Conrad: A Good "Citizen"

05/20/2005 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

With a wide-ranging focus from utilities and telecom to REITs and energy trusts, Roger Conrad is a leading authority on income investing. Here, the editor of  Utility Forecaster and the new Canadian Edge, looks at some favorite income ideas.

"Although we haven’t had a new high in the general market for about five years, these have been very good times for income investors. First of all, interest rates have been generally well behaved and, in fact, have trended downward the last few years. The economy, while not spectacular, continues to run along. So the credit risk side of the spectrum isn’t too high. Companies are boosting dividends because they perceive that is what investors want, so you have a lot more variety of things to choose from in the income arena. And of course the tax cut has been a real godsend, with the maximum tax now 15% on dividends. These are positives that will continue.

"On the other hand, there are also some challenges that I think we face. One is that we have already had a nice rally for five years in income investments. For example, one of my favorite groups for years has been REITs, but if you start looking at that group right now, you have yields that are now one-half to one-third of what they were, while multiples have expanded dramatically. So they are not cheap anymore. So while there are good things going on in the income sector, much of that is already priced into the stocks. Indeed, that is a problem I find throughout the income universe.

"Also of concern is that we have cyclical pressures, such as high energy prices, which are causing a lot of uncertainty. Another wild card is the Federal Reserve, which is raising interest rates. Everyone remembers the Long Term Capital debacle and there are rumors now that similar things could be happening as a result of huge leveraged bets being made today. So there’s always the risk of an accident out there. In light of these factors, my current investment strategy is to stick with quality and focus on situations or companies where things are getting better. There are a lot of yield chasers out there who just chase a big number. But in my mind, quality will be very important going forward.

"Number one on my buy list now would be Citizens Communications (CZN NYSE). This is a company that had a portfolio of utilities, which they’ve turned into a portfolio of telecommunications properties in rural areas, and put themselves up for sale about a year ago. They didn’t find any takers, as nobody was interested in local phone lines. Nevertheless, local phone lines still make a lot of money. They are huge cash cows. So the company started paying a dividend of about $1 a share. Right now, based on the current price, the yield is nearly 8%. The reason it stayed so high is because there is a profound lack of understanding about the company and its earnings potential. During the period when it was acquiring rural telecoms, the company took on a lot of goodwill. That goodwill has zeroed out taxes through 2007. Based on free cash flow, the firm now has about a 66% payout ratio. There are not a lot of companies with that kind of position. And while its not a high growth situation, they are cutting debt and paying investors a big yield. In fact, it’s now the highest yielding stock in the S&P 500.

"Another top pick would be a Canadian trust, ARC Energy (CA:AET.UN  Toronto), which has one of the oldest and strongest pedigrees among the energy trusts. One of the things I really like about ARC is that while a lot of other trusts have been out there making acquisitions and issuing a lot of shares and becoming more leveraged to the commodity price cycle, ARC has cut its operating costs and shed some of its higher cost reserves and has become less leveraged. They also have a reserve life that is at the top of the industry. The trust is yielding about 10%.

"Another income idea is Duke Energy (DUK NYSE). The company is in the process of doing a merger with Cinergy. In my mind, there are a lot of good aspects to this situation. The market, on the other hand, is not very excited about this merger, or mergers in general. As a result, the stock price has come down. I don’t know how long it will stay down, but I think that at prices under $28 it’s an interesting situation. It’s a long-term player based on a turnaround, good assets, and potential growth in the utility industry, which nobody is really paying attention to right now. In addition, the shares currently provide a yield of nearly 4%.

"Another stock that I have has also been involved in a merger. ChevronTexaco (CVX NYSE) is a big oil that is very financially strong. The company had a reserve problem and they solved that by merging with Unocal. By doing that, they become more leveraged to the commodity cycle. As a result, investors got scared and sold the stock. Where it had previously been overvalued, the stock has has fallen in price fairly dramatically. The company is a major controlling force in oil, one of the most vital commodities in the world. For investors, I believe the stock, which yields 3.6%, is providing an opportunity to own shares in a company with improving quality that has not yet caught the attention of income investors."

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