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Exelon: Utility Selling At 10-Year Lows, Again

Exelon’s share price bottomed in 2013 at $26.91, rose to $36.83 in Aug 2014 and Dec 2014, only to drop to $26.60 this month. The long-term investment thesis remains the same. Exelon’s profitability is still dependent on competitive wholesale prices driven by natural gas pricing. Two years ago, almost to the day, I penned an article discussing Exelon (NYSE: EXC ) trading within a hair’s breath of its 10-yr low. Unfortunately, I can write a follow-up as this is the case again. It seems EXC is just as controversial today as it was back then, and uncertainty remains the major obstacle. New income investors looking for higher relative yields should review EXC and current shareholders should continue to hang in and even add to their position. In the previous article, the investment thesis was laid out: Management and investors are making a huge bet that demand will increase, wholesale pricing will increase, and base-load capacity will decrease. Demand will increase with strengthening economic activity in the Northeast and Midwest. Pricing will pick up with a turn in natural gas pricing. Base-load capacity will decrease as coal-fired plants are retired and as more intermittent-load wind replaces investments in additional base-load capacity. When these three events positively influence EXC’s bottom line, share prices will be substantially above their current 10-year lows. However, these events have not happened, and the timeframe continues to get pushed out. With the growth of natural gas as a generating fuel, electricity pricing continues to be influenced by the price of natural gas. As we know, natural gas is once again sub-$2.00, applying pressure on electricity pricing. Below are three graphs from sriverconsulting.com that tell the story. The first is the Forward Market price for electricity in ISO New England. The most recent forward price matches its 10-yr low of March 2012. The second shows the relationship of the 5-yr forward price of natural gas and electricity and the third shows the same relationship on a 1-yr basis. The last two charts demonstrate the correlation between natural gas pricing and electricity pricing, and the trend over the previous 12 months has been for tighter correlations. As of the week of Dec 9, the forward 12-month NYMEX price for natural gas was $2.34. (click to enlarge) Source: sriverconsulting.com (click to enlarge) Source: sriverconsulting.com (click to enlarge) Source: sriverconsulting.com Natural gas pricing will continue to be a key factor in PJM markets. According to ISO New England, in 2000, natural gas represented 15% of the fuel used to generate power in the Northeast, and this percentage grew to 44% in 2014. The growth has been at the expense of coal and oil, with these fuels declining from 18% to 5% and 22% to 1%, respectively. Nuclear remained almost constant at 31% and 34%. The following 17-yr chart shows the growth in MW capacity by fuel type in the Northeast, as offered by the ISO New England 2015 Regional Electricity Outlook. (click to enlarge) One advantage of merchant power generators in other parts of the US is many utilize 20-yr purchase power agreements with electric distribution utilities, usually including a “fuel cost plus” formulation. However in the Northeast, Mid-Atlantic and eastern Midwest, pricing is controlled by the Regional Transmission Organizations RTO, of which PJM Interconnect is the largest. The silver-lined underbelly of the auction process is the premium PJM now allows for “reliability,” and EXC’s nuclear generation qualify for these premiums. During the Polar Vortex of early 2014, power generation along the East Coast was dangerously close to falling under demand as frozen coal stocks and frozen natural gas valves caused an uncomfortably large amount of generating capacity being off-line. In response, PJM instituted an added premium for power generation with higher commitments to remain online, backed by huge fines for those who take the premiums but can’t deliver during similarly stressful times. Nuclear power, of which Exelon is the largest provider, is a qualified fuel for this premium. Over the next two years, this premium will be implemented and will help EXC realize a bit higher price for its commodity product. Demand and capacity retirements have been progressing along as expected, with additional nuclear plants announcing their retirement. Even after the acquisition of Pepco Holdings (NYSE: POM ), which is now expected to be EPS-neutral over the short-term, power generation sold mostly using the PJM 3-Yr Rolling Auction process will still represent about 50% of EXC’s earnings. While this exposure to the merchant market has declined from 80% in 2008, the graphs above have a large impact on earnings for EXC. Concerning the proposed merger with Pepco, management seems to