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TECO Energy: What A Difference A Day Makes

Over the past decade or so TECO Energy has shown stagnant growth and average investment results. Recently the company received a bid to be acquired at a much higher share price. This article shows the difference that just a single day can have on an investment. Over the past decade or so, Tampa, FL-based TECO Energy (NYSE: TE ) has been what I would classify as an “average” investment. You have a slow growing business that just sort of plugs along and pays out a large percent of its earnings in the form of dividends. It’s the classic utility model. I’ll show you what I mean. Here’s a look at the company’s history from the end of 2005 through the end of 2014: TE Revenue Growth -1.8% Start Profit Margin 7.0% End Profit Margin 8.3% Earnings Growth 0.1% Yearly Share Count 1.3% EPS Growth -0.6% Start P/E 17 End P/E 22 Share Price Growth 2.0% % Of Divs Collected 43% Start Payout % 76% End Payout % 93% Dividend Growth 1.6% Total Returns 5.6% TECO began the period with a little over $3 billion in revenue and ended with a bit less than $2.6 billion, or a compound growth rate of -1.8% per annum. Granted certain operations have been sold or discontinued, but it remains that the company as a whole was not growing on the top line. Based on the $3 billion in revenues, TECO earned about $211 million – representing a profit margin of about 7%. By 2014 the margin had expanded to 8.3%, resulting in a net profit of $213 million. In other words, despite the revenue decline, the overall company profitability increased ever so slightly. Yet this slight advantage did not remain for shareholders. At the beginning of the period the company started out with roughly 208 million shares outstanding. By the end of the period this number had grown to 235 million. As such, the earnings-per-share growth also was negative – coming in at -0.6% annually. At the end of 2005 shares of TECO were exchanging hands around $17, resulting in a trailing multiple of about 17. By the end of 2014 the share price had climbed to $20.50, indicating a multiple closer to 22. This is why it’s important to allow for a wide range of possibilities. During this same time frame a company like Union Pacific (NYSE: UNP ) was providing 20% EPS growth, yet it saw P/E compression . On the other hand, TECO was providing negative EPS growth yet saw a higher multiple. When you suggest anything is possible, it’s not just a coverall – strange things happen in the investment world. Due to this multiple expansion, shareholders saw the share price increase by about 2% annually. This is nothing to text home about – especially over a decade period – but still something considering the growth headwind. The real story for TECO has been its dividend. The company, like many utilities, has committed to paying out a large portion of earnings in the form of dividends. Although this payout did not grow much, it did allow for a solid and consistent cash flow. Over the period an investor would have collected about $7.50 per share in dividend payments against capital appreciation of just $3.50. In total this equates to total annual returns of about 5.6% per year. Hence the beginning reference to “average.” Actually it’s slightly impressive given the lack of growth, but basically investors received the dividend payment along the way and not much more. Had you owned a couple thousand shares it could have paid for your electric bill, but there were certainly better wealth providers during this time. Both the business and investment performance of the company wasn’t especially inspiring. Yet this changed a bit due to a recent announcement. On September 4, 2015, TECO announced that Canadian-based Emera Inc. ( OTCPK:EMRAF ) would acquire TECO Energy for $27.55 per share, representing a 48% premium to the July 15th price and roughly 31% higher than the previous close. As a result, shares opened the next trading day over 20% higher, moving to about $26 per share. This is the sort of thing that transforms an investment. During the past decade, shares of TECO Energy have provided about 5.4% annualized returns (quite similar to the exercise above, but moving away from the 2005 and 2014 year-ends.) As a result of the buyout offer, shareholders suddenly have a 7% annualized gain. Over the past five years shares have provided 8.5% annualized returns (incidentally, demonstrating what a move from a low to high earnings multiple can do in the face on a stagnant business.) As a result of the higher price on September 8th, this 8.5% annualized return is suddenly a 12.5% annualized gain. Naturally you can’t predict whether or not a buyout offer will come. Yet the above result is instructive. For one, it shows that business performance and investment performance can vary. The typical investor over the last decade or so actually saw their underlying earnings claim decrease. Had you owned the entire business you would have had a slightly greater claim, but due to share issuance common stockholders were diluted. Still, even though the growth rate was negative, overall returns were still positive. This happened for two reasons. First, investors were willing to pay more for less earnings power. Strange things happen in the investment world, so you can never