Best Buys of the Month - The High Income Factor

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The
A Publication of Newsmax & Moneynews
High Income Factor
Unlocking Powerful Strategies to Achieve Superior Returns
Tom Hutchinson, Editor
Vol. 4, No. 10 / October 2014
A Tsunami of Profits: Ride the Global
Wave Everyone Else Has Missed (So Far)
“It’s like déjà vu all over again.” — Yogi Berra
T
he term “déjà vu” is a French term meaning
“already seen.” It is used to describe a common
sensation or strong feeling that a current experience
or event has already happened to you in the past.
I’m sure you’ve experienced the sensation at
some point. I know I have. It’s a bizarre feeling you
get when you do something
and your brain tells you that
this exact thing has happened
before. A person can get a
similar sensation by looking
though today’s headlines.
“The stock market is in
a precarious situation lately.
While the European debt
crisis seems to have subsided
for now, an even worse catastrophe could erupt at
any time. And there’s another looming problem
in the United States, as political wrangling in
Washington, D.C., is pushing us closer to a debt
showdown, all while uncertainty over upcoming
elections is causing both parties to punt on highprofile issues. On the geopolitical front, there is
growing speculation that Israel will attack Iran.”
Wait a minute . . . that’s not today’s news. That’s
actually from old notes of mine written in the fall
of 2012. Sorry about that, let’s try this again:
“A lot of uncertainty surrounds the current
market. Politicians are pushing key legislation to
the absolute deadline, and no one knows what will
happen when the Federal Reserve begins rolling
back its stimulus program — any timeline of which
“
is unclear — leaving investors dumping more
defensive income-oriented stocks and funds for fear
of rising interest rates. On the geopolitical front,
tensions in Syria have Western nations on edge.”
Wait, I did it again. That was a note from the
fall of 2013. That’s not going to help us, is it? Now
I’ll do the fall of 2014, I promise.
“The stock market is making new all-time highs
(as of this writing) amid
a resurgent U.S. economy,
although concerns persist
about what will happen
once the Federal Reserve
stimulus is officially off
the table later this year.
Meanwhile, geopolitical
tensions increasingly threaten
to derail the market. It seems
all but certain that the United States will have to
increase military action against ISIS in Iraq and
Syria. At the same time, the crisis in Ukraine is
getting worse as Russian troops have entered the
country. These tensions, along with the economic
sanctions imposed on Russia, are tipping a very
fragile European recovery back toward recession. At
the same time, many emerging market economies
are struggling, and Brazil has actually fallen into
recession. Investors worry how long the U.S. market
can forge higher while the rest of the world is in
such bad shape.”
See the glaring similarities in all of those
narratives? Of course, I pulled those old paragraphs
out for a reason — I wanted to illustrate the point
that there are reasons for worry and doubt about
We can achieve better
results by paying more
attention to longer-term
bankable trends than
short-term headwinds.
”
Percent of total
Chart 1
what’s immediately around us. Like a hedge maze,
the market every single year.
you can’t see the exit route from where you’re
Reiterating the concerns of recent years puts
standing.
today’s headlines in better perspective. In the prior
When we’re asked about the situation in
examples, let’s take a look and see how the S&P
the market, the country or even the world, we
500 went on to perform amid all that uncertainty
automatically think of current events. There’s
and trepidation.
increasing instability overseas, the world economy
One thing’s for sure:
Timeframe
S&P 500
(Sept. 3 to Sept. 3)
Return
is still in a funk but the U.S. economy is improving.
Overemphasizing the
2012–2013
17%
There is increasing speculation about when the
negative headlines of the
2013–2014
23%
Federal Reserve will raise interest rates and if stocks
day would’ve served as a
2012–2014
43%
are overvalued.
poor guide for investors.
All those things are true, and relevant. But the
Of course, that isn’t to say that the market always
bigger picture is lost in that thinking. Macro trends
goes up regardless of the issues. Market corrections
drive the longer term, not micro trends. We live in
happen and the market will most certainly sell off
an unprecedented time. The world has radically
again at some point.
transformed in just the last 20 years.
I also don’t dismiss the global political
I remember when my wife and I moved into
tensions as hogwash. A crisis could easily escalate
our first home in 1992. We didn’t own a computer
to a point where the market cannot ignore it,
or a cellphone. And we were by no means unusual.
sending stock prices reeling. It’s very possible that
We were a young couple living in the New York
by the time you read this, a global crisis could
metropolitan area. At that time very few people
have already knocked the market down. It can
owned such things.
happen that fast.
Now, of course, it’s difficult to imagine not
The point is, there are always risks to the
using the computer, the Internet, or email. I use
market in the short term. We can achieve better
these things every day. It’s how I make my living.
results by paying more attention to longer-term
Technology has transformed the world in
bankable trends rather than the short-term
less than a generation. But perhaps the most
headwinds that come and go every single year.
pronounced difference in the world over this time
Income investors in particular are generally longterm oriented and should consider the
Emerging-Market Share, World GDP
bigger picture.