have satisfied DC regulators with the move of some executives and their offices to the Washington area, along with $78 million in payments to DC customers. Exelon agreed to relocate 100 jobs from outside D.C. into the city and create an additional 102 union jobs. The company also agreed to co-locate its headquarters in D.C. Exelon has six months after the merger is approved to relocate elements of its corporate headquarters from Chicago to D.C. It will shift the primary offices of CFO Jack Thayer and Chief Strategy Officer William Von Hoene Jr. to D.C., as well as the entire Exelon Utilities division, which is now based in Philadelphia, along with divisional CEO, Dennis O’Brien. The merger could be finalized before management’s commitment to walk away if not completed by April 2016. Over the longer term, management estimates the merger can increase earnings by $0.25 a share over the next 4 years, or about 9% of the estimated $2.57 2016 EPS. Management believes the acquisition of Pepco will accomplish two important goals: the ability to fund the dividend entirely through its regulated businesses and the ability to gain sufficient critical mass to separate the regulated and unregulated businesses, if advantageous to shareholders. On a valuation basis, EXC offers an inexpensive entry point. Below is a comparison of fundamentals for EXC vs. the utility average, as offered by Morningstar.com: Source: morningstar.com, Guiding Mast Investments Consensus earnings estimate for next year have been increasing since June 2015. Below is a chart of 12-month consensus EPS estimates for 2015 and 2016, as offered by 4-traders.com. Insidermonkey.com wrote a positive article on EXC earlier this month. In summary: It’s been a down year for most utility companies as big mutual funds rotate out of the sector due to normalizing yields. Although Exelon Corporation shares are down 23% year-to-date because of the Great Rotation, Exelon’s decline has made it an attractive dividend play. Shares now yield 4.57% and trade at a reasonable 10.6 times forward earnings. Seeing as the company’s payout ratio of 0.55, Exelon’s dividend is secure and has room to expand given the company’s predicted next five year average EPS growth rate of 5.03%. Hedge funds are certainly bullish as the number of elite funds long the stock jumped by 10 during the third quarter. According to morningstar.com, in 2014, EXC’s total return was +39.9% while year-to-date total return has been a negative -23.0%. This compares to +20.3% and -11.3% for Diversified Utilities and +28.7% and -6.9% for the S&P Utility ETF (NYSEARCA: XLU ), respectfully. While the past 2 years have not been as profitable for EXC shareholders as the average industry investment, the current yield of 4.9% should be sufficient for income investors to buy and hold for the “eventual turnaround” in the same investment thesis outlined above. These 10-yr lows in share prices only come around every 10 years… or every 2 years in the case of EXC. Author’s note: Please review Author’s disclosures on his profile page.

No Respite For Oil And Energy ETFs In 2016?

The vicious trading of oil and the energy sector is likely to persist for more months especially after the Fed finally pulled its trigger on the first rate hike in almost a decade. Higher interest rates will drive the U.S. dollar upward, making dollar-denominated assets more expensive for foreign investors, and thus, dampening the appeal for the commodity. In addition, it will make the borrowings, in particular for high-yield firms, costlier and result in less money flows into capital-intensive shale oil and gas drilling projects. This in turn will lead to higher bankruptcies, hitting the already battered energy sector. Following the rate hike announcement, U.S. crude dropped nearly 5% to $35.52 per barrel, just a few dollars away from $32.40 that it hit during the financial crisis in 2008. Meanwhile, Brent oil tumbled to the nearly 11-year low of $37.11, which is not very far from the December 2008 low of $36.20. Analysts expect breaking the 2008 levels could take oil prices to levels not seen since 2004 given fears of growing global glut and weak demand that have been weighing on the oil prices. Weak Trends The latest inventory storage report from the EIA for the last week showed that U.S. crude stockpiles unexpectedly rose by 4.8 million barrels against the expected 1.4 million-barrel drawdown, underscoring further weakness in the energy sector. This is because production has been on the rise across the globe with the Organization of the Petroleum Exporting Countries (OPEC) continuing to pump near-record levels of oil to maintain market share against non-OPEC members like Russia and the U.S. Additionally, Iran is looking to boost its production once the Tehran sanctions are lifted. On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world’s biggest consumer of energy – China – will continue to weigh on the demand outlook. Further, a warm winter in the U.S. will depress demand for energy and energy-related products. Adding to the grim outlook is the International Energy Agency’s (IEA) expectation that the global oil supply glut will persist through 2016 as worldwide demand will soften next year to 1.2 million barrels a day after climbing to a five-year high of 1.8 million barrels this year. ETF Impact The Fed move and the bearish inventory data have battered the oil and energy ETFs and are expected to continue doing so in the coming months with bleak oil fundamentals. In particular, the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA: OIL ) , the United States Oil ETF (NYSEARCA: USO ) , the PowerShares DB Oil ETF (NYSEARCA: DBO ) and the United States Brent Oil ETF (NYSEARCA: BNO ) lost over 3% in Wednesday’s trading session. All these products focus on the oil futures market and are directly linked to the U.S. crude or Brent oil prices. In the equity energy ETF space, the First Trust ISE-Revere Natural Gas Index ETF (NYSEARCA: FCG ) and the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA: XOP ) were the worst hit, shedding 2.7% and 2.2%, respectively. These were followed by declines of 2% for the Market Vectors Unconventional Oil & Gas ETF (NYSEARCA: FRAK ) and the PowerShares S&P SmallCap Energy Portfolio ETF (NASDAQ: PSCE ) . FCG This fund offers exposure to the U.S. stocks that derive a substantial portion of their revenues from the exploration and production of natural gas. It follows the ISE-REVERE Natural Gas Index and holds 30 stocks in its basket that are well spread out across each component with none holding more than 6.95% of the assets. The fund has amassed $161.1 million in its asset base while charging 60 bps in annual fees. Volume is solid with more than 1.8 million shares exchanged per day on average. XOP This fund provides equal-weight exposure to 66 firms by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. Each holding makes up for less than 2.3% of the total assets. XOP is one of the largest and popular funds in the energy space with an AUM of $1.5 billion and expense ratio of 0.35%. It trades in heavy volume of around 12 million shares a day on average (see all the energy ETFs here ). FRAK This ETF provides exposure to the unconventional oil and gas segment, which includes coalbed methane, coal seam gas, shale oil & gas, and sands market. This fund follows the Market Vectors Global Unconventional Oil & Gas Index, holding 57 stocks in the basket. Average daily volume at 39,000 shares and an AUM of $41 million are quite low for the fund while expense ratio is at 0.54%. PSCE This fund provides exposure to the energy sector of the U.S. small-cap segment by tracking the S&P Small Cap 600 Capped Energy Index. Holding 32 securities in its basket, it is heavily concentrated on the top two firms that collectively make up for one-fourth of the portfolio. Other firms hold less than 5.8% of total assets. The fund is less popular and less liquid with an AUM of $33 million and average daily volume of about 19,000 shares. Expense ratio came in at 0.29%. In Conclusion Investors should stay away from the above-mentioned funds as more pain is in store for oil and the energy sector. FRAK and FCG have a Zacks ETF Rank of 5 or “Strong Sell” rating while XOP and PSCE have a Zacks ETF Rank of 4 or “Sell” rating, suggesting their continued underperformance going into the New Year. Original post

Is DCA Ready To Bounce Back From Tax Loss Selling?

Summary This balanced closed-end fund has been hurt this year by its energy holdings. The 17% discount to NAV is higher than average due to tax loss selling. The high 10.9% distribution yield helps you earn alpha even if the discount does not narrow immediately. This is a good time of the year to look for closed-end funds that have been beaten down by tax loss selling. There is seasonal tendency for many of these funds to bottom out in late December and then rally the first few months of the next year. The Virtus Total Return Fund (NYSE: DCA ) was formed in February 2005. It is a global balanced fund that invests about 60% in equities and 40% in fixed income. The fund’s objective is total return, consisting of both capital appreciation and current income. (Data below is sourced from the Virtus website unless otherwise stated.) The equity portion of the fund invests globally in owners/operators of infrastructure in the communications, utility, energy and transportation industries. Its performance has been hurt this year by a 21% equity allocation to the energy sector including positions in Williams Companies (NYSE: WMB ), Kinder Morgan (NYSE: KMI ) and Enbridge (NYSE: ENB ) in the top ten holdings. The fixed income portion of the fund is designed to generate high current income and total return using extensive credit research. The fund managers seek to