market high in Sept and are 23% below its 52-week high of last spring.  There is concern the current drop in oil prices will curtail oil and gas infrastructure projects, negatively affecting FLR and other oil and gas E&C firms.  However, with only 60% of its business in the oil and gas business, the slide in share prices has eliminated the company’s well-deserved valuation premium. 

One consideration is management’s negative Net Return on Invested Capital.  Below is the Weighted Average Cost of Capital WACC as offered by and the three-year average Return on Invested Capital, as offered by Morningstar.  The list includes FLR, CBI and competitor Jacobs Engineering (JEC):

As shown, FLR capital costs seem to be in line with its competitors.  With the decline of CBI’s returns post-Shaw merger, the trailing twelve months ROIC for FLR and CBI are neck-in-neck at 14.2% for FLR and 13.8% for CBI.  

With a 2015 forward PE of 13 and a growth rate of 13%, the PEG ratio is 1.00, or fairly valued.  Earnings should grow from $4.02 in 2013 to $5.62 in 2016.  With a yield of 1.2%, the anticipated total annual return of 18.7% over the next 24 months will come from its share prices moving back over its previous high of $87.

Barron’s recently published an article on FLR titled “Oil Slump Makes Fluor Stock a Potential Double.  Sliding crude prices have put shares of the biggest U.S. engineer in the bargain bin.”  From their article:

Long-term Fluor shareholders have made out handsomely, with a yearly total return of 12.7% over the past decade, versus 8% for the Standard & Poor’s 500 index. However, year-to-date, Fluor has flopped, selling off 19% while the S&P 500 has gained 4%.
Earnings estimates have moved lower, but not nearly as fast as the share price. For example, back in July analysts predicted Fluor would earn $5.15 a share next year. Now they say $4.97, or 3% less. One reason forecasts have held up better than the shares is that Fluor has a $40 billion backlog of upcoming projects, enough to supply it with 21 quarters worth of revenue.
About 80% of the backlog consists of “cost-plus” jobs, where visibility on profits is high, according to investment bank D.A. Davidson. It initiated coverage of Fluor shares at the beginning of this month with a Buy recommendation and price targets of $85 over the next 12 to 18 months, and $150 over five years. The nearer-term target is about 30% above Fluor’s recent price of just below $65. The longer-term one is 130% higher.

The article can be found here:

Investors looking for a large-cap growth company with exposure to expanding oil and gas infrastructure should review Fluor as a core holding in the energy sector.  The current market weakness should provide a good entry point for new positions.

Johnson Controls: Automotive Batteries and HVAC Make Strange Bedfellows

Johnson Controls is an industrial company with diverse interests in automotive, heating and air conditioning. Johnson Controls is really three companies in one. Already one of the leading automotive seating and interiors suppliers, Johnson Controls continues to diversify. Growth in its building efficiency and power solutions group helps offset vicious cyclical declines in the automotive experience group.

The automotive segment contributed 51% of fiscal 2013 sales, down from 69% in fiscal 2005, which shows the company's increasing diversification.

Building efficiency in fiscal 2013 was a $14.6 billion business, contributing 34% of sales compared with 21% in fiscal 2005. The 2006 acquisition of York, manufacturers of heating and air conditioning equipment, made Johnson Controls a much larger player in HVAC equipment and service. This depth allows the company to market itself as a one-stop shop for service, controls, and equipment, which differentiates JCI from other large providers. Eighty-three percent of segment sales come from repeat business, but the company seeks to increase its exposure to more profitable HVAC product sales for a 50/50 product and service segment mix.

Power solutions is highly profitable, with 15% of fiscal 2013 sales and an operating margin over 15% in fiscal 2013. The segment has 36% share in the lead acid automotive battery market. This business is also a good diversifier because 80% of segment sales are to the replacement market, which makes battery demand more inelastic and gives the company strong pricing power. Johnson is the dominant player in start-stop vehicle technology thanks to its leading position in absorbent glass mat AGM batteries. Power solutions should benefit from automakers needing more fuel-efficient vehicles to meet environmental regulations.