50
What do I mean? Well, this month
I’ve identified a company that’ll directly
benefit from the continuing and
45
inevitable rise of global trade. This is
one of the most powerful trends in the
world . . . and very few people are paying
attention right now.
40
The stock pays a secure and growing
5.2 percent yield. Profits are positioned
to grow in a big way in the quarters and
35
years ahead. And the stock is dirt-cheap
at a time when U.S. stocks are generally
pricey. This long-term winner is ripe for
plucking.
’93
’95’00’05’10
’12
The Rising Global Tide
Admittedly, it can be hard to see
the bigger picture. We tend to take in
2
The emerging market countries’ share of world GDP has increased
drastically since just the early 1990s, now representing about 50
percent of the total.
SOURCE: IMF
TheHighIncomeFactor.com
October 2014
Index
Chart 2
is the stratospheric increase in economic
Volume of World Trade
growth.
150
Since World War II, the globe
had been divided into two spheres of
influence, Communist and free. The
100
United States, Western Europe, and Japan
80
completely dominated global economic
activity. The communist world and the
60
rest of the free world added little to global
production and trade. Then came the end
of the Cold War, with the fall of the Berlin
40
Wall and the collapse of communist
Eastern Europe.
30
’91 ’93’95’97 ’99 ’01 ’03’05’07’09 ’11 ’13
What a difference 20 years makes.
After the Cold War, the world essentially
As shown in this index of world trade volume, the level of merchandise
traded throughout the globe has more than tripled since the early
embraced capitalism and the number of
1990s.
active participants skyrocketed. Economic
SOURCE: Netherlands Bureau for Economic Policy Analysis
production from emerging markets
primarily in China, India, and the rest of Asia
economic output creates the ability to grow more
exploded.
and at a faster pace. The rate of increase in world
In 1990, emerging market countries produced
production has accelerated exponentially in recent
about 20 percent of global economic output (of a
years, and most of the increase in global production
much smaller total). Today, these countries account
since 1990 has occurred in the past 10 years.
for over 50 percent. (See Chart 1.)
In 2005, gross world product was $31.3 trillion
In fact, this year the collective GDP of
(again in constant 1990 dollars). That amount
developing nations has eclipsed that of the
grew to $45.7 trillion by 2012, a massive 46 percent
developed world. From this year forward, emerging
increase in global economic output in just seven
markets will account for the majority of global
years, and this was despite the interruption of the
economic output.
financial crisis.
The effect on the global economy has been
It may seem like we’re mired in a rough patch
incredible. In 1990 the gross world product (total
in the global economy. But in the grander scheme
amount of goods and services produced in a given
of things, we’re in the middle of a golden age of
year by all nations) totaled $27.5 trillion. By 2012
global economic expansion.
that amount increased to $45.7 trillion (in constant
Even more pronounced than the increase
1990 dollars).
in global economic production has been the
Today, the economic output of the world has
consequential explosion in the volume of world
nearly doubled in a generation. Since 1990, the
trade. (See Chart 2.) Obviously, as more goods and
world has produced as many goods and services as
services are produced, they need to be sold. All
it did from the beginning of time until 1990!
the increased production has found its way into
But just as success breeds more success, increased
 About
Tom Hutchinson
I’ve worked in finance my entire career, from the back office of a Wall Street firm to the floor of the New
York Mercantile Exchange learning how markets work. Eventually, I became a financial adviser where I met
with thousands of investors and managed the portfolios of hundreds over the course of about 15 years. I
left my career as a financial adviser, writing for The Motley Fool as well as StreetAuthority LLC, researching
companies, industries, and markets. In The High Income Factor, I can bring you the full benefit of my years of
investing experience.
October 2014
Moneynews.com3
the global marketplace.
Chart 3
Stuck in the Mud
Global GDP Growth, 2010–2014
4.5%
4.0%
While the global economy recovered
strongly after the financial crisis, it went
3.5%
into a bit of a funk the past several years.
3.0%
As the Chinese economy matures, its GDP
2.5%
growth has slowed from the torrid 10
2.0%
percent per year pace of the past couple of
decades to about 7 to 7.5 percent over the
1.5%
past couple of years.
1.0%
At the same time, as we noted earlier,
2010
2011
2012
2013
2014
much of Europe is mired in recession as
The World Trade Organization (WTO) states that world merchandise
trade growth, after averaging about 5.3 percent per year for the past 20
the European Union works through its
years, slowed to just 2.3 percent in 2012 and 2.1 percent in 2013.
debt crisis, and many emerging market
SOURCE: Bloomberg, U.S. Global Investors
countries struggle with structural issues.
and even stronger growth beyond that.
Global GDP is slowing from its pace in 2010
and 2011, as shown in Chart 3. The level of global
The WTO is already seeing a pickup in world
merchandise trade has also taken a hit over the past
merchandise trade volume. From an average of just
two years. The World Trade Organization (WTO)
2.2 percent per year growth over the past two years,
states that world merchandise trade growth, after
the organization forecasts trade growth to more
averaging about 5.3 percent per year for the past
than double in 2014 to 4.7 percent. It also expects
20 years, slowed to just 2.3 percent in 2012 and 2.1
trade volume further increasing to 5.3 percent
percent in 2013.
growth in 2015, which is the average over the past
The global slowdown is very apparent in nontwo decades.
