Tag Archives: transaction

Essential To Understand This If You Are A 60/40 Investor

Summary We show exactly why the 60/40 allocation has provided better risk adjusted returns by evaluating 60/40 from the perspective of the enterprise. Buying stocks is buying a business, which invariably includes assumption of debt, i.e. being short bonds. Viewed in this light, actual 60/40 “net” bond exposure is significantly less than 40%. Portfolio risk is 90% from stocks and 10% from bonds, not because stocks are 9x riskier than bonds, but because your average true net dollar exposure is close to 90/10. We show historical returns for a variety of strategy combinations based on the insights of this approach, including combinations that target an “actual” net bond exposure. Targeting a true 40% bond exposure has slightly lower returns than traditional 60/40, but better risk adjusted returns with much lower drawdowns; beneficial for retirees who are making annual withdrawals. The 60/40 portfolio (60% equities, 40% bonds) has been the stalwart of the investment management industry. It has delivered better risk adjusted returns than either stocks or bonds individually since 1973. The basic idea is that some balanced combination of two non-correlated assets will provide a consistent and less volatile return stream. It has developed an aura of its own and is the go-to benchmark for other portfolio strategies to compare to. The founder of one of the large investment management firms likened it to Adam Smith’s ‘Invisible Hand,’ saying “We don’t know exactly why it works, it just always seems to work. In the end, when you look back over a 15-year period of time, it works.” Clearly, it would provide much comfort if we did understand why it worked, and this article will shed some light on how 60/40 works in a way you have probably not seen before. Going back to Basics First To understand the concept in its simplest sense, we need to cover some basics of investing across the capital structure. The graphic below shows the enterprise triangle, with the various levels of participation that an investor can choose from. Bonds are the least risky form of investment in the enterprise because they have the highest priority claim against the assets of the business. Equity carries the highest risk because it is the last to get paid after all other stakeholders have been paid. By definition, you should expect a higher return from equity than debt because it carries more risk. Except for government debt, all other debt and equity are dependent on the performance of the enterprise. (click to enlarge) Key concept When investing in stocks, you are buying an ownership interest in the whole enterprise. This means that you also assume (not personally) the debts of the enterprise. Assuming debt or borrowing is the opposite of lending, investing or being long. Borrowing is therefore the same as being short debt. Investing in equities of companies that have debt therefore creates two risk exposures, 1) long equities and 2) short debt. The following box shows an example of creating a 60/40 portfolio at the simplest level. Assume company SPX, representing the entire investment universe, has a market cap of $600,000 and has debt outstanding of $400,000. Assume further that your portfolio of $1,000,000 is currently in cash and ready to be invested in a 60/40 portfolio. (click to enlarge) There are two transactions necessary, 1) allocating 60% of your capital to stock, and 2) 40% to bonds. In Transaction #1, when you buy the equity in a company you automatically assume (not personally) the debt of that company. The debt as a percent of the market cap is 66.7% ($400,000/$600,000). Assuming the debt, as explained above is the same as being short the debt, so your exposure from Transaction #1 is to be long $600,000 in equities and short $400,000 in debt. In Transaction #2, you allocate 40% of your $1,000,000 to bonds. By investing $400,000 in the bonds of the company, you have effectively neutralized your bond exposure. Your net bond exposure is now zero . Obviously, the investment universe is a lot more diverse than just our company SPX, including government debt, but hopefully you get the concept of your “net debt” exposure. We will use the terms net debt, net bond and net leverage exposure interchangeably. Extrapolating the concept to the real world Most 60/40 portfolios will invest the equity portion into a diversified fund or ETF that tracks the entire market such as the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) or the Vanguard S&P 500 ETF (NYSEARCA: VOO ). When you purchase the SPY, you are by definition assuming the total debt of all those companies in the same proportion to your equity ownership. How do you know how much debt you are assuming? The Federal Reserve Z1 makes this data available on a quarterly basis. It shows the total credit market liabilities as a percentage of the market value of equities outstanding (debt/market cap ratio). Here is the chart since 1953. (click to enlarge) You will notice that the amount of