There is tremendous growth and profit potential in AGMs because the batteries sell for twice the price of a normal lead acid battery. AGMs also generate 50% better profit margin. European auto production is forecast to increase the use of advanced lead acid batteries, such as AGMs, to 75% by 2015 from 40% in 2011. North American auto production is forecast to increase advanced lead acid use to 59% by 2015 from nearly zero in 2011. Globally, management expects start-stop to be 50%-60% of powertrains in new vehicles by 2020, up from 14% in 2012.

At the current price and a 15% anticipated EPS growth rate, JCI is trading below its earnings growth rate with a 2014 PE of 13.  JCI has been paying a dividend for decades and the current price offers a dividend yield of 2.0%.  JCI has a 5-yr dividend growth rate 7.9% and a 3-yr growth rate of 13.5%.  Management recently announced a dividend increase of 16.1%.  However, reported EPS over the same timeframe have been rather flat, mainly due to restructuring charges. 

JCI has a price target of $56, about 35% above its current price of $41.  While EPS have been stagnant over the past few years due to restructuring and charges, management should be about complete with its realignment of their businesses.  The underlying strength in the automotive and construction industries should help turn earnings around.   After being negative in 2010 and 2012, Free Cash Flow (operating cash flow minus capital expenditures) turned positive in 2013 to the tune of over $1.3 billion, and continues positive YTD.  Management believes free cash flow could top $2.0 billion by the end of 2016.

From Morningstar’s JCI report:

Johnson Controls has 15,000 HVAC service providers, making it 3 times the size of the second-largest player.
More governments wanting green buildings and the company's unique ability as a one-stop shop will keep the building segment growing and profitable, especially in emerging markets.
Increases in lead prices are mitigated by the fact that 100% of the lead price pass-through has been standard contracting with battery retailers for more than 70 years.
The company still gets about half of its sales from the very cyclical auto industry, and the market perceives it as an auto-parts supplier.
Commercial property servicing is very fragmented, and it could take time to capture significant share in the middle-market segment.
About 20% of battery sales are to automakers, which further exposes Johnson Controls to declines in auto production.

Investors looking for a high quality industrial company for the long term should review JCI.  Stock valuations have been consistently near the top of our universe.  More information can be found in JCI’s most recent investor’s presentation:

First appeared in the Oct 2014 issue of My Investment Navigator newsletter
Thanks for reading,  George Fisher

Lockheed Martin's Growth Fueled by Net ROIC of 30%

The world’s largest defense contractor offers dividend growth above inflation expectations and a yield higher than the current 30-yr Treasury.    Lockheed Martin (LMT), with $45.4 billion in revenues, has a 5-yr average dividend growth of 21% and a current yield of 3.5%.

A good description of the company is from their website:

LMT is a global security and aerospace company principally engaged in the research, design, development, manufacture, integration, and sustainment of technology systems and products. The Company also provides a range of management, engineering, technical, scientific, logistic, and information services. It serves both domestic and international customers with products and services that have defense, civil, and commercial applications, with its principal customers being agencies of the United States Government. It operates in five business segments: aeronautics (31% of 2013 sales), missiles and fire control (17%), mission systems and training (16%), information systems and global services (18%), and space systems (18%).

 LMT manufactures the newest jet fighters, F-35, and its fortunes will pivot on this important defense business, both in the US and abroad. 

 Dividend increases have been fueled by an 8% earnings growth and a payout ratio that has expanded from 30% of earnings to 53%.  While unsustainable at this growth rate, a long-term dividend growth matching its earnings growth of 8% would remain a respectable combination. 

 LMT should not be considered a value selection as it is trading at a PE of 18 with an underlying growth rate of 8%.  Share prices are up 12% from early August, and up 50% over the past year, substantially outperforming the market.  However, LMT has been a solid dividend payer with a lower-than-market beta of 0.72.    

 Helping long-term eps growth has been a reduction in shares outstanding.  Over the past 10 years, LMT has reduced share count by 28% - from 443 million shares outstanding in 2004 to 319 million currently.  This has help drive both eps and share prices higher. The combination of dividend growth and share reductions is a double positive for long-term shareholders.  It should be anticipated LMT will continue this trend.