U.S. stocks. The S&P 500 has vastly outperformed
Recent events have muted the global
global markets as measured by the iShares MSCI
turnaround story. Yet the growing economy is here
EAFE (EFA), which tracks the benchmark MSCI
to stay. In fact, it is a trend so powerful that it will, I
global stock market index. In fact, the return of the
believe, define the current era in years to come.
S&P 500 has tripled that of the MSCI index return
While anything is possible, of course, it is
over the past five years.
reasonable to surmise that the recent global
No wonder it seems that everybody is down
slowdown has already bottomed, or is close to it.
in the dumps about foreign markets and foreign
It is also not likely that the dominance of the U.S.
stocks. You can see why the credo in recent years
market will continue for that much longer. It’s a
has been that the United States is the place to be.
good bet that global GDP, and consequently world
But I think it’s a mistake to get too caught
merchandise trade growth, will improve in the
up in the moment. The global economy won’t
months and years to come.
stay down forever. With a longer-term view, the
The good news is, plays on global growth and
recent slowdown is just a minor blip in the longworld trade have gotten cheap. At a time when
term uptrend. In fact, things appear to be turning
most U.S. stocks look expensive, I like the idea of
around already.
investing at much lower prices ahead of a powerful
Encouraging Signs
long-term trend.
Estimates for global GDP growth (according
A Shopping Lesson
to the Conference Board) are for acceleration to
In preparation for a vacation this past summer
3.3 percent in 2014 from 2.9 percent last year,
I had to go shopping for some new clothes. My
although The World Bank forecasts just 2.8 percent
wardrobe mainly consists of Christmas and
growth for the year. However, the World Bank is
predicting a sizable pickup next year to 3.5 percent
birthday presents and it was high time I got serious
4
TheHighIncomeFactor.com
October 2014
about the summer clothes situation.
I went shopping for summer clothes in late July
and early August and I noticed that everything was
on sale. Nobody wants to buy summer clothes in
mid-summer, it seems. The stores were trying to get
rid of the summer stuff so they could bring the fall
clothes out.
Just about everything I bought was on sale. But
it’s not as though the clothes were worth any less.
After all, it will be summer again one day. In just
a few months the stores will be rushing to get rid
of the spring clothes to bring out the full-priced
summer clothes I just bought at a discount.
It’s just that the timing was wrong, or in my
case, right. The world just didn’t value the clothes
very highly at the time I bought them.
This is a great lesson for investing. Just like
stores that value clothes according to the timing
of the fashion seasons, investors price stocks
according to the latest headlines. By finding
companies that are poised to benefit from
bankable trends rather than constantly changing
circumstances, we can often find bargains in great
investments.
Profit From the Rise in Global Trade
So, as an investor, how do you play a rise in
global growth and trade?
Generally, I don’t like investing in foreign
markets, especially emerging markets. There are
just too many issues like odd politics, currency
issues, and even weather problems that make
investing directly in a country or its stocks highly
unpredictable.
The thing is, most of the global growth is in
emerging markets, but investments in these areas
are rarely good for income investors. Things may
change in the future, but my experience with
emerging markets is that they’re volatile. When
they rise they really take off — an ETF that tracks a
country could be up 100 percent or 200 percent in
just a couple of years. Then the market crashes and
does nothing for the next five to seven years.
In my experience it has not been a good
practice to try to invest in emerging markets
early, before they start moving up, because you
may be too early, waiting years before the positive
move. Instead, it’s better to buy in once they are
October 2014
definitively on the move. I wouldn’t even worry
about missing the first 30 or 40 percent of an
uptrend because there is usually a lot more upside
beyond that. (That’s a big reason such investments
are good momentum plays or short-term trades,
not necessarily good income investments. )
As I’ve mentioned in previous issues, my
favorite way to play global growth is instead
through U.S. companies that benefit from business
overseas. But even then, individual companies
often have individual peculiarities that could
mute the benefit of increased global trade. For
example, many global companies sell soda or farm
equipment or cereal. There could be reasons, like
rising commodity prices or increased competition,
that could mean such companies wouldn’t benefit
as expected from a global growth pick-up.
So to play this global trade trend more directly,
you want a company that benefits purely and
directly from the simple occurrence of an increase
in global trade.
Usually, the standard play on global growth
has always been shipping. The ability of seagoing
vessels to transport enormous weight cheaply
makes it the mode of choice to transport goods
around the globe. In fact, ships are responsible
for roughly 90 percent of goods exchanged
throughout the world.
But the problem with shipping stocks is that
they can be quite volatile and often don’t pay
stable or predictable dividends. The exception
is existing High Income Portfolio position and
dry bulk shipping company Navios Maritime
Partners (NMM). That company is highly unusual
in the industry because the bulk of its earnings
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Moneynews.com5
pick at a glance
textainer group holdings limited (tgh)
security type: Common Stock
industry: Container renting and leasing
price: $35.00 (as of Sept. 9, 2014)
52-week range: $34.00–$41.07
yield: 5.2%
profile: Textainer is the largest lessor of containers by
fleet size in the world.
positives
•Containers are a less
volatile way to play global
trade than shipping.