debt that companies hold relative to the market value of their equity is not constant. For every dollar you have invested in equities, you are effectively short bonds in the amount of $1 x debt/market cap ratio percentage, shown on the vertical axis of the graph. This would be offset by your 40% long investment in bonds. Based on this, we can show the net debt exposure for a 60/40 portfolio, rebalanced annually, going back 40 years to 1973. Key Takeaways Net debt exposure is not constant with 40% in bonds. Net exposure will differ depending on the debt/market cap ratio, and it changes continuously. Over 40 years, the 60/40 portfolio, rebalanced annually, had only 3.01% net exposure to bonds . From 1974-1993, net exposure averaged -7.73% and from 1994-2014 was a positive 13.25%. This exposure worked out well for 60/40 investors because it was generally short debt in the rising interest rate environment and long debt in the declining interest rate environment. The often cited fact that stocks in a 60/40 represent 90% of the risk is true, but not because stocks are 8-9 times riskier than bonds, but because the true net dollar exposure of bonds has been less than 10%. Dollar allocation does approximate risk allocation when you think about it in this framework. 60/40 has worked by essentially maintaining a relatively unlevered exposure to the enterprise. Note that while we have assumed all debt is corporate debt, in reality a large portion of the 40% gets allocated to government debt. While the risk profiles are somewhat different, the net bond exposure is the same, and the performance over 40 years is very similar. The Mechanics of Rebalancing The mechanics of rebalancing, which we show below, are a bit complicated, but in a nutshell, when equities go down relative to bonds you increase your risk profile at rebalance time, and when equities go up relative to bonds you reduce your risk profile at rebalance time. The transactions that occur at rebalance time are shown below for two scenarios, 1) equities go down relative to bonds, and 2) equities go up relative to bonds. The dynamics change slightly depending on how you treat the book value of debt. Does it go to market or stay at book? We show it both ways. In Scenario #1, when equity values decline, the debt/market cap ratio increases, increasing your short debt exposure at the enterprise level, making your portfolio more volatile; rebalancing increases your equity exposure, and your implied short debt exposure (both of which contribute to increasing your risk profile), which is then offset by the increased allocation to your long debt exposure. Like I said, it’s a bit complicated. The bottom line of each table shows the new net debt exposure. If you are interested in the workings, then review the tables below else skip ahead to the next section. Questions and Possibilities There are literally dozens of possibilities that arise in thinking around this idea, but I want to give you some actionable insights, so I will highlight a few possibilities and show a range of performance comparisons to finish. Can we replicate the 60/40 risk profile by just investing 100% of the portfolio in equities of a basket of unlevered, or low levered companies? There is no index that we know of that tracks exclusively low leverage; some include leverage as a factor in their quality index. Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) almost fits the bill, and we show the performance, but Buffett is an anomaly, so we cannot assume similar performance. Risk is not only a function of leverage, but also industry and size, so expecting low leverage alone to match the risk profile of 60/40 is not realistic. The S&P Low Volatility Index (implement with SPLV) does have about 25% less leverage than the S&P 500, so we show those returns both individually and in combination with 20% government bonds. As an investor, you have the choice of deciding how much net leverage you are comfortable with. You can adjust your bond exposure to achieve this. We show the performance of a portfolio that targets 0% net bond exposure, and one that targets 40% net bond exposure. It turns out that 60/40 outperforms any positive target debt level we could find, but on a risk adjusted basis, the true 40% bond target does much better. While there is some benefit to government bonds, over 40 years the difference between using corporate and government is very small – corporate has a slightly higher return, but government has slightly better risk adjusted returns. Corporate bonds are exposed to the enterprise risk, so for diversification you may prefer more exposure to government bonds. Government bonds provide that flight to safety when the future of the economic enterprise looks risky, even though corporate bonds seem to have performed better individually. We show the traditional 60/40 with both government and corporate bonds. Performance Comparisons The following table shows returns for stocks, government bonds, corporate bonds, low volatility, and Berkshire, individually, and then in a series