 Management has one of the highest and most consistent returns on invested capital (ROIC) at a whopping 34% to 43%, with a 6-yr average of 37%.  Based on a cost of capital of 7.3%, management generates an eye-popping 30% net ROIC annual return.       

Analysts at Stifel upgraded shares of LMT to Buy from Hold and raised the stock's price target to $220. Joseph DeNardi stated,

“We believe the cash flow generation outlook for Lockheed’s core business, combined with the expected cash recovery from its pension over the next several years, should support continued growth in the company’s dividend and share repurchase activity to a degree that will differentiate it from its peers.”

Other highlights include: Defense spending bottoming in fiscal year 2015.  Analysts anticipate growth in F-35 sales as production rates increase.  DeNardi believes Lockheed is the best way to play what it see as a challenging but stable outlook for defense budgets.

Equity income investors looking for strong dividend growth with current yields competitive with long treasuries should review LMT.  However, share prices are currently overvalued and capital gains may be hard to come by from here.  Waiting a bit for a pullback, and buying the dip, should be the most prudent approach to this dividend growth machine.

 First appeared in the Oct 2014 issue of My Investment Navigator newsletter. 
Thanks for reading,   George Fisher

Which Equities Should Perform Better in Times of Higher Inflation and Why Should I Care?

One aspect of rising interest rates is the fight to control inflation.  As history demonstrates, loose monetary policy leads to too many dollars chasing too few goods, creating upward pressure on inflation.  In the previous piece, Atlanta Federal Reserve Bank’s Mr. Dennis Lockhart stated that a prominent risk of low interest rates is an uptick in inflation.   As the chart at the end shows, interest rates are set to rise in 2015 and continue into 2016, but if the Feds are already behind the curve and if rates do not rise sufficiently to curb inflation, it will once again creep back into our everyday lexicon.

There are sectors of the economy that historically do better with a touch of inflation and positive real interest rates.  While the list is not meant to be exhaustive, we hope to touch on a few sectors and which stocks in our universe may be poised to benefit from this environment.

Commodities and basic materials usually react favorable with a touch of inflation and usually rise with it over time.  Glencore (GLNCF) is a trader and miner of industrial chemicals.  BHP Billiton (BHP) is a global miner of industrial commodities as well. Southern Copper (SCCO) is a major global miner of copper.  

 Financial firms with fixed income investments, especially international finance and insurance, should experience an uptick in investment income as rates improve.  Berkshire Hathaway (BRK-B) has less of its investment portfolio invested in bond than its peers do.  Buffet prefers equities and entire businesses than purchased a portfolio of fixed income investment.  While this has worked to its favor as equity markets have outpaced the bond markets over time, other insurance companies may see a bigger boast in their investment income.  Power Corp of Canada (POW.TO, PWCDF) owns a majority percent of Power Financial/Sun Life of Canada.  Although a substantial chunk of fixed assets held by AFLAC (AFL) are in Japanese and European fixed income markets, higher income from its US bond portfolio should boost earnings.   Lincoln National (LNC) should benefit as well.

Real Estate usually increases with rising inflation. Both rents and home/commercial prices trend higher with the inflation rate.   Many REITs should perform adequately, however rising interest rates may pressure competitive yield offered by REITs.  Established triple-net REITs, such as National Retail Properties (NNN) or Reality Income (O), are structured to pass along increases in operating costs to their tenants. 

Gold is usually mentioned as benefiting from inflation.  The S&P Gold ETF (GLD) and various gold miners should rise as gold’s price tracks inflation numbers.  Gold mining mutual fund Tocqueville Gold (TGLDX) should benefit from inflation.   Gold mining and energy income fund Gabelli Global Natural Resources (GGN) offers a 10% distribution (mainly categorized as return of capital) and should benefit as well.     

Oil and natural gas prices will move higher along with inflation.  Suncor (SU), Dorchester Minerals (DMLP), and Total (TOT) should respond favorably.

