2 Champions of the Fiscal Cliff

01/31/2013 11:10 am EST


John Mauldin

Chairman, Mauldin Economics

If you're looking for solid income in the years beyond the fiscal cliff mess, look no further than these two stocks, writes John Mauldin in Yield Shark.

Some $165 million of free government money is designed to pay for track maintenance, but we believe that the railroad car industry is going to be one of the prime beneficiaries, because the taxpayer subsidy frees up capital that would have been spent on maintenance and purchasing more rolling stock of railroad cars.

And boy, does the railroad industry need more cars. Shipments of petroleum on US railroads rose more than 46% in 2012 as shale oil producers put record amounts of crude on trains to overcome pipeline capacity constraints.

According to the Association of American Railroads, petroleum shipments reached 540,000 carloads in 2012, up from 370,000 carloads in 2011. That big increase is from the booming US shale oil sector, and the opposition to the construction of new pipelines, such as the Keystone Pipeline, has created a shortage of tankers.

One company set to cash in is American Railcar Industries (ARII), a leading manufacturer of tanker and hopper (grains, fertilizers) railcars. The booming business was evident in the most recent quarter:

  • Revenues jumped to $168.2 million, a 37% increase from the $125.8 million for the third quarter of 2011.
  • Earnings per share rose to 66 cents, a new all–time quarterly record.
  • Orders continue to pour in, with the order backlog growing by 7,630 railcars. ARII sold 1,460 railcars last quarter, so that backlog is about 1 1/3 years of business on the books, and new orders continue to pour in.

ARII is cheap at ten times earnings and pays a quarterly dividend of 25 cents a share, giving it a dividend yield of roughly 3%. By the way, Carl Icahn—a man who knows a thing or two about investing—is the majority shareholder of ARII.

Fiscal–Cliff Winner No. 2
Congress and the Obama White House may talk a tough game about Wall Street and the top 1%, but they continue to dole out tax breaks to them.

As we've mentioned, hedge funds and private–equity investors will continue to enjoy the “carried interest” treatment on their profits. This essentially gives them long–term capital gains treatment on what is considered ordinary income for the rest of the world.

When it comes to private–equity companies, the granddaddy of them all is Kohlberg Kravis Roberts (KKR), which defined the wheeling and dealing of the 1980s with its $31.4 billion takeover of RJR Nabisco and became well known for hostile takeovers, often financed with junk bonds raised by Drexel Burnham, led by Michael Milken.

KKR is one of the leading private–equity firms in the world, with a truly impressive track record, that manages an impressive $66 billion. When you buy KKR stock, you are essentially investing side–by–side with KKR in companies such as Del Monte Foods, Dollar General, First Data, HCA hospitals, Sealy mattresses, and Toys R Us. In all, KKR has invested in more than 70 companies, which provides excellent diversification.

KKR is required to distribute at least 90% of its profits to its shareholders, so the quarterly payouts will vary. Those payouts, however, have been both large and growing.

KKR is publicly traded, but it is structured as a limited partnership, not a corporation. Instead of a 1099, you will receive a K–1 form, which allocable your share of KKR’s income, gain, loss, deduction, credits, and cash. These distributions will be identified as (a) income, (b) qualified dividends, and (c) capital gains.

In general, the majority of the distributions you will receive will be characterized as capital gain distributions, which under the new fiscal–cliff agreement is taxed at 15% unless your household income exceeds $450,000. For example, of its 24–cents–per–share quarterly distribution that was paid on November 20, roughly 14 out of the 24 cents, or 58% of the payout, qualified for long–term capital gains treatment.

KKR is currently trading in the mid–teens and throws off a handsome 6% dividend based on the payouts over the last 12 months. We expect that payout stream to regularly increase over time.

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Related Reading:

MLPs That Hedge Commodity Risk

Where to Hunt for Big Yields

4 Cash Cows for Bad and Good Times

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