A Stock for All Seasons
The market is at a crossroad.
After falling into bear market territory and beyond in the first half of the year, the S&P 500 mounted a sizable 17% rally from the low in June. That rally is petering out. Now what?
All year long this market has been dogged by persistent high inflation and an increasingly hawkish Fed to battle it. Fed rate hikes and other measures became increasingly likely to pull the economy into a recession and have probably already succeeded.
But optimism about the end game surfaced. The market anticipates and envisioned a Fed that was done hiking rates by early next year amid falling inflation, and perhaps even talking about lowering them again. The rally ended with growing skepticism for that rosy scenario.
While inflation was lower in July than June, it is far from tamed. Even if it has indeed peaked, which is a big if, it’s still way too high and likely will be for a while. The embarrassed and behind-the-curve Fed is countering recent market optimism with hawkish statements and may continue raising rates well into next year. Then there’s the recession.
People can argue about whether the last two quarters of consecutive GDP contraction constitute a recession in this case, but many economic indicators signal that the economy is getting worse. We have high inflation, a likely recession, and a hostile Fed. Under the circumstances, it’s hard to see how stocks will continue to generate significant upside traction soon, especially after a 17% rally.
Although uncertainty in the market is growing, there are still strong income stocks out there. But we must be careful to find the right ones. A good stock needs to be resilient in a continuing recession, yet able to thrive amidst high inflation—or both, or neither. In this issue, I highlight such a rare bird.
What to Do Now
The recent rally caused much consternation on Wall Street. The main question has been this: Is it the end of the bear market or a bear market rally?
After the pandemic low, the market took off and never looked back. But that was a very unusual situation. In most bear markets, rallies like we just saw are common. In fact, there were six or seven double-digit rallies during the financial crisis bear market of 2008-09 before the indexes bottomed. The fact that the recent rally seems to be petering out well below the high is raising concern that it was indeed a bear market rally.
A bear market rally suggests that this market may still not have hit the low. Even if that turns out to be overly pessimistic and stocks can hold most of the recent gains, it’s hard to see how stocks resume a significant upside move in the near future without some unexpected good news.
And Labor Day is coming. That’s when investors start really paying attention again and the rubber hits the road while the summer is going out on a negative note.
Under the circumstances, it’s not a good time to buy cyclical stocks. In fact, this portfolio is selling one of its cyclical positions in this issue in order to reduce risk. While there could be more selling in the technology positions in the weeks ahead, those stocks remain undervalued and should have strong upside in the intermediate term.
But for now, the portfolio is eliminating a cyclical position and adding a more defensive one. At the same time, we are seizing upon recent strong performance in another position and selling a call to generate income in this uncertain market.
Monthly Recap
July 27th
Purchased Intel Corporation (INTC) - $40.18
August 3rd
Intel (INTC) – Rating change “BUY” to “HOLD”
August 24th
SELL One Liberty Properties (OLP)Buy Williams Companies Inc. (WMB)Sell OKE October 21 $65 calls at $3.40 or better
Featured Action: Buy Williams Companies Inc. (WMB)
Yield 4.9%The most resilient and higher growth midstream companies tend to deal in natural gas and natural gas liquids (NGLs). Natural gas is by far the cleanest burning and fastest-growing fossil fuel source in the world, and the U.S. is the world’s largest producer. It is also viewed more favorably by regulators because it is so much cleaner than oil and coal.
The U.S. still has more natural gas than it can use, and other parts of the world are desperate for the stuff. Massive natural gas export facilities have been built in recent years that liquify gas and ship it overseas. That market should remain red hot, especially with Europe looking for other sources after their fallout with Russia.
Williams is an American midstream energy company involved in the transmission, gathering, processing and storage of natural gas. It operates the large Transco and Northwest pipeline systems that transport gas in densely populated areas from the Gulf to the East Coast. Roughly 30% of the natural gas in the U.S. moves through its systems.
The bulk of adjusted EBITDA comes from pipeline transmissions plus a smaller deep-water presence in the Gulf of Mexico (47%) and gathering and processing facilities (38%). The rest is from marketing and NGL (natural gas liquids) services, exploration and production joint ventures, and oil gathering and processing. The company has minimal commodity price exposure, and the vast majority of revenues are fee-based and secured under long-term contracts with inflation adjustments.