Floating rate bank loan mutual funds will increase their income as higher interest rates and inflation take hold.   Fidelity Floating Rate High Yield Income (FFRHX) and Oppenheimer Senior Floating Rate (OOSYX) are two examples of funds that hold variable rate bank loans. 

Investors should care because inflation will become a headline event not too far into the future, and when it happens, it could be too late to move into these inflation-sensitive investments. Do not be like the Feds and become behind the inflation-curve. 

First appeared in the Sept 2014 issue My Investment Navigator
Thanks for reading and your interest,  George Fisher




FS Investment Co went from being privately-held to the 4th largest publically traded co. in its industry-overnight

FS Investment Co (FSIC) went from being privately held to the fourth largest publicly traded company in its industry – overnight. FSIC was spun off from Franklin Square Holdings, a private investment company.  FSIC is a Business Development Company BDC and supplies capital for smaller companies looking to raise equity and debt.  By market capitalization, FSIC is the 4th largest BDC out an industry consider to total 41. 

Before the Great Recession, BDCs were very popular with investors due to their high yields and unique expose to growing companies.  However, as many businesses began to fail, BDCs ran into severe trouble and were unable to collect on their debts. Most lost money, experienced rapid declining book values, and failed to make money for longer-term investors.  A good example is American Capital LTD (ACAS).  A $10,000 investment in 2004 would have been worth $416 or less during much of 2009.  Currently, the $10,000 would be worth $15,000 vs. $22,000 if invested in the S&P 500.     

A business description is found on their website:

FS Investment Corporation is a publicly traded business development company (BDC) focused on providing customized credit solutions to private middle market U.S. companies. We seek to invest primarily in the senior secured debt and, to a lesser extent, the subordinated debt of private middle market U.S. companies to achieve the best risk-adjusted returns for our investors. In connection with our debt investments, we may receive equity interests such as warrants or options.
FSIC is advised by FB Income Advisor, LLC, an affiliate of Franklin Square Capital Partners, a leading manager of debt-focused alternative investment funds, and sub-advised by GSO/Blackstone Debt Funds Management LLC, an affiliate of GSO Capital Partners, the credit platform of Blackstone. 

 Of interest to investors is the connection between FSIC and Blackstone (BX), one of the largest investment, hedge fund and private-equity managers.  The majority of FSIC loans (76%) are variable rate with an average maturity of 2020 and the average credit rating of its 125 portfolio companies is B3.  

FSIC could be substantially overpriced if the 9.3% current yield is unsustainable.  The monthly dividend is $0.88 annualized, and a $0.10 special dividend was recently announced.  The dividend is supported by the company’s portfolio of loans with an average interest rate of 9.9%.

As the overall interest rate environment remains low, these loans are at risk of being refinanced at lower rates, reducing income for FSIC.  In addition, the advisory fees charged by Franklin Square and BX are around 2.0%, expensive for the assets managed - $4.2 billion.   

 BDCs with longer operating histories include Triangle Capital (TCAP) with an 8.1% yield and PennantPark Investments (PNNT) with an 11% yield.  While their industry was collapsing around them during the financial crisis, these two companies did not cut their dividends.  All BDC investors should appreciate this important trait. 

The bottom line for FSIC is that there may be better avenues for generating above average income and the risks associated with FSIC are not necessarily fully compensated by a 9.3% yield.

More information on FSIC can be found in their investors presentations:

First published in the Sept 2014 issue of My Investment Navigator
Thanks for reading, George Fisher

Suncor: If It's Good Enough for Warren Buffett, It Should be Good Enough for You

Suncor (SU) is the largest Canadian oil company, but not quite large enough to be included with the Big Seven Sisters.  (The phrase was coined in the 1950s, referring to the largest seven global oil companies of the time.  The original group comprised Anglo-Persian Oil Company (now BP); Gulf Oil, Standard Oil of California (SoCal), Texaco (now Chevron); Royal Dutch Shell;  Standard Oil of New Jersey (Esso) and Standard Oil Company of New York (Socony) (now ExxonMobil)). 