of different combinations, including 60/40 conventional with T-bonds, 60/40 with corporate bonds, 0% net bond target, 40% net bond target, and 80% low vol/20% government bonds. Years in which stocks had negative returns are highlighted in red to easily see how each strategy performs under those conditions. While I will leave you to peruse these without comment, I just want to highlight the performance of the “true” 40% net bond exposure versus the traditional 60/40 (both circled); it has slightly lower returns but much better risk adjusted returns and the drawdowns are much smaller. This can be especially beneficial for retirees who are withdrawing assets from their portfolio every year to live on. Conclusion This article just scratches the surface, and there are many portfolio construction possibilities to explore around this idea. Viewing 60/40 from an enterprise value perspective offers a better insight into your risk profile characteristics. Targeting a true 40% long bond exposure gives a lower absolute return than traditional 60/40, but much better risk adjusted returns, with much lower drawdowns. Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in SPY, VOO, TLT, AGG, LQD, SPLV over the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Cleco (CNL) Bruce A. Williamson on Q4 2014 Results – Earnings Call Transcript

Cleco Corp. (NYSE: CNL ) Q4 2014 Earnings Call March 02, 2015 9:30 am ET Executives Robbyn Cooper – Manager, Investor and Public Relations Bruce A. Williamson – Chairman, President & Chief Executive Officer Thomas R. Miller – Senior Vice President and Chief Financial Officer Darren J. Olagues – President, Cleco Power LLC Analysts Paul T. Ridzon – KeyBanc Capital Markets, Inc. Brian J. Russo – Ladenburg Thalmann & Co., Inc. (Broker) Operator Welcome to the Cleco Corporation Fourth Quarter 2014 Earnings Call. My name is Laura, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Ms. Robbyn Cooper, Manager of Investor and Public Relations. Robbyn, you may begin. Robbyn Cooper – Manager, Investor and Public Relations Good morning, and welcome to Cleco Corporation’s 2014 fourth quarter and year-end earnings call. You can access this call and slide presentation live via the Internet from Cleco’s website at www.cleco.cominvestors. Telephone and Internet replays can be accessed through our website. The dial-in number for the telephone replay is 888-843-7419 if in the U.S., or 630-652-3042 if outside the U.S. The conference ID is 38458256. With me on the call today is Bruce Williamson, Chairman, President, and Chief Executive Officer of Cleco Corporation; and Tom Miller, Senior Vice President, Chief Financial Officer and Treasurer; along with other members of Cleco management. Before we begin, please keep in mind that during the conference call, we will make some forward-looking statements. These statements are subject to many risk and uncertainties. Actual results may differ materially from these contemplated in our forward-looking statements. Please refer to our cautionary note regarding forward-looking statements and risk factors in various reports filed with the U.S. Securities and Exchange Commission, including our 2014 Annual Report on Form 10-K and current reports on Form 8-K. In addition, please note that the date of this conference call is March 2, 2015, and any forward-looking statements that we may make today are based on assumptions as of this date. And with that, I will turn the call over to Bruce. Bruce A. Williamson – Chairman, President & Chief Executive Officer Thanks, Robbyn. Good morning and thank you for joining us. This morning, we’ll review the 2014 fourth quarter and full year results. Let’s start with the agenda for today’s call, which is on slide 3 of our presentation for those of you following along via the webcast. I’ll begin today’s call with an update on the merger transaction and a recap of 2014 accomplishments. Tom will then discuss fourth quarter and year-end financial results and I’ll finish up the call with a discussion of our objectives for 2015 and then we’ll move to Q&A. Please turn to slide 4. As discussed in our previous call last October, the company announced an agreement to be acquired by a group of North American-based long-term infrastructure investors led by Macquarie Infrastructure and Real Assets or MIRA and British Columbia Investment Management Corporation, also known as BCIMC. In February, we were pleased to receive notification that all four corporate governance and shareholder advisory firms had joined our board in recommending that both the merger-related votes be approved. Last Thursday, we held a meeting of our shareholders to vote on the proposals related to the merger. I’m pleased to report that our shareholders overwhelmingly approved the merger transaction. The merger proposal passed with a vote of more than 94% of votes cast, which is equal to approximately 77% of all shares outstanding. This overwhelming vote of confidence for management, the board of directors and the transaction shows that we structured a transaction