New Buys and Sells to Start the New Year

We are starting off the new year with a batch of buys and sells in the 2015/2016 Blended Income Model Portfolio. We have determined it will be most helpful to simply carry all of the models forward for the new year instead of liquidating and starting fresh.  To be able to do this we need to make some portfolio changes that more accurately reflect our current economic outlook. 

While we have always tried to minimize “trading” we did sell between 25 and 30% of the holdings we started the year (2015) with in the Blended Income Model Portfolio.   We certainly are not happy with a number that high, but for the most part we are satisfied with the outcomes (of course we would have preferred to have performed better and wish we could have a “do over” on a number of purchases, but such is life).  The 2015 Blended Income Model Portfolio ended 2015 with a gain of 2.30% versus gains (including dividends and interest) in the benchmarks of the Total Bond Fund (NYSE:AGG) and S&P500 of around 1/2% and 1% respectively. We will recap 2015 in another article soon.

First we will be selling the General Finance Corporation 8.125% baby bonds (NASDAQ:GFNSL).  This is painful as the 8.125% yield is lucrative, but it is necessary at this time. We wrote about this issue back in October and at that time sold the shares from our more conservative 2014/2015 Short/Medium Duration Income Portfolio.  We continued to hold it in the larger, more diversified, Blended Income Portfolio, but the time has arrived to let it go.  General Finance leases and sells modular offices, liquid storage tanks and other support equipment mainly to the oil and gas industry.  On November 9th they announced revenues fell by about 20% and they recorded a net loss of approximately $2.0 million compared to the year ago period profit of $3.2 million.  Additionally they reported $350 million worth of debt, which is a scary number for a company with a current run rate of about $250 million.  This company is very tied to the energy market and with our outlook of $30.00 to $50.00 crude oil prices in 2016 we aren’t going to hang around even though there doesn’t appear to be any immediate danger (at least more than we currently are aware of).

We will be buying the following issues—

Diamond Rock Hospitality (NYSE:DRH) common shares.  DRH is a lodging REIT which focuses on the ultra high end of the market and has 29 properties with branding such as the Westin Waterfront in Boston, The Lodge at Sonoma and the Renaissance Worthington Hotel Fort Worth.  These are hotels with average revenue per available room of $175-put on your white shirt and tie when you are at these properties (although we stay at Westins all around the country and seldom do we wear anything but our Levi’s).  This REIT (real estate investment trust) has real net income and doesn’t have to depend on trying to impress you with FFO (funds from operations–a typical REIT metric) and recorded net income of over $24 million in the last 3 month period. The payout ratio on the distribution is less than 50%. Please note if you are reviewing DRH’s financial reports that they show a decline in earnings year over year, but this is caused by extraordinary gains last year on a property sale.  It should also be noted that the 4th quarter (the current quarter) will be hurt by 1 large property being converted to a new brand.

The best part of DRH is that the stock is now trading at a 52 week low at $9.65/share.  It has a range of $9.65 to $16.00 and a current yield of 5.18%.  While the current yield isn’t spectacular it is likely that DRH is on the radar screen of many potential buyers and the Blackstone Group (NYSE:BX) would be a perfect buyer as they have just completed the acquisition of Strategic Hotels and Resorts which was a REIT and a holder of properties not dissimilar to those owned by DRH.  As conservative investors we wouldn’t buy DRH simply on buy-out hopes, but at the current rock bottom price there are certain to be bean counters penciling out the numbers. 

Next we will be buying a large position in the Gladstone Commercial Corp 7.125% term preferred shares (NYSE:GOODN).  While we have never been impressed with any of the Gladstone companies we think these shares fit our needs perfectly.  These shares have a tasty yield and they have a mandatory redemption date of 1/31/2017–so obviously this is a 1 year holding only. The fly in the ointment is that there is a “optional redemption date” starting on 1/31/2016. We would be really surprised if they were redeemed early as there are 3 outstanding perpetual preferred issues with interest rates at or above the coupon on this issue. Regardless, even with a large position, the downside risk is limited as it is currently trading at $25.16. GOOD is a triple net lease commercial REIT and as such dividends on this security are not tax qualified for preferential tax treatment. Dividends are paid monthly.

We have reviewed the most recent GOOD financial statements and they have had steady revenues, net income and FFO (funds from operations) over the course of the last year.  The company showed net income of $96,000 in the last quarter and FFO of just over $8 million. The common share dividend is covered (meaning available cash fully pays for the dividend) although the payout ratio (percentage of available cash paid to common holders) is right at 1.  

Lastly, we will be purchasing a “starter position” (a position in which we may add more at a later date) in Aqua America (NYSE:WTR) common shares. WTR is one of the largest water supply and treatment companies in the U.S. We can’t think of a single utility that will have the potential for near unlimited growth in the future as WTR. Note that we already have a position in small water company Artisian Resources (NASDAQ:ARTNA) and it returned over 20% to us in 2015.  With WTR we gain exposure to a wide variety of customers throughout the United States.  WTR is in Texas, Illinois, Pennsylvania, Ohio, Indiana, New Jersey, North Carolina and Virginia and I don’t think I need to tell you that there are issues galore (a technical term) in many of these states relative to water and sewer infrastructure.  The opportunities are endless as municipalities struggle to finance water and sewer systems.  Just yesterday WTR closed 2 additional small water system acquisitions and while small these purchases exemplify just why WTR has nothing but opportunity ahead.  Currently WTR owns and operates 1,400 public water systems and 187 wastewater treatment systems. 

Reviewing the most recent Aqua America financial reports one finds that revenue growth is slow but steady, although net earnings grow faster as scale equals efficiency.  The stock price has traded in a range of $24.40 to $31.09 during 2015 and closed out the year at $29.80/share.  The dividend is a rather meager .71 cents/share (2.35% current yield) as the company chooses to retain free cash for reinvestment.  The payout ratio is in the area of 35%.  WTR has paid consecutive quarterly distributions for 70 years. The company currently sports a market value of over $5 billion as investors believe, and rightfully so, that this is going to be one of the best businesses to be involved with in the years ahead.

With the above executions (on Monday) we will be, perhaps, 1/3rd of the way through a portfolio restructuring. As we get had mentioned previously we are going to be a bit less strict on maintaining a low level of perpetual preferred stocks for 2016.  This doesn’t mean we are going to go hog wild with purchases, but we will add a few worthy issues that are yet to be determined.

Additionally as we restructure we are going to give consideration to some energy issues and even $50 and $100/share preferred stocks including convertible preferreds.  Purchases in these areas will not occur until late January, if they happen at all.  Our long time reader Howard made some of these suggestions and while we know he is correct suggesting we expand our horizons we just need to find the time to feel more confident with areas new to us. Also our reader John suggested we look at Nustar Logistics LP 7.625% Fixed to Floating rate debt (debt in which the initial coupon is fixed and at some point in time the rate moves to a floating rate) (NYSE:NSS).  We are looking at issues like this as well as some midstream energy companies. As they say “once burnt, twice shy” and our singular midstream energy company, NGL Energy (NYSE:NGL) has been soundly thrashed this year reducing our portfolio performance by 1%.