count out multiple expansion (or contraction). Investor sentiment waxes and wanes as the business results tend to be a bit steadier. Yet even if the multiple had remained steady, thus resulting in negative share price appreciation, your overall returns would not have been negative. Due to a solid and slow growing dividend, you were able to accumulate cash payouts along the way. There’s a lot to be said for collecting dividends while you wait for something good to happen. Of course these payouts can’t always “protect” you, but they can still provide a nice return buffer. You won’t shout in joy over 4% returns, but it’s not an awful consolidation prize. Further, you can reinvest these payments to increase your income. In a more abstract sense, this example demonstrates why it can pay to remain patient. Had you purchased shares a few years ago with an earnings multiple below 15 (or higher), the subsequent decline in earnings and rise in share price resulted in a multiple over 20. You could have then elected to sell, but naturally that would have concluded in missing out in a 20%-plus higher price today. Of course you can’t predict this, but the idea is to be ready for the outcome. If that sort of “missing out” would bother you, then perchance there are worst things in the world than collecting a solid dividend payment while a company regains its footing. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Cushing MLP Total Return Fund: A Lesson For CEF Investors

Summary CEF investors are often attracted by the high yields in this space. SRV’s anomalously high yield and premium provided a ripe recipe for disaster. This article identifies three warning signals that investors could have heeded before the devastating event. The date is Dec. 22nd, 2014. With oil prices collapsing around you, you decide that now would be a good time to dip your toes in an MLP close-ended fund [CEF]. You read Stanford Chemist’s just-published article entitled ” Benchmarking The Performance Of MLP CEFs: Is Active Management Worth It? “, where he recommended, among five MLP CEFs yielding 5.43% to 6.85%, the Tortoise Energy Infrastructure Corporation ( TYG ) due to its strong historical total return and outperformance vs. the benchmark Alerian MLP ETF ( AMLP ). But the 5.43% yield of TYG and the 6.25% yield of AMLP are a bit low for your tastes. You decide to invest in the Cushing MLP Total Return Fund ( SRV ) with a whopping 14.02% yield , more than double that of the other two funds. With twice the yield, you might expect twice the return, right? Fast-forward to today. You have lost half of your investment. The following chart shows the total return performance of SRV, TYG and AMLP since Dec. 2014. SRV Total Return Price data by YCharts What happened to SRV? As with some other high-profile CEFs profiled recently, what transpired with SRV in early 2015 was a distribution cut that triggered a massive collapse in premium/discount value. As can be seen from the chart below (source: CEFConnect ), SRV slashed its quarterly distribution by 68%, from $0.2250 to $0.0730 in 2015. Amusingly, after paying one quarter of its reduced distribution, SRV cut its distribution again by 26%, while simultaneously changing to a monthly distribution policy (perhaps to make the second distribution cut less obvious!). Taken together, the overall change from a distribution of $0.2250/quarter to $0.0180/month represented a 84% reduction for SRV holders. (click to enlarge) The distribution cut was accompanied by a massive reduction in premium/discount value, from some +30% to -10%, as can be seen from the chart below. This explains the severe underperformance of SRV vs. TYG and AMLP since Dec. 2014. (click to enlarge) Obviously, hindsight is always 20/20. But I believe that there were some warning signs that SRV investors could have heeded before the disastrous event. Lesson #1: Consider historical performance While historical performance is no guarantee of future results, the past return of a CEF can give an indication of the management’s competency in running the fund. The 3-year total return to Dec. 2014 (the hypothetical start date of this exercise) shows that even before the distribution cut had occurred, SRV had been severely underperforming TYG and AMLP on a total return basis. SRV Total Return Price data by YCharts On a price-only basis, the underperformance of SRV becomes even more visually striking. SRV data by YCharts The above charts indicate that the high distribution paid out by SRV has prevented it from growing its NAV, despite the bull market in MLPs. Even when total returns are considered, SRV still lagged TYG and AMLP in the three years to Dec. 2014. Lesson #2: Premium/discount matters! As investors in the Pioneer High Income Trust (NYSE: PHT ) (see here for my previous article warning of PHT’s expanding premium) and more recently, the PIMCO High Income Fund (NYSE: PHK ), have found out , a high starting premium simply increases the amount that a fund can fall when adversity strikes. On Dec. 22nd, 2014, SRV’s premium/discount had stretched to a massive +28.4%. In comparison, TYG’s premium/discount was -6.1% at the time. The following chart shows the 3-year premium/discount profiles for SRV and TYG. (click to enlarge) The chart above shows that in the two years leading to Dec. 