that our shareholders see value in. We’ll now turn our focus towards the remaining regulatory approvals needed to close the transaction. On February 10, we filed our merger application with the Louisiana Public Service Commission and that filing can be found on our homepage. Independent consultants and legal counsel selected by the LPSC in December will help them review the application. The LPSC staff has begun the discovery phase of the review and, in the coming months, an administrative law judge will set a procedural schedule for the timetable for the application process. The remaining applications, including among others the Federal Energy Regulatory Commission or FERC, Hart-Scott-Rodino or HSR are expected to be filed later this month. In structuring the merger agreement, we work to ensure that Cleco will remain a Louisiana-based company with local operations and local management. We believe our proposed regulatory commitments address the LPSC’s concerns and represent our commitment to our employees, retirees, customers, and the communities we serve. We’re exceptionally pleased with the outcome of the shareholder vote and will continue to work through the approval process to obtain the remaining regulatory approvals. We still expect the transaction to close in the second half of 2015. I’ll now turn to slide 5 to recap 2014 accomplishments. In addition to announcing the strategic transaction, we also delivered on key regulatory and strategic initiatives. We produced another strong year and reported operational earnings of $2.74 per share, up $0.21 per share when compared to 2013, which puts us near the top-end of our earnings guidance range of $2.65 per share to $2.75 per share. Positive drivers for the year included higher revenues associated with the start of the wholesale contract with Dixie Electric Membership Corporation or DEMCO, a favorable multi-year settlement with taxing authorities and ongoing cost management efforts. These positive drivers helped to offset mild weather for the year, and the rate decrease and customer refund associated with our formula rate plan extension that began in July. Our strong financial position prompted us to raise the annual dividend on the company’s common stock to $1.60 per share, which represents a 10% increase. This marks the sixth dividend increase in the last 4.5 years. Finalizing the formula rate plan was perhaps the most important regulatory accomplishment. The rate plan extension, which went into effect July 1, extends our previous rate plan design by four years. The extension did reduce our target ROE to 10% from 10.7%, but it also retained some customer sharing provisions. Importantly, the extension finalized the rate treatment of the Coughlin Power Station, which we transferred to our regulated utility in March. And overall it reduced forward rates to customers by about $34 million annually, which is in large part due to cost management efforts of the last 3.5 years along with the reduction in target ROE and thereby reset our earnings downward to the guidance range that we issued in late 2014. Coughlin Power Station was the last remaining asset in our unregulated business. Following the completion of the transfer, our company is streamlined to focus on the regulated utility subsidiary. Coughlin is a combined cycle gas-fired unit and it increases the efficiency of the generation fleet and provides low-cost power for all retail and wholesale customers. Moving on, last year we were successful in negotiating a tax settlement with a state taxing authority. The settlement produced a benefit to earnings that was recorded in the third quarter of 2014 and the settlement is favorable for both the company and the state, and will provide clarity on future tax treatment of agreed-upon items. And with that, I’ll now turn the call over to Tom to discuss our fourth quarter and year-end financial results. Thomas R. Miller – Senior Vice President and Chief Financial Officer Thanks, Bruce. (7:24-7:29) of our fourth quarter operational results. GAAP earnings were $0.35 per share for the fourth quarter of 2014, a $0.06 decrease compared to the fourth quarter of 2013. Operational earnings for the quarter were $0.60 per diluted share, a $0.19 increase compared to the fourth quarter of 2013. Lower O&M related to outages at our generation facilities and a gain on the sale of property drove operational earnings for the quarter. Operational earnings exclude items associated with tax levelization expense, which was $0.05, and merger transaction cost, which were $0.20 in the fourth quarter. Looking from left to right on the operational reconciliation chart, Cleco Power’s non-fuel base revenue declined $0.09 per share from this time last year. Higher revenues primarily to a new wholesale customer increased earnings by $0.06 per share. A lower rate refund associated with site specific customers increased earnings by a $0.01. These increases were offset by $0.09 per share as a result of lower retail customer usage and milder weather. And the 2014 formula rate plan