During the obligatory disclosure period at the end of each quarter, Berkshire Hathaway (BRK.B) revealed it initialed a position in SU by purchasing 17.7 million shares.  While still rather minor at just 1.2% of SU shares outstanding, the investment of $500 million is no small potatoes, even for Mr. Buffet.  Shares are up nicely to $41 from a purchase price of between $27 and $32. 

Suncor is an investment that is depended on its 100-yr potential of oil reserves locked in the Oil Sands.  While the firm also produces oil from conventional offshore drilling along the Canadian East Coast and in the North Sea, the majority of its production will come from oil sands.   

SU had a rough 2nd quarter 2014 with write-downs of some of its projects.  The company wrote down $223 million in Oil Sands projects following a review of certain assets that no longer fit Suncor’s revised growth strategies. SU also incurred $297 million charge against the company’s Libyan assets due to continued political unrest.

The company said production volumes from the Oil Sands operations increased to an average of 378,800 barrels per day in 2Q14—compared to 276,600 bpd in the same quarter last year.

Quarterly production volumes for the Exploration and Production segment decreased to 115,300 barrels of oil equivalent per day (or boe/d).  Production volumes were 190,700 boe/d in the same quarter last year, but included conventional natural gas assets recently sold. 

Suncor’s cash cost of production is around $12 per boe offshore in the Maritimes, $6 in the North Sea, and $32 in the oil sands.   While operating costs are higher, the future of the company is based on achieving higher production volumes from their sands projects.  

The investment trade off with Suncor is accepting higher operating costs in exchange for higher production reserves. SU owns 37 yr. Proven and Probable Reserves compared to 19.7 yrs. for Apache (APA) and 13.5 yrs. for Total (TOT).  The amount of estimated recoverable oil in the area of SU’s assets could contain as much as 22.5 billion barrels, which could sustain 500,000-boe production for over 100 years.  Below are two graphs from Suncor’s investor presentation outlining planned production growth and historic operating costs from their oil sand projects:



Since 2011, SU has generated $8.3 billion in free cash flow, or operating cash flow less capital expenditures.  An important consideration in the oil business is the high cost of capital expenditures needed to offset production declines.  Apache generated $0.5 billion in free cash flow and Total $4.1 billion during the same period.

Management has earned a 12-month return on invested capital of 7.75%, and is about the industry average of 8.76%.  Operating margins of 16.1% are above industry average of 10.2%. 

Suncor pays a dividend of $1.03 a share and offers a 2.5% yield. The dividend was recently raised by 22% and marks the 12 straight year of dividend increases.  With a payout ratio of 30%, future dividend increases should track long-term earnings growth rate of 8%.

More information can be found in the most recent Suncor investor presentation:

First published in the Sept 2014 issue My Investment Navigator
Thanks for reading,   George C. Fisher

ITC Holdings: An Unconventional Utility with Oversized Growth Prospects


ITC Holdings (ITC) is a mid-cap regulated electric utility with substantial growth prospects not seen elsewhere in the sector. ITC is expected to grow earnings by 13% a year, more than double the utility sector’s 4% to 6% growth rate. ITC focuses solely on federally regulated (Federally Energy Regulatory Commission FERC) transmission assets where allowed return on investment is higher than the typical state-regulated assets. The difference is federally regulated usually allows for about 12% to 13% return on equity vs. the most recent quarter’s rate case average for state regulated allowed return on equity of 10.5%.

Translating this into potential profits – for every dollar ITC invests in transmission assets, the allowed return is between 14% and 23% higher than the average utility investment whose rates are regulated by state agencies. The company just announced a $4.5 billion capital expenditure budget for the next 5 years. This should drive earnings higher by 11% to 13% annually as these assets become included in its rate base calculations. Net Property, Plant and Equipment should double in size from $4.8 billion to over $9.3 billion by 2018.

The stock has had an impressive run over the past year, rising from $30 to $37. ITC is up 23% over the previous 12 months while the S&P Utility ETF (XLU) is up 5%. Price targets range from $41 to $48, leaving plenty of room for future shareholder returns. There are currently 156 million shares outstanding, which is low for the sector, even after a 3-1 stock split (remember those?).