It’s also worth noting that Williams has been the most active of large midstream energy companies in carbon reduction. It issued a report in 2021 committing to a 56% reduction in greenhouse gas emissions from 2005 to 2030. That helps with the regulators. In addition, the company acquired the remaining 26% ownership from its limited partner and is now a regular corporation (not a master limited partnership).
YTD performance
WMB has returned roughly 35% year to date. That is far better than the midstream energy group and only a little below the performance of the overall energy sector. Williams has been able to achieve a higher level of earnings growth than the group because it is reaping the reward of $8 billion invested in new projects between 2018 and 2021.
Adjusted earnings per share is up 29% in the first half of 2022 versus the same period last year. The recently reported quarter featured a whopping 48% earnings per share spike over last year’s quarter. Williams also increased 2022 earnings guidance.
A huge tailwind is that the there is a rise in natural gas demand in all its sectors. There continues to be a growing need for secure and reliable supplies amid high prices, geopolitical volatility, and climate concerns. In fact, Williams’ earnings continued to rise right through the heart of the pandemic lockdowns, one of the worst periods for the industry ever.
The Dividend
Williams currently pays out $0.425 per share quarterly, or $1.70 annually, which translates to a current yield of 4.90%. While the company has paid a quarterly dividend since 1974, it hasn’t always raised or maintained the payout. The company slashed the dividend in the aftermath of the 2014 oil price crash. But it has since restructured in a way that makes the current dividend far safer.
Williams restructured to a regular corporation in 2018. It has since reduced its net debt-to-EBITDA by 21% while investing $8 billion in new projects with an 18.8% return on capital between 2018 and 2021. Operating margins have increased from 57% in 2015 to 70% in 2021. And adjusted earnings per share have increased at a CAGR of 18% since 2018.
As a regular corporation, Williams doesn’t have to pay out 90% of earnings that are shared with a general partner. It is retaining cash that goes back into the company with a much lower cost of capital than issuing new shares or increasing debt. The company has a staggering 2.2 times coverage ratio (adjusted funds from operations). That’s the best coverage I’ve seen for any large midstream energy company.
In fact, Williams uses only about 45% of that cash flow to pay the dividend. The rest is enough to cover its growth capital expenditures plan including a recent acquisition with room to spare. The cash retention is a huge cost advantage over competitors, and it makes the dividend far more secure.
The Future
As I mentioned above, the prospects for natural gas volumes going forward are tremendous. And Williams also has the advantage of having a large and well-established network. Regulators tend to be much more lenient for expansions than new projects, favoring established players.
The company currently has $1.5 billion invested in six projects that will boost the bottom line over the next several years. That should keep the growth pump primed.
Despite the high returns so far this year, the stock still sells and just 9 times cash flow, a very reasonable valuation for a company with such solid earnings growth and a high and safe dividend.
In addition to the solid 4.9% yield, WMB tends to fetch higher call premiums than most other midstream players. It’s a great place to boost income with a stock that should be resilient in recession and inflation.
The Williams Companies, Inc. (NYSE: WMB)
Security type: Common stock
Industry: Energy, midstream
Price: 35.07
52-week range: $23.53 - $37.97
Yield: 4.90%
Profile: Williams Companies is one of the largest American midstream energy companies that transports, processes and stores about 30% of U.S. natural gas volumes.
Positives
- Natural gas has rising demand in the short and long term.
- The regulatory hurdles are much lower for expansions to established networks.
- Williams uses retained earnings to fund growth and has a lower cost of capital than peers.
- Recent growth projects should power solid growth for years.
Risks
- The regulatory environment remains hostile for any fossil fuel operator.
- A recession could reduce throughput volumes and decrease earnings growth.
Sell OKE October 21 $65 calls at $3.40 or better
Expiration date: October 21
Strike price: $65
Call price: $3.40
ONEOK, Inc. (OKE)
For many of the reasons mentioned above, this fellow midstream energy company is promising going forward. But the market looks dicey here and it makes sense to hedge our bets. If midstream energy companies thrive in the months ahead and OKE gets called away at expiration, we still have WMB. If the market and midstream energy stock prices fall or flatline, we managed to lock in a strong income in an ornery market.