•Revenues from long-term
contracts are a highly
dependable backdrop
from which to pay
dividends.
•Textainer is the best in
class, and the current
industry lull creates an
excellent entry point for
longer-term investors.
risks
•Instability in the Middle
East and Russia or
somewhere else could
derail the global recovery
and put pressure on TGH.
•Increasing competition
and shipping industry
consolidation present
secular headwinds for the
company.
shippers on long-term contracts of five to eight
years. Revenues are highly predictable and the
assets are low risk. From 2005 until the end of
2013, the average profit margin for container
shipping lines was about 10 percent. Not bad —
but container leasing companies averaged profit
margins of 40 percent over the same period.
Textainer (TGH) is the world’s largest lessor
of intermodal containers, leasing over 2 million
containers to more than 400 shipping lines. The
Bermuda-based company has existed since 1979
and its initial IPO was in 2007.
The company is also involved in managing
containers for third parties and buying and selling
new and used containers. But the main focus of
the business is leasing out containers to shipping
customers, which accounts for 85 percent of
revenues. These containers are mostly purchased
(77 percent of them) and then leased out for
contracts of five to eight years, usually. In fact, 76
percent of Textainer’s assets are on long-term leases
(as of June 30).
The solid long-term nature of the leases is key.
It provides bankable and dependable revenue from
contracts with guaranteed rates that isn’t derailed
by short-term dips and spikes in the global trade
environment. Of the company’s top 25 customers,
19 are among the world’s leading shipping
lines. These companies typically run more stable
businesses and have superior credit.
Because of the dependable nature of revenue,
the industry remained profitable throughout the
financial crisis — Textainer continued to maintain
the same quarterly dividend without interruption,
Chart 4
are in long-term contracts, which makes earnings
predictable despite the short-term ups and downs
of the industry.
Aside from Navios, there is a much better way
to play international trade growth besides shipping
— containers.
An intermodal container is a standardized
and reusable steel box used to transport and store
goods. Intermodal means that the containers can
be moved from one mode of transport to another;
for example, from ship to rail or truck. I’m sure
you’ve seen these things on the backs of semis on
the highway. If you’ve ever driven by a
Textainer (TGH) Stock Price, 2009–2014
port, you may have noticed vast numbers
of these containers stacked atop each
$40
other.
$35
Massive amounts of world goods
$30
traded are transported in them because
$25
they’re a good idea. You ship goods,
$20
unload them, and put them right on
$15
a truck. It makes delivering products
’09
’10’11 ’12’13 ’14
efficient and easy.
Textainer was founded in 1979 and has been trading since 2007. After
Companies that deal in containers
the overall market lows of 2009, it has gained in price, although it’s still
undervalued at its current levels and represents a high-yield bargain.
tend to have a stable business. The reason
SOURCE: Yahoo Finance
is that containers are usually leased to
6
TheHighIncomeFactor.com
October 2014
a claim that not many dividend payers can make.
The company’s container portfolio consists
primarily of dry freight (85 percent) with a smaller
but fast-growing presence in refrigerated freight
(12 percent) and some specialty containers (3
percent) for extra-large and heavy shipments.
Textainer manages the container assets through
their typical 12-to-15-year life cycle. According to
the company, revenue achieved through containers
consists of the initial lease period (55 percent)
and then the mid-life or contract-renewal phase
(30 percent), and finally the disposition of sale
(15 percent), where historically the company has
recouped 40 to 50 percent of the initial cost.
Basically, TGH offers an essential staple of
global trade at a point in history when trade is on
the uptrend. The company is also one of the best in
its business, if not the best. Textainer is the lowest
cost and most profitable per employee operator of
its peers.
Eyeing the Price History
While TGH has an excellent track record since
its October 2007 IPO, the stock has struggled of
late. In the past two years (as of early September
for purposes of this calculation), the stock price
remained flat while the S&P 500 soared more than
40 percent. This recent underperformance is in
stark contrast to the longer-term track record.
Since the IPO, $10,000 invested in TGH
(with dividends reinvested) would have grown
to over $30,000 for an annualized return of
17.53 percent. Over the same period, the overall
market, as measured by the S&P 500, would’ve
turned a $10,000 investment into only $12,880, an
annualized return of 3.67 percent.
The recent problems have been twofold: a
sluggish global economy and lower container
leasing and sale prices. The global economy
woes have hurt demand while easy financing for
competitors has flooded the market with extra
containers. Pricing has been the primary reason
that Textainer’s earnings per share have taken a hit.
In 2013 EPS fell 19 percent from 2012, and in the
first half of 2014 they were 5 percent lower than
the first half of 2013.