Over the past few years, the stock has had several uninterrupted moves higher. After collapsing in the 2009 market meltdown from $17 to $7, the stock rose nonstop back to $17 in 2010, paused a bit to $15, then rose to $26 in 2011. The stock paused again between $25 and $22, and then ran up to $32, paused again, then climbed to $35 in 2012/2013. Recently, the stock fell back to $31, and then charged up to its current $37 as the stock split was announced. Share prices would have to drop below $34 to signal a break in the most recent up trend.

The dividend yield is quite low for a utility, as ITC has been plowing investable cash back into its cap ex program. The current yield is only 1.5%, but dividends are expected to grow by 10% annually over the next few years. Dividend growth investors should be savoring this growth rate.

ITC may be considered to be fully valued and future capital gains will come from higher earnings and dividends. ITC is trading at a PE of 25, vs its previous 5-yr high of 23 and price to cash flow ratio is double industry valuations. With a low payout ratio of 36%, higher earnings and an expansion of the payout ratio will support higher dividends over the long-term.

Starting a beginning position in ITC, with the concept of adding to shares over time, would make a timely addition to the utility allocation of your portfolio.

Disclosure: Long ITC and ITC is followed by My Investment Navigator Newsletter.  First published in the May 2014 issue of newsletter.

Update:  The FERC recently reduced the allowed ROE for electric transmission assets.  With incentives for being an independent company, ITC should earn 11.47% ROE, down for a range of 12.16% to 13.88%.  ITC should be eligible for the highest allowed ROE of its peers. 

Thanks for your time and interest in My Investment Navigator,
George C. Fisher, Founder and Publisher

Are Bond Fund Exit Fees In Your Future?

While not getting much mainstream press, the Fed may be thinking about what will occur as interest rates increase and its effect on the value of bond mutual fund prices.  From a Barron’s article, June 21 Up and Down Wall Street:: 

“The Federal Reserve is floating a trial balloon, or at a minimum give bond investors a “heads up”.  It might be well that the Federal Reserve appears to be thinking about the consequences of the end -- and eventual reversal -- of its massive experiment in monetary stimulation. Last week, the Financial Times reported that the central bank is mulling exit fees on bond mutual funds to prevent a potential run when interest rates rise, which, given the ineluctable mathematics of bond investing, means prices fall. Quoting "people familiar with the matter," the FT said that senior-level discussions had taken place, but no formal policy had been developed.
Those senior folks apparently did not include Fed Chair Janet Yellen. Asked about it at her news conference on Wednesday, she professed to be unaware of any discussion of bond-fund exit fees, adding that it was her understanding that the matter "is under the purview" of the Securities and Exchange Commission.
That nondenial denial leaves open the possibility that some entity in the U.S. financial regulatory apparatus is indeed mulling bond-fund exit fees. The Financial Stability Oversight Council established by the Dodd-Frank legislation oversees so-called systemically important financial institutions, or SIFIs, which include nonbank entities. And, indeed, the FSOC has considered designating asset managers as SIFIs, as Barron's has noted previously.”

Remember that in the jaws of the last financial crisis, a run on money market accounts during the fall of 2008 caused the Feds to alter money market fund status by temporarily guaranteeing them, equaling the protection of FDIC-insured bank savings accounts.  This temporary guarantee expired in Sept 2009. 

An exit fee for bond fund sales might be an attempt to stem potential fund outflows as rates increase.  While most commentators do not believe this will actually happen, it is important for investors to take notice of the Fed’s worry.   

Most of us have some bond funds and it essential for investors to understand the “interest rate risk” and its potential impact on that specific fund.  While seemingly a complex calculation, it is actually quite easy.  Most of the complicated math has been done for you and is reflected in two important bond fund fundamentals.   These are “Average Maturity” and “Average Duration”.

The important takeaway is the topic of interest rate hikes is starting to gain traction, even within the inner circle of the Fed.  How are you preparing for the next move up in the interest rate cycle and how will it affect your finances?

First published June issue of  My Investment Navigator newsletter
I appreciate your time and interest in My Investor Navigator,
George Fisher, Founder and Publisher