Here are the three scenarios.
1. The stock closes above the $65 strike price but at expiration.
Call premium: $3.40
Dividends: $0.94
Appreciation: -$0.14 ($65.00 strike price minus $65.14 purchase price)
Total: $4.20 (total return will be 6.45% in 5 months)
2. The stock price closes below but near our $65 strike price.
Call premium: $3.40
Dividend: $0.94
Total: $4.34 (total return of 6.67% in 5 months)
3. The stock price declines.
There will be $4.34 in income to offset the decline.
Portfolio Updates
| CIA STOCK PORTFOLIO | |||||||
| Open Recommendations | Ticker Symbol | Entry Date | Entry Price | Recent Price | Buy at or Under Price | Yield | Total Return |
| Qualcomm Inc. | QCOM | 5/5/21 | $152.13 | $141.61 | $140.00 | 2.12% | 7.61% |
| One Liberty Properties | OLP | 7/28/21 | $30.37 | $25.58 | NA | 7.04% | -10.53% |
| Visa Inc. | V | 12/22/21 | $217.96 | $208.61 | NA | 0.72% | -3.77% |
| Global Ship Lease, Inc. | GSL | 2/23/22 | $24.96 | $17.84 | NA | 8.09% | -25.82% |
| ONEOK, Inc. | OKE | 5/25/22 | $65.14 | $63.50 | $67.00 | 5.89% | -0.99% |
| Star Buld Carriers Corp. | SBLK | 6/1/22 | $33.30 | $25.25 | NA | 26.21% | -20.17% |
| Intel Corporation | INTC | 7/27/22 | $40.18 | $33.84 | $42.00 | 4.31% | -14.92% |
| The Williams Companies | WMB | 8/24/22 | $34.69 | $38.00 | 4.90% | ||
| EXISTING CALL TRADES | |||||||
| Open Recommendations | Ticker Symbol | Intial Action | Entry Date | Entry Price | Recent Price | Sell To Price or better | Total Return |
| QCOM Sep 16th $145 call | QCOM220916c00145000 | Sell | 7/20/22 | $11.75 | $3.81 | $11.75 | 8.73% |
| OKE Oct 21st $65 call | OKE221021C00065000 | Sell pending | $3.30 | $3.40 | |||
| as of close on 8/22/2022 | |||||||
| SOLD STOCKS | |||||||
| Security | Ticker Symbol | Action | Entry Date | Entry Price | Sale Date | Sale Price | Total Return |
| Innovative Industrial Props. | IIPR | Called | 6/2/20 | $87.82 | 9/18/20 | $100.00 | 15.08% |
| Qualcomm | QCOM | Called | 6/24/20 | $89.14 | 9/18/20 | $95.00 | 7.30% |
| U.S. Bancorp | USB | Called | 7/22/20 | $36.26 | 9/18/20 | $38 | 3.42% |
| Brookfield Infras. Ptnrs. | BIP | Called | 6/24/20 | $41.92 | 10/16/20 | $45 | 8.49% |
| Starbucks Corp. | SBUX | Called | 8/26/20 | $82.41 | 10/16/20 | $88 | 6.18% |
| Visa Corporation | V | Called | 9/22/20 | $200.56 | 11/20/20 | $200 | 0.00% |
| AbbVie Inc. | ABBV | Called | 6/2/20 | $91.04 | 12/31/20 | $100 | 12.43% |
| Enterprise Prod. Prtnrs. | EPD | Called | 6/24/20 | $18.14 | 1/15/21 | $20 | 15.16% |
| Altria Group | MO | Called | 6/2/20 | $39.66 | 1/15/21 | $40 | 7.31% |
| U.S. Bancorp | USB | Called | 11/25/20 | $44.68 | 1/15/21 | $45 | 1.66% |
| B&G Foods Inc, | BGS | Called | 10/28/20 | $26.79 | 2/19/21 | $28 | 4.42% |