But there is reason to believe that the
challenging industry conditions have reached a low
October 2014
point. As I mentioned above, the global economy
may pick up from here and perhaps strongly,
creating more demand for the containers. Also, the
easy credit terms in the industry, often providing
credit to much smaller and less financially secure
competitors, is unlikely to last long. Higher interest
rates would also put a damper on borrowing and
curb the supply.
The stock has lost about 9 percent so far this
year and returned just 6.6 percent over the past
year compared to a 25 percent return for the
market. TGH as of this writing is about 14 percent
below its 52-week high, selling at just 10.37 times
earnings, compared to over 18 times for the S&P
500. The stock is also trading at lower price/book,
price/sales, and price-to-cash-flow ratios than its
five-year averages. And over those five years TGH
provided an average annual return of 24.6 percent.
The Dividend
Meanwhile, the stock provides a stellar 5.20
percent yield at the current price. In other words,
you get paid to wait for the container market to
inevitably rebound. As a Bermuda-based company,
there is no withholding tax and dividends are
subject to the maximum 15 percent rate in the
United States.
There is also an impressive record of dividend
growth. The quarterly payout of $0.47 per share, or
$1.88 annually, is 135 percent higher than in 2007.
Textainer has grown the dividend by increasing
cash flow at a compound average growth rate
(CAGR) of 23 percent per year from 2008 through
2013. Dividends have expanded at a 15.76 percent
per year clip over the past five years.
Capital expenditure (CAPEX) should drive
more dividend raises in the future. The company
develops its business in two primary ways:
acquiring new containers or acquiring smaller
companies in a very fragmented market. Textainer
invested about $2.5 billion in CAPEX between
2008 and the end of 2013, and $600 million in the
first half of 2014.
As a result of the ongoing investments in new
containers and additional business, the company
grew lease rental income by 7 percent year over
year in the first half despite the challenging
industry conditions. The company was also able
Moneynews.com7
to lower interest rates on debt and lower funding
costs. Textainer continues to expand and cut costs
as container prices and global trade levels are
poised to recover.
Conclusion: Textainer pays a strong and
growing dividend. It is a company well
positioned to benefit from the all but certain
trend of increased global trade in the years
ahead. The current industry lull creates an
excellent entry point for the stock, a good value
in an otherwise higher-priced market, and a
great way to diversify outside of the United
States. I recommend Textainer (TGH) at or
under $40 for the Wealth Builder Portfolio.
Portfolio Update: Big News From
Kinder Morgan
On Aug. 10, oil and gas pipeline giant
Kinder Morgan (KMI) announced a corporate
consolidation plan that will involve parent KMI
buying out its subsidiaries for $71 billion. The
company will purchase Wealth Builder Portfolio
position Kinder Morgan Energy Partners (KMP),
as well as El Paso Pipeline (EPB) and Kinder
Morgan Management (KMR).
The market loved it. All four stocks have been
up big since the announcement, with KMP shares
rising 18 percent since then (as of this writing).
So what is this deal about, and is it still worth
holding? Let’s take a closer look.
The deal is expected to close in December and,
as of the closing, KMP will no longer trade. Each
KMP shareholder will receive 2.1931 shares of KMI
and $10.77 in cash for each share of KMP owned.
Current holders of KMP will no longer own a
master limited partnership (MLP) but rather a
regular corporation. The new company will be the
third-largest energy company in the country next
to Exxon Mobil (XOM) and Chevron (CVX).
Currently as an MLP, KMP enjoys special
tax incentives. The partnership pays no tax at
the corporate level, provided 90 percent of
income is paid out to shareholders in the form of
distributions. The MLP is able to pay out money
that ordinary companies lose to taxes and it is thus
able to offer a higher yield. KMP currently yields
5.8 percent even after the run-up in price.
8
Why is Kinder Morgan abandoning the
MLP structure? The Kinder Morgan companies
are in an unusual position. The United States is
currently undergoing a massive boom in oil and
gas production (see the April 2014 issue). As an
energy infrastructure company primarily involved
in the piping and storage of oil and gas, KMP is
seeing a massive growth in demand for its services.
To accommodate the production expansion,
KMP currently has a backlog of about $17 billion
in expansion and growth projects over the next
several years.
But there’s a problem . . . the incentive
distribution rights (IDRs).
IDRs in a partnership structure give the general
partner (in this case KMI) an increasing share of
the distributions a partnership generates. They’re
called incentive rights because they’re designed
to incentivize a general partner to rapidly grow
distributions from the limited partner.
The IDRs work for a while. But when a
company grows distributions beyond a certain
point, they become a major problem.
As the limited partner increases distributions,
the general partner is entitled to a greater
percentage of the distribution as certain thresholds
are crossed. When an MLP is around for a long
time and successful, its distribution goes well past
the highest threshold level where the GP gets 50
percent of the payout.
Here’s a look at KMPs distribution structure.
Kinder Morgan Energy Partners
Incentive Distribution Rights
Note: General partner is Kinder Morgan; minimum quarterly
distribution is $0.15125; latest quarterly distribution is $1.39.