capitalize on opportunities across undervalued sectors of the bond market. About 43% of the fixed income allocation has been in corporate or emerging market high yield which has also hurt performance this year. The fund uses an option income strategy where it purchases and sells puts and calls, creating option spreads. The fund also uses leverage and borrows at short-term rates to invest at higher yields. There could be a good medium-term trading opportunity in DCA setting up from now until year-end because of tax loss selling. Over the last year, the average discount to NAV has been -12.42%, while it is currently around -17%. The 1-year discount Z-score is -1.58, which means that the current discount to NAV is about 1.5 standard deviations below the average. Source: cefanalyzer Five Year Historical Premium/Discount for DCA (click to enlarge) From an overall asset allocation perspective, DCA is similar to a global 60-40 balanced fund, but because of the leverage and sector concentration, it has higher risk than a typical balanced fund you would find at Vanguard or Fidelity. These were the asset allocation breakdowns as of Sept. 30, 2015: Equity Sector Allocation Breakdown Utilities 37.25% Energy 21.85% Telecommunications 18.58% Industrials 14.40% Financials 5.36% Consumer discretionary 2.56% Fixed Income Sector Allocations Corporate- High Yield 38.92% Corporate- High Quality 14.94% Bank Loans 11.55% Non-Agency Residential MBS 7.69% Non-Agency Commercial MBS 6.21% Mortgage Backed Securities 5.11% Asset Backed Securities 4.39% Emerging Market- High Yield 4.00% Yankee- High Quality 3.98% Non-USD 1.54% Treasury 1.52% Taxable Municipals 0.16% DCA has had about average long term NAV performance. But it may be good for a swing trade now because of the very high discount to net asset value. Since inception, it had big losing years in 2007 and 2008, and it is also struggling a bit this year. Here is the total return NAV performance record since 2006 along with its percentile rank compared to Morningstar’s World Allocation category: NAV Performance Table DCA NAV Performance World Allocation NAV Percentile Rank in Category 2006 25.40% 21.21% 100 2007 -41.41% 11.85% 100 2008 -66.08% -39.30% 65 2009 +27.75% +46.71% 91 2010 +48.54% +23.98% 25 2011 +6.29% -3.21% 13 2012 +15.29% +19.81% 78 2013 +13.12% +11.07% 56 2014 +13.60% +6.14% 20 YTD -4.98% -3.05% 64 Source: Morningstar The tables below are compiled as of September 30, 2015: Top 5 Countries United States 49.49% Canada 9.50% United Kingdom 8.43% Australia 5.10% France 3.91% Top 10 equity holdings Williams Companies, Inc ( WMB ) 3.62% Kinder Morgan Inc. class P ( KMI ) 3.57% AT&T Inc. (NYSE: T ) 3.36% Verizon Comm. (NYSE: VZ ) 3.28% Enbridge Inc. ( ENB ) 3.09% National Grid Plc (NYSE: NGG ) 2.87% NextEra Energy, Inc. (NYSE: NEE ) 2.66% Crown Castle Intl. (NYSE: CCI ) 2.25% Transurban Group Ltd. ( OTCPK:TRAUF ) 2.23% Atlantia S.p.A ( OTCPK:ATASY ) 2.13% Fixed Income Ratings Distribution Aaa 8.74% Aa 3.34% A 5.34% Baa 27.87% Ba 23.00% B 18.96% Caa 8.74% Not Rated 3.61% Fund management DCA is run by a team of three portfolio managers. All three managers have been with the fund since 2011. Connie Luecke, CFA Industry start date: 1983 Randle Smith, CFA Industry start date: 1990 David L Albrycht, CFA Industry start date: 1985 Alpha is Generated by High Discount + High Distributions The high distribution rate of 10.90% along with the 17% discount allows investors to capture alpha by recovering some of the discount whenever a distribution is paid. The fund has been paying a $0.10 quarterly distribution since April, 2014. Whenever you recover NAV from a fund selling at a 17% discount, the percentage return is 1.00/ 0.83 or about 20.5%. So the alpha generated by the 10.90% distribution is computed as: (0.1090)*(0.205)=0.0223 or about 2.23% a year. Note that this is more than the 1.58% baseline expense ratio, so you are effectively getting the fund managed for free with a negative effective expense ratio. Here are some summary statistics on DCA: Virtus Total Return Fund ( DCA ) Total Assets: 173 Million Total Common assets: 122 Million Annual Distribution (Market) Rate= 10.84% Last Regular Monthly Distribution= $0.10 (Annual= $0.40) Fund Baseline Expense ratio: 1.58% Discount to NAV= -17.08% Portfolio Turnover rate: 56% Effective Leverage: 27% Avg. 3 month Daily Volume= 75,964 (Source: Yahoo Finance) Average Dollar Volume = $280,000 DCA is a moderately liquid stock and usually trades with a bid-asked spread of one cent. You can often get some price improvement on marketable limit orders and buy or sell between the bid-asked spread. Because the price is so low, some care should be taken when trading DCA. DCA appears to be an attractive purchase for a swing trade at current levels with a discount to NAV of 17%, if you believe that the underlying portfolio has potential to bounce back from tax loss selling early next year.