extension decreased revenue by $0.07 per share. Other expenses increased earnings by $0.21 per share due to $0.13 per share related to fewer planned outages at our generation facilities this past quarter compared to the fourth quarter last year; $0.06 per share related to a gain on the sale of property, $0.05 per share of lower taxes other than income and $0.03 per share related to lower depreciation and amortization expense. These increases were partially offset by $0.03 per share from the absence of the recovery of capacity expense related to the Coughlin tolling agreement, $0.02 per share related to higher capacity cost associated with wholesale contracts and $0.01 per share of higher miscellaneous expenses. Interest expense was lower and increased earnings by $0.03 per share. $0.02 were related to the absence of a surcredit customer giveback, which is now included in base rates as a result of the FRP extension, and $0.01 per share of lower miscellaneous charges. And finally, lower income taxes increased earnings by $0.04 per share due to $0.03 per share of miscellaneous tax items and $0.02 per share of tax expense to reflect the annual projected tax rate. This was partially offset by $0.01 per share due to lower tax credits. Now, please turn to slide 7 for a review of year end results. For 2014, GAAP earnings were $2.55 per diluted share, a $0.10 decrease compared to 2013. Operational earnings for 2014 were $2.74 per share, a $0.21 increase compared to 2013. As a reminder, operational earnings exclude non-operational items associated with $0.01 benefit from Acadia Unit 2 indemnifications, a $0.03 gain from insurance policies and $0.23 associated with the merger. Again, looking from left to right on the reconciliation chart, Cleco Power’s non-fuel base revenue was up $0.08 per share from this time last year. Higher revenues primarily from wholesale business growth including the contract with DEMCO increased the earnings by $0.35 per share. These increases were offset by a $0.22 decrease related to the one-time customer refund in September as part of the formula rate plan extension and $0.05 per share related to lower customer usage and mild weather for the year. Other revenue increased earnings by $0.03 per share due to transmission revenue as a result of joining MISO. Other expenses decreased earnings by $0.15 per share, primarily due to $0.18 per share from the absence of the recovery of capacity expense related to the Coughlin tolling agreement. As Bruce stated earlier in the call, Coughlin Power Station has now included base rates as part of the FRP extension. $0.04 per share related to higher depreciation and amortization expense, $0.04 per share related to higher capacity cost associated with wholesale contracts, and $0.02 per share related to higher planned outages at our generation facilities. These decreases were partially offset by $0.06 per share of lower taxes other than income, and lower taxes related to favorable settlement with taxing authorities. $0.06 per share related to the gain on the sale of property, and $0.01 per share, related to lower loss on disposal of assets related to the Coughlin outage. Interest expense was lower and increased earnings by $0.11 per share due to $0.06 per share from favorable settlements with taxing authorities, $0.04 related to the absence of a surcredit credit customer give back, and $0.01 per share of lower miscellaneous charges. AFUDC earnings – increased earnings by $0.02 per share due to MATS capital spend. And finally, lower income taxes increased earnings by $0.12 per share, primarily due to $0.18 per share of lower taxes due to favorable settlements with taxing authorities, and $0.02 per share of lower miscellaneous tax items. These benefits were partially offset by a $0.08 per share due to lower tax credit. I will now turn to slide 8 to discuss our 2015 earnings guidance. On last quarter’s earnings call, we issued our 2015 consolidated operational earnings guidance of $2.28 to $2.38 per diluted share. This earnings guidance is based on normal weather, reflects a full year of operations under the new FRP extension, assumes an effective tax rate of approximately 36%, and excludes adjustments related to life insurance policies and merger transaction cost. Cleco will continue to operate in the ordinary course of business until the merger closes. Prior to the closing of the transaction, Cleco’s ability to buy back stock or make tax-based investments without the consent of the new owners is generally limited to the ordinary course of business. Bruce will give some closing marks. Bruce A. Williamson – Chairman, President & Chief Executive Officer Thanks, Tom. Before going to Q&A, I want to take a few minutes to address our near-term strategic objectives and then we’ll take your questions. Our most important task for 2015 is obviously to finalize the regulatory and other approvals required to complete the merger transaction. As I stated earlier on the call, we anticipate a closing date in the second half of 2015. Over the last four years, our