2014, SRV’s premium/discount expanded from around +15% to over +30%. On the other hand, TYG’s premium/discount declined from +15% to around -10% over the same time period. Does it make any sense to you that the perennial underperformer SRV was immune to the MLP sell-off that began in the summer of 2014, while the benchmark-beating TYG was not? No, it doesn’t make any sense to me either. In fact, SRV’s premium continued to expand even while the oil crash was already well underway. My only explanation for this was that retail investors were enamored with SRV’s high yield and pushed up its market price relative to its NAV. CEF expert and Seeking Alpha contributor Douglas Albo frequently laments the “Insanity of CEF Investors.” I believe that this example qualifies. Lesson #3: Beware of yields that seem too good to be true On Dec. 22, 2014, SRV yielded 14.02% with a premium/discount of +28.4%, meaning that its yield on NAV was even greater, at 18.00% (!). Meanwhile, TYG yielded 5.43% with a premium/discount of -6.1%, giving a NAV yield of 5.10%. Given that both funds employ similar leverage (around 30%), and are investing in essentially the same universe, how can SRV be yielding more than three times on its NAV compared to TYG? It just doesn’t make any sense. Simply put, SRV’s yield was way too good to be true. Summary I believe that there were several warnings signs that could have allowed investors to avoid SRV before the calamitous distribution cut in early 2015. These were [i] a poor historical performance, [ii] a rising premium (while other and better funds in the same category witnessed premium contraction), [iii] a yield that seemed way too good to be true. My main regret is not being able to identify this short opportunity for readers, and/or warn existing holders to exit the fund beforehand. Nevertheless, I hope that this article will help investors pick out similar warning signs in their existing or potential CEF investments to allow them to take action earlier. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Distribution Cuts: Threats And Opportunities For Income CEF Investors

Summary Closed-end funds are often targeted to the income investor. A predictable and stable income stream is among a CEF investor’s highest priorities. When funds are forced to cut distributions, the market response will frequently be an immediate sharp decline in the fund’s price and its premium/discount. In this article, I look at five income CEFs that have cut distributions from 15% to 33%. For the most part, CEFs are designed for and targeted to income investors. For the income investor, closed-end funds are hard to beat. Average distribution yields are in the 8%-9% range for taxable funds (general equity, 8.99%; preferred stocks, 8.09%; fixed-income, 8.55%). Tax-free national municipal bond funds pay an average yield of 5.92% with no federal tax liability. Many funds make an effort to maintain stable distributions; others pay out variable distributions based on the fund’s earnings. Distribution increases are rare for funds that maintain stable distributions. Managers often prefer to issue special distributions when earnings exceed regular distributions in part because they can do so without creating potentially unrealistic expectations. Decreases are uncommon as well, but managers are often find themselves in situations where there is no choice but to cut payouts to shareholders. One could argue that modest distribution cuts, when they are essential, are not completely negative. It may be preferable to the alternative, which is a return of investor capital at the expense of the fund’s net asset value. Income investors, however, can be a fickle lot and will react when a fund that has maintained a stable distribution reduces that payment. On the other hand, others who are not invested in a fund that cuts distributions (and therefore not subject to the cut in income) may find opportunities in such cases. For CEF investors, especially those who have not experienced the aftermath of a sharp distribution cut, a look at some recent occurrences may be instructive. The topic is timely because it is clear that at some point in the near future, interest rates will begin going up. When that happens, it is not unlikely that many funds will feel the pinch on their holdings and from rising leverage costs. One consequence may well be distribution cuts by CEFs, especially fixed-income CEFs that have been paying out unsustainably high distributions. One highly visible case occurred just last week when PIMCO High Income Fund (NYSE: PHK ) cut its payout amount on Sept 1. PHK has maintained an exceptionally high distribution yield over many years. Investors flocking to that high yield drove the premium for the fund into the 80% range. The fund had many detractors, but shareholders who enjoyed the high income the fund generated were often vigorous advocates. The fund’s share price and premium had been declining for months. Then PIMCO declared a 15% reduction in the distribution (the first distribution deduction in fund’s history), and there was a strong sell-off. The high yield, extraordinary premiums and regular controversy surrounding it made PHK’s plight highly visible. But it is not the only fund to have cut distributions this month. Two Allianz funds, AGIC Convertible & Income (NYSE: NCV ) and AGIC Convertible & Income II (NYSE: NCZ ), did so as well. I want to look at those three funds and two other examples. Two tax-free municipal bond funds from Pioneer: Pioneer Muni High Income Advantage (NYSE: MAV ) and Pioneer Municipal High Income (NYSE: MHI ), which cut their distributions in May. This chart illustrates the extent of the distribution cuts for these five CEFs. Distribution cuts ranged from 15% to 32.35%. These are drastic cuts. Anyone depending on the funds’ distributions for stable income would find a 15% income cut difficult and a 32% cut devastating. The first thing that comes to mind is the importance of diversification. Obviously, a portfolio with a high allocation to one or more of these would have delivered an income shock well in excess of a portfolio where they fill a moderately small fraction of the income holdings. This is such a primary factor in portfolio building; I will not discuss it here other than to point out how these actions underscore the need for holding a diversified portfolio. The second is to ask if an investor might have anticipated the cuts, a point I recently considered ( here ) for PHK with an eye on other PIMCO funds. And the third involves the aftermath: How might the cuts affect new investment decisions in the funds? What these CEFs had in common is high distributions and moderate to high premiums relative to their peers. Income CEFs tend to modulate discounts/premiums to adjust payout at market price to a point near some market equilibrium level. This creates a feedback loop: A manager does a good job generating high returns. The high returns drive investors to bid up prices into premium ranges. The high premiums mean that the distributions on NAV that fund managers have to earn to pay those high distributions on premium market prices are even higher. Eventually it becomes impossible to sustain such high NAV yields and managers are forced to cut distributions. Because it was the high yield that drove investors’ decisions to own the fund, many take a quick exit when that yield drops. Market price declines and premiums shrink or go to discounts to bring market distribution yields closer to the equilibrium value. PHK PHK is an extreme example. From the chart above, we see the distribution was cut 15.1%. The price dropped 10.4% the next day and 15.6% by the week’s end. NAV stayed completely stable, thus the premium dropped from 32.9% to 12.1% at Friday’s close. The net result was that distribution yield at market price remained stable. Obviously, this is a short window. Deeper losses may be in the offing, or the share price may stabilize near the 15.5% yield point. There were clear predictors of PHK’s cut and many observers have been pointing them out for a long time. The most glaring was PHK’s failure to cover its distribution. I’ve discussed this in detail in a recent postmortem analysis of the cuts in the article linked above and will not repeat that. As for opportunity, I do not see anything approaching opportunity in PHK’s slide. The 15% distribution cut may not have been adequate to stabilize the fund as its coverage ratio prior to the cut was only 65%. As I’ve said previously, more cuts may well be on the horizon for PHK. NVC and NVZ Distribution cuts for the two Allianz funds came the same day as PHK’s cut. These were much steeper than PHK’s: distribution for NCV was sliced by 27.8% and for NCZ by 32.4%. The market’s response was equally rapid. NCV’s share price dropped 11.3% in a day and was down 8.82% at the week’s close. NCZ, which suffered even larger distribution cuts, lost 12.8% the first day. It too picked up a bit by the week’s close. NCV was priced at a small premium (0.83%) prior to the cut; it fell to a discount (-8.94%) but still above the average for fixed-income CEFs (-11.9%). NCZ’s 3.12% premium went to a discount of -9.72%. For both funds the distribution yields at market price ended the week at 11.8%, well off the yields before the cut, but still in the upper reaches of their category, ranking 10 and 11 among the 146 taxable income funds in the cefconnect screener. Note that after the initial drop, each fund saw a meaningful uptick. This suggests that there may be opportunity in NCV and NCZ. I will be researching both in more detail with an eye to determining if the distribution cuts were sufficient to bring the funds into a sustainable position. Others interested in income CEFs may want to do the same. On first look, it’s hard for me to decipher what drove the sharp decreases in payout for these two funds and I certainly will want a clearer picture here before I consider any moves into either. Undistributed net investment income or UNII certainly does not raise red flags. For NCZ, it was slightly negative (-$0.0667) at the end of February, and for NCV, it was slightly positive ($0.0319) (both from cefconnect.com). For the August distributions, NCV management estimated “that approximately 22% is from net investment income and approximately 78% is from net profits from the sale of portfolio securities or other capital gains.” For NCZ , “$0.0652 per common share [77%] of this distribution is from net investment income and $0.0198 [23%] is from paid-in capital in excess of par.” These factors need to be looked at more closely. Michael Foster addressed