Low
High
LP Unitholders
GP Units/IDRs
Tier 1 $0.151250 $0.151250 98.00% 2.00%
Tier 2 $0.151250 $0. 178750 85.00% 15.00%
Tier 3 $0.178750 $0.233750 75.00% 25.00%
Tier 4 $0.233750 —
50.00% 50.00%
In the early 1990s, KMP was one of the very
first major MLPs on the market. As you can see
from the table, when the company was new and
paying quarterly distributions of about $0.15
per share, it only had to fork over 2 percent
of distributable cash flow to KMI. Even when
TheHighIncomeFactor.com
October 2014
distributions rose over $0.20 per share, it only had
to pay 25 percent of the portion of the distribution
greater than $0.17875.
But KMP continued to grow the distribution
for a long time. Now, the quarterly distribution
is $1.39 per share. The partnership has to pay 50
percent of the distribution in excess of $0.233750
per share to KMI. That’s too much.
To put it in simpler terms, for every quarterly
distribution of $1.39 KMP pays to shareholders,
it has to pay over $0.60 to KMI. That means that
it has to give away more than 43 percent of the
distributable cash flow it generates.
KMP can only keep a little more than half
of what it earns. KMP shareholders can only
receive about half the partnership’s cash flow in
distributions. The IDRs have become a massive
cash flow burden.
As a result, the $17 billion in expansion projects
are only half as profitable as they otherwise would
be. KMP simply has too much cash flow burden
to generate a powerful return from the expansion
opportunities ahead.
The deal was done primarily to rectify the IDR
problem. Similar moves have been done before
by other MLPs. Magellan Midstream Partners
(MMP) and Enterprise Product Partners (EPD)
both bought out their GP in order to get rid of the
IDRs. However, both those companies remained
MLPs. Kinder Morgan is taking a different route
and converging into a regular corporation.
The Corporate Route
To make a long story short, KMI is opting
for the corporate rather than the MLP structure
because it better accommodates the massive new
investments that lie ahead. A regular corporation
has more options for raising money and can
reinvest its earnings. And according to analysts at
RBC, the Kinder Morgan empire will be able to cut
its cost of capital nearly in half by eliminating the
cash distribution obligations.
The new company will have tax advantages
to offset the loss of MLP tax incentives.
Through depreciation deductions (plant and
equipment will be priced as new assets after
the consolidation) and write offs for expansion
expenses, KMI estimates it will have about $20
October 2014
billion in deductions over the next several years.
The bottom line is that for those who own
KMP stock, your holding will morph from a high
income/low growth investment to a moderate
income/high growth investment. KMI estimates a
payout of $2 per share in 2015, which translates to
a little more than 4 percent. KMP currently pays
5.82 percent.
However, the new KMI estimates dividend
growth of 10 percent per year from 2015 to 2020,
compared to an estimated 5 percent distribution
growth for KMP. The new KMI will also have a
greater likelihood of capital appreciation.
Investors who must generate a higher level
of income may wish to look elsewhere. However,
those who can tolerate the lower income and
have an interest in appreciation over time have a
tremendous opportunity. KMI is perched in front
of a huge trend that will enable the company to
grow earnings and the dividend for years to come.
The market sees the opportunity, which
explains the run-up. For now, I recommend that
we keep our shares of KMP through the transition,
although I will continue to monitor the situation
and let you know if conditions change and warrant
a sale.
Best Buys of the Month
“Best buys” comprise what I think are
especially good values among all the holdings in
our portfolio as we go to press. The picks are not
necessarily those with the cheapest price compared
to their recommended “buy in” level.
What they are, however, is a good guideline,
especially for those new to the High Income Factor
newsletter. They’re the answer to the question, “If
I were just starting to invest in the High Income
Factor Portfolio, which securities would I buy
first?”
OCTOBER BEST BUYS
Price*
52-Week Range
Yield
Ventas Inc. (VTR)
Security
$64.75
$54.89–$69.09
4.48%
Main Street Capital (MAIN)
$32.38
$28.69–$35.72
6.11%
Brookfield Infrastructure Partners (BIP)
$41.87
$35.58–$42.83
4.59%
*As of Sept. 9, 2014
Ventas Inc. (VTR)
Ventas is one of the largest real estate
investment trusts (REITs) investing in healthcare
Moneynews.com9
properties and seniors housing in the United States
and Canada. The main reason to buy this stock is
that the REIT is positioned in front of a massive,
undeniable trend: The number of older people in
the population is exploding and will continue to
do so for decades.
The vastly larger multitudes of older people
will demand the services and properties that Ventas
has. With a tailwind like that, VTR has a big edge
up on most other investments. It has also provided
an average annual return of 23 percent per year
over the past 15 years. And earnings growth is
accelerating.
The company has been growing its portfolio
of properties at a rapid pace in recent years
to accommodate the increasing demand for
healthcare and seniors housing. Since 2011,
the busy REIT has made almost $16 billion in
acquisitions.