shareholders have received an exceptional return on their investment as shown by an approximate 90% total shareholder return, including the premium associated with the upcoming merger. Another way to think about the value of the transaction is when you apply 2015 earnings to the offered share price of $55.37, we’re trading CNL through the transaction at a PE multiple of approximately 23.8 times the midpoint of our 2015 operational earnings guidance, which is about 50% to 60% higher than where the electric utility industry trades today. Lastly, another way to think about it is our earnings or rate base which drives the earning power would need to be 50% to 60% higher than what it is today to realize enough earnings to support this price point. In summary, we achieved a very full valuation for our public shareholders and their support of the merger vote shows they understand this. Importantly, however, this transaction also benefits all of our stakeholders. Our new owners will ensure that Cleco remains to be locally managed and operated, and the transition for our customers and communities will be seamless. Our employees and retirees will retain the same pay and benefits and Cleco will remain dedicated to its core business of safe operations and reliable power and prompt customer service. And with that, we’ll open the call for questions. Question-and-Answer Session Operator And our first question comes from Paul Ridzon. Paul, your line is open. Paul T. Ridzon – KeyBanc Capital Markets, Inc. When do you expect the procedural schedule to be filed? I’m sorry, I missed that. Bruce A. Williamson – Chairman, President & Chief Executive Officer Paul, I’ll let Darren answer that one. Darren J. Olagues – President, Cleco Power LLC Paul, we have to get through the intervention period first, right, which ends on March the 10. Then we’ll proceed towards that as part of the next step. So I don’t have a specific answer for you right now, but I guess the next milestone, if you will, now that the application has been filed with the 30-day window for the interveners, is this March 10 date. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Okay. And then, is there some weather sensitivity at the industrial side? They were down I think 13% this quarter or is that just some planned outage or something? Bruce A. Williamson – Chairman, President & Chief Executive Officer One of our customers has a planned outage that brought down some of the industrial use, that is true. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Okay. Thank you. Operator And our next question comes from Brian Russo. Brian, your line is now open. Brian J. Russo – Ladenburg Thalmann & Co., Inc. (Broker) Hi. Good morning. Bruce A. Williamson – Chairman, President & Chief Executive Officer Hey, Brian. Brian J. Russo – Ladenburg Thalmann & Co., Inc. (Broker) Just curious on the independent consultant review of the merger agreement. Is there some sort of formal process there, meaning will that analysis be made public and/or be discussed in some sort of upcoming open meeting? Bruce A. Williamson – Chairman, President & Chief Executive Officer Darren? Darren J. Olagues – President, Cleco Power LLC Yeah. I mean, ultimately we – like our past practices, we hope to have a settlement proceed towards the commission ultimately for the vote. And in that, there is testimony that’s provided by the consultants in that, and so, the essence of their analysis will be reflected in that testimony. Brian J. Russo – Ladenburg Thalmann & Co., Inc. (Broker) Got it. Okay. Great. Thank you very much. Operator Okay. And I’m actually seeing no questions at this time. Bruce A. Williamson – Chairman, President & Chief Executive Officer Okay. Thank you for your questions this morning. As we close this investor call, I’d like to recognize the work of Sybil Montegut and Mallory Biegler who comprise our investor team. They were nominated as finalists by institutional investors to be an all American IR team, and it’s an honor to have them be named as finalists by the input and voting of our largest institutional investors. Obviously, if anyone has any questions after the call today, please give Mallory or Sybil a call. I’d also like to commend (19:38) and the rest of the safety department along with all of our employees for their continued focus on employee safety. We initiated a complete top to bottom rework of our safety program in late 2011 and they’ve continued to seek best practices over historic practices in all facets of safety, and today we’re firmly among the best performing utilities in terms of safety performance. We do not take this performance improvement lightly, however, and we want every employee to continue to focus in 2015 and strive for Target Zero. I also would like to end the day with just a final thanks for our shareholders to their resounding support for the strategic transaction with Macquarie and the BCIM led investor group. Thank you. Operator Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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