| Valero Energy Inc. | VLO | Called | 8/26/20 | $53.70 | 3/26/21 | $60 | 11.73% |
| Chevron Corp. | CVX | Called | 12/23/20 | $85.69 | 4/1/21 | $96 | 12.95% |
| KKR & Co. | KKR | Called | 3/24/21 | $47.98 | 6/18/21 | $55 | 14.92% |
| Digital Realty Trust | DLR | Called | 1/27/21 | $149.17 | 7/16/21 | $155 | 5.50% |
| NextEra Energy, Inc. | NEE | Called | 2/24/21 | $73.76 | 9/17/21 | $80 | 10.00% |
| Brookfield Infras. Ptnrs. | BIP | Called | 1/13/21 | $50.63 | 10/15/21 | $55 | 11.65% |
| AGNC Investment Corp | AGNC | Sold | 1/13/21 | $15.52 | 1/19/22 | $15 | 5.92% |
| ONEOK, Inc. | OKE | Called | 5/26/21 | $52.51 | 2/18/22 | $60 | 19.62% |
| KKR & Co. | KKR | Sold | 8/25/21 | $64.52 | 2/23/22 | $58 | -9.73% |
| Valero Energy Inc. | VLO | Called | 11/17/21 | $73.45 | 2/25/22 | $83 | 15.53% |
| U.S Bancorp | USB | Sold | 3/24/21 | $53.47 | 4/13/22 | $51 | -1.59% |
| Enterprise Product Ptnrs | EPD | Called | 3/17/21 | $23.21 | 4/14.2022 | $24 | 11.25% |
| FS KKR Capital Corp. | FSK | Called | 10/27/21 | $22.01 | 4/14/22 | $23 | 13.58% |
| Xcel Energy Inc. | XEL | Called | 10/12/21 | $63.00 | 5/20/22 | $70 | 12.66% |
| Innovative Industrial Props. | IIPR | Sold | 3/23/22 | $196.31 | 7/20/22 | $93 | -51.23% |
| EXPIRED OPTIONS | |||||||
| Security | In/out money | Sell Date | Sell Price | Exp. Date | $ return | Total % Return | |
| IIPR Jul 17 $95 call | out-of money | 6/3/20 | $3.00 | 7/17/20 | $3.00 | 3.40% | |
| MO Jul 31 $42 call | out-of-money | 6/17/20 | $1.60 | 7/31/20 | $1.60 | 4.03% | |
| ABBV Sep 18 $100 call | out-of-money | 7/15/20 | $4.60 | 9/18/20 | $4.60 | 5.05% | |
| IIPR Sep 18 $100 call | in-the-money | 7/22/20 | $5.00 | 9/18/20 | $5.00 | 5.69% | |
| QCOM Sep 18 $95 call | in-the-money | 6/24/20 | $4.30 | 9/18/20 | $4.30 | 4.82% | |
| USB Sep 18 $37.50 call | in-the-money | 7/22/20 | $2.00 | 9/18/20 | $2.00 | 5.52% | |
| BIP Oct 16 $45 call | in-the-money | 9/2/20 | $1.95 | 10/16/20 | $1.95 | 4.65% | |
| SBUX Oct 16 $87.50 call | in-the-money | 10/16/20 | $3.30 | 10/16/20 | $3.30 | 4.00% | |
| V Nov 20 $200 call | in-the-money | 9/22/20 | $10.00 | 11/20/20 | $10.00 | 4.99% | |
| ABBV Dec 31 $100 call | in-the-money | 11/18/20 | $3.30 | 12/31/20 | $3.30 | 3.62% | |
| EPD Jan 15 $20 call | in-the-money | 11/23/20 | $0.80 | 1/15/21 | $0.80 | 4.41% | |
| MO Jan 15 $40 call | in-the-money | 11/25/20 | $1.90 | 1/15/21 | $1.90 | 4.79% | |
| USB Jan 15 $45 call | in-the-money | 11/25/20 | $2.00 | 1/15/21 | $2.00 | 4.48% | |
| BGS Feb 19 $27.50 call | in-the-money | 12/11/20 | $2.40 | 2/19/21 | $2.40 | 8.96% | |
| VLO Mar 26 $60 call | in-the-money | 2/10/21 | $6.50 | 3/26/21 | $6.50 | 12.10% | |
| CVX Apr 1 $95.50 call | in-the-money | 2/19/21 | $4.30 | 4/1/21 | $4.30 | 5.02% | |