this issue in July, and for NCZ, he tells us that “these payments are not returns of capital; they are profits from sold bonds and convertible notes that the fund has held and liquidated.” He did not consider this to be cautionary with regard to the sustainability of NCZ’s distributions. The UNII numbers would seem to support his conclusion, but the distribution cuts call that into question. Most importantly, I see none of the indicators I (and others I’ve looked to for knowledgeable input on CEF investing) look to as signs of pending distribution cuts other than a subjective reaction to the fact that the funds had to generate high, possibly unrealistically high, returns on NAV to sustain those high distributions. I would certainly appreciate hearing any insights readers may have here. MAV and MHI I want to turn my attention to the two muni bond CEFs which have a bit of history following their cuts. Here again there is a tale of sky-high premium valuations coming down to earth. Fours months ago, the funds announced distribution cuts of 15.8% and 17.7%. Both funds were posting distributions above the peers, sufficiently above to generate premium valuations for each: 24.5% for MAV and 10.6% for MHI. Investors were paying those premiums for 9.1% and 7.7% yields on NAV, either without asking or answering to their satisfaction the question of how the managers were getting those returns from low-yielding municipal bonds. Here again, it is hard to find, even in retrospect where it’s usually easy, what might have predicted the distribution cuts and warned investors that a fall was coming. UNII was strongly positive for both funds. UNII was reported for MAV as $0.2021 at the end of March 2015, and $0.1622 for MHI in April. I suspect neither of those reports were in investors’ hands on May 5 when the axe fell, but I think it’s safe to say UNII would not have provided a clue that cuts were imminent. Neither fund was holding the highest-quality bonds, but that was nothing new for them. Duration was moderately long, but not out of line with peer funds that were returning lesser distributions. Sure the funds were on the riskier end of the muni-bond spectrum, but both had been handling that position for some time. If investors were concerned, as well they might be, there was little in the obvious data to heighten that concern in April. The most telling point might have been the exceptionally high distributions on NAV required to fund the payouts to shareholders. Muni-bond portfolios simply do not earn 9.2% or even 7.7% sustainably in the present ultra-low interest rate environment. MAV and MHI are leveraged, which would enhance their income-generating potential, but at 33% and 25%, neither is leveraged to a degree sufficiently above its peers to account for those exceptional yields. Unlike the other funds, we now have a four-month, post-cut record. Both funds continued to fall. MAV’s price has fallen 16.7% from its pre-cut level. It still maintains a premium (5.6%), albeit reduced substantially from its pre-cut level of 24.5%. MHI’s market price is 15% below its pre-cut level, and its premium is now down to a -5% discount. Both funds saw premium/discount levels pop a bit after their initial falls but then decline sharply. This chart shows MAV’s YTD premium/discount status. And this shows MHI’s. Are the funds offering buyers opportunity at these prices? Perhaps a case can be made that they are. Management has shown the ability to outperform peer funds over time. Distributions have been brought down to levels more consistent with their muni-bond fund peers. Bottoms seem to have been set for market price and possibly for discounts. The funds may well falter, but I think that’s more likely to be as part of a broad, sector-wide downturn for muni bonds rather than something specific to these funds. As a muni-bond CEF investor, I had considered MAV as the discount was falling but I am loath to buy any CEF at a premium valuation. Regardless, I did take the plunge in early August when the premium was close to zero and looked like it may have reached bottom. So far, that has turned out to be a reasonably good call but it’s still early days. Meanwhile the 7.5% distribution, free from federal taxes, is a welcome addition to my income stream. MHI with its lower leverage, similar portfolio and deeper discount may be the preferable opportunity at this time. I began this exercise in pursuit of a cautionary tale. Regrettably, the only one of these five funds that showed clear signs of imminent disaster is PHK, where the situation was so ripe for a crash that anyone should have been able to see it. For the others, the indicators are more subtle, sufficiently so that I would certainly have been taken by surprise had I been invested in any of them. The most I can infer is that if it looks too good to be true, it likely is. Not very satisfying, but the most noteworthy lesson I can take away from NCV, NCZ, MAV and MHI is that funds selling at premium valuation and turning in exceptional returns on NAV to support those valuation are best avoided even if there is no obvious marker for trouble ahead. I would appreciate any input from readers who have more substance to put on those sketchy bones. Disclosure: I am/we are long MAV. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.