While such fast-paced expansion can be a
concern in a few cases — some companies can
experience growing pains and make missteps along
the way — the strategy appears to be working
well for Ventas. The pace of its profit growth has
increased from historic averages since the buying
spree. Second-quarter earnings were better than
expected as funds from operations (FFO) increased
11 percent from last year and revenues grew 10
percent year over year.
The fact that VTR is a defensive business with
solid growth prospect that pays a solid yield should
make it a winner in any environment. Ventas is a
buy at or under $65 per share.
Main Street Capital (MAIN)
MAIN is, in my opinion, the best company at
what it does. The business development company
(BDC) invests in growing businesses that are
underserved by traditional lenders. The stock offers
both high income and growth by investing in highinterest loans and equity stakes.
The stock has been a phenomenal performer,
posting an average annual return of 30 percent
over the past three years. But Main Street Capital
is also ideally suited for the current environment.
This BDC invests in smaller and fast-growing
companies that tend to do better as the overall
economy improves, and its portfolio of adjustable10
rate and short-term loans provides excellent
protection against rising interest rates.
The stock also does something that income
investors love: It pays dividends every single
month. The recently boosted dividend is $0.17 per
share, a 6 percent hike over last year. MAIN has
also been paying special dividends in addition to
the regular payout. The stock paid an extra $0.80
last year and an extra $0.275 per share so far this
year. Main Street Capital a buy at or under $32 per
share.
Brookfield Infrastructure Partners (BIP)
There is a massive need for additional and
improved infrastructure throughout the world,
both in developed and emerging markets. And
Brookfield Infrastructure Partners is at the
forefront of that need, with infrastructure assets all
over the globe.
Every time I write about this company, I list
an example of the properties it owns. And its
impressive enough that I’m going to do it again
here. Among its assets it has:
•The sole railroad network in Southwest
Australia;
•Chilean utilities that generate 98 percent of the
country’s electricity;
•Toll roads that serve as crucial transportation
arteries in Brazil and Chile, covering over 3,200
kilometers;
•Ports throughout Europe and in China;
•Natural-gas storage terminals in Canada.
These are high-quality properties that don’t go
out of style. In fact, they are desperately needed for
a society to function.
They are also long-life assets that generate
remarkably stable and growing cash flows. The
company also has plenty of opportunity for growth
given the additional infrastructure needs all over
the world. BIP has a sizable backlog of projects
right now.
It’s great to have it both ways; the company
is both defensive and fast-growing. The stock has
provided an average annual return of 27 percent
over the past five years and there’s every reason
to believe it will continue to outperform going
forward. Brookfield’s stock is a buy up to $42 per
share. 
TheHighIncomeFactor.com
October 2014
The High Income Factor Portfolio
THE HIGH INCOME PORTFOLIO
Ticker
Entry Date
Entry Price
Recent Price
Buy at or
Under
Current
Yield
Effective
Yield
Dividend
Pay Date
Total
Return
Navios Maritime Partners
NMM
01-Mar-12
$16.37
$20.23
$17.50
8.75%
10.81%
11/13/14
59.26%
Terra Nitrogen
TNH
01-Apr-12
$249.75 $146.36 HOLD
9.80%
5.75%
12/3/14
-21.57%
FLY Leasing Limited
FLY
27-Nov-12
$11.97 $14.22 $16.00
6.19%
7.35%
11/20/14
31.08%
Teekay LNG Partners LP
TGP
20-Dec-12
$38.30 $42.50 $42.00
6.35%
7.05%
11/8/14
24.20%
Recommendation
Prospect Capital
PSEC
26-Feb-13
$11.06 $10.34 $11.50
12.88%
12.04%
9/25/14
10.05%
Main Street Capital
MAIN
21-Aug-13
$29.21 $32.38 $32.00
6.11%
6.78%
9/15/14
20.03%
Buy at or
Under
Current
Yield
Effective
Yield
Dividend
Pay Date
Total
Return
10/30/14
46.31%
THE WEALTH BUILDER PORTFOLIO
Recommendation
PepsiCo
Ticker
Entry Date
Entry Price
Recent Price
PEP
01-Apr-12
$66.74 $91.42 $72.00
2.87%
3.93%
Eli Lilly
LLY
01-Apr-12
$40.48 $64.44 $52.00
3.04%
4.84%
10/9/14
76.41%
Williams Partners
WPZ
01-May-12
$57.30 $54.80 $58.00
6.61%
6.32%
11/12/14
22.86%
Vodafone
VOD
27-Sep-12
$28.72 $33.26 $34.00
4.84%
5.61%
9/22/14
16.90%
Intel
INTC
27-Nov-12
$19.98 $34.91 $27.00
2.58%
4.50%
12/3/14
84.94%
Philip Morris
PM
04-Feb-13
$87.00 $83.83 $87.00
4.49%
4.32%
10/14/14
1.46%
Riocan REIT
REI-UN.TO
20-Mar-13
$26.97 $24.51 $29.00
5.78%
5.25%
9/15/14
10.74%
General Mills
GIS
19-Apr-13
$49.94 $53.17 $50.00
3.08%
3.28%
12/3/14
9.87%
KMP
22-May-13
$88.50 $92.86 $95.00
5.82%
6.10%
11/14/14
13.27%
Kinder Morgan Energy Ptnrs
Brookfield Infrastr Ptnrs
BIP
03-Jun-13
$36.00 $41.87 $42.00
4.59%
5.33%
10/28/14
21.96%
Health Care REIT
HCN
15-Aug-13
$60.00 $67.22 $60.00
4.73%
5.30%
11/20/14
17.95%
Realty Income
O
18-Dec-13
$39.14 $44.63 $40.00
4.92%
5.61%
11/21/14
18.04%
HSBC Holdings
HSBC
27-Jan-14
$52.98 $53.15 $60.00
3.76%
3.78%
11/19/14
4.18%
Verizon
VZ
21-Feb-14
$47.27 $48.90 HOLD
4.34%
4.48%
11/3/14
4.55%
Northern Tier Energy
NTI
26-Mar-14
$26.00 $25.32 $28.00
6.48%
6.31%
11/28/14
3.29%
Ventas, Inc. Magellan Midstream Ptnrs#
Deere &
Company#
buy Textainer Group Holdings#
VTR
23-Apr-14
$64.42 $64.75 $65.00
4.48%
4.50%
12/1/14
1.63%
MMP
—
—
$82.04 $65.00
—
—
—
—
DE
—
—
$82.25 $80.00
—
—
—
—
TGH
—
—
$35.00 $40.00
—
—
—
—
Current
Yield
Effective
Yield
Dividend
Pay Date
Total
Return
INCOME STRATEGIES PORTFOLIO
Recommendation
Blackrock Enhanced Cap Fund
Barclays 7.75 Preferred
PowerShares Preferred
Ticker
Recent Price
Buy at or
Under
Entry Date
Entry Price
CII
01-Jan-12
$12.50 $15.24 $13.00
7.87%
9.60%
9/30/14
47.09%
BCS-PC
27-Sep-12
$25.52 $25.60 Hold
7.97%
7.99%
10/16/14
16.94%
PGX
24-Oct-12
$14.84 $14.42 Hold
6.07%
5.90%
10/8/14
6.78%
Osterweis Strategic Income OSTIX
25-Sep-13
$11.80 $11.98 $12.00
4.99%
5.07%
9/18/14
2.62%
BKLN
25-Sep-13
$24.77 $24.64 $25.00
4.09%
4.07%
10/8/14
2.80%
PowerShares Sr Loan Port
SPDR BarCap ST HY Bnd SJNK
25-Feb-14
$31.03 $30.26 $32.00
4.88%
4.76%
9/15/14
-0.40%
People’s United Financial
PBCT
25-Aug-14
$14.90 $14.90 $15.00
4.43%
4.43%
11/17/14
0.00%
Duke Energy
DUK
—
—
$73.79 $69.00
—
—
—
—
Notes on all portfolios: In order to receive the dividend payment, you will need to own the stock several weeks before the pay date. The “Total Return” column includes all reinvested
dividends at concurrent recommended buy prices. Returns calculated based on a purchase of $1,000 of the security on the listed entry date and price. The “Effective Yield” column
reflects the yield investors receive assuming they bought at the entry price and followed all subsequent recommendations. #Denotes recommendation not yet purchased. To see the
chart of previous “sold” positions, subscribers can log onto www.highincomefactor.com (under the “Portfolio” tab). All chart data is as of close September 9, 2014.
Closing Thoughts
October 2014
Moneynews.com11
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12
Closing Thoughts
I believe strongly in investing ahead of a trend. When I was
young, I had a boss who told me and my financial adviser co-workers
something I still haven’t forgotten. He said that when the market is
booming, you only have to do things half right and you’ll be fine.
But when the market stinks, the marketing, customer contacts, and
everything else it takes to run the business have to be done at least
90 percent right.
In the same vein, a company positioned in front of a strong
trend will face a smoother path to success. The market will be more
forgiving. If the company has a bad quarter, the stock won’t get hit
that hard. If the stock price falls, it should quickly recover because
investors will understand the company is in the right place at the
right time. The advantage a strong trend can give an investment is
precisely the edge we need to generate large returns over time.
I also believe in buying companies cheap. Buying at a good price
makes generating solid returns far easier. The encouraging returns
also motivate investors to stay invested longer, which is usually a
more successful strategy.
Textainer (TGH) is both cheap and positioned in front of a
powerful trend. The level of global trade will continue to grow
strongly over time and drive its profits. Meanwhile, the stock is
inexpensive because most investors are too influenced by the latest
headlines. So we can target smart investments by seeing the bigger
picture, while everybody else is looking the other way.
Actions to Take Now
Action No. 1: Buy Textainer (TGH) at or under $40 for the
Wealth Builder Portfolio.
Action No. 2: Visit www.highincomefactor.com to find past
monthly issues and weekly updates. (For password assistance, contact
my team at 800-485-4350 or [email protected])
Sincerely,
Tom Hutchinson
To renew or subscribe to this newsletter, please go to
www.moneynews.com/offer
TheHighIncomeFactor.com
October 2014
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