| AGNC Jun 18 $17 call | out-of-money | 4/13/21 | $0.50 | 6/18/21 | $0.50 | 3.21% | |
| KKR Jun 18 $55 call | in-the-money | 4/28/21 | $3.00 | 6/18/21 | $3.00 | 6.25% | |
| USB Jun 16 $57.50 call | out-of-money | 4/28/21 | $2.80 | 6/18/21 | $2.80 | 5.24% | |
| DLR Jul 16 $155 call | in-the-money | 6/16/21 | $8.00 | 7/16/21 | $8.00 | 5.36% | |
| AGNC Aug 20 $17 call | out-of-money | 6/23/21 | $0.50 | 8/20/21 | $0.50 | 3.00% | |
| OKE Aug 20 $57.50 call | out-of-money | 6/23/21 | $3.50 | 8/20/21 | $3.50 | 6.67% | |
| NEE Sep 17 $80 call | in-the-money | 8/11/21 | $3.50 | 9/17/21 | $3.50 | 4.75% | |
| BIP Oct 15 $55 call | in-the-money | 9./01/2021 | $2.00 | 10/15/21 | $2.00 | 3.95% | |
| USB Nov 19 $60 call | out-of-money | 9/24.2021 | $2.30 | 11/19.2021 | $2.30 | 4.30% | |
| OKE Nov 26 $65 call | out-of-money | 10/20/21 | $2.25 | 11/26/21 | $2.25 | 4.28% | |
| KKR Dec 17 $75 call | out-of-money | 10/26/21 | $3.50 | 12/17/21 | $3.50 | 5.42% | |
| QCOM Jan 21 $185 Call | out-of-money | 11/30/21 | $9.65 | 1/21/22 | $9.65 | 7.17% | |
| OLP Feb 18 $35 Call | out-of-money | 11/19/21 | $1.50 | 2/18/22 | $1.50 | 4.94% | |
| OKE Feb 18 $60 Call | in-the-money | 1/5/22 | $2.75 | 2/18/22 | $2.75 | 5.24% | |
| USB Feb 25 $61 call | out-of-money | 1/13/22 | $2.50 | 2/25/22 | $2.50 | 4.68% | |
| VLO Feb 25 $83 call | in-the-money | 1/18/22 | $4.20 | 2/25/22 | $4.20 | 6.13% | |
| EPD Apr 14th $24 call | in-the-money | 3/2/22 | $1.25 | 4/14/22 | $1.25 | 5.69% | |
| FSK Apr 14th $22.50 call | in-the-money | 3/10/22 | $0.90 | 4/14/22 | $0.90 | 4.09% | |
| XEL May 20th $70 call | in-the-money | 3/30/22 | $3.00 | 5/20/22 | $3.00 | 4.76% | |
| SBLK July 15th $134 call | out-of-money | 6/1/22 | $1.60 | 7/15/22 | $1.60 | 4.80% | |
Global Ship Lease, Inc. (GSL)
Yield 8.1%The recovery in this container shipping company petered out a couple of weeks ago. The problem is that this is a cyclical global stock and the global economy is flirting with recession. The good news is that shippers are likely in the earlier stages of a secular bull market with a very favorable supply/demand dynamic. In the near term a reopening Chinese economy may put upward pressure on shipping rates and GSL could get new life. We’ll see how this plays out after Labor Day. HOLD
Global Ship Lease, inc. (GSL)
Next ex-div date: TBD (latest was August 22, this past Monday)
Intel Corp. (INTC)
Yield 4.3%
The chip maker’s earnings were a disaster. Other semiconductor companies fared even worse. It’s a double whammy of coming back to earth since the pandemic and now recession. INTC had already been decimated before this latest wave of bad news. I’m skeptical that the news could get much worse for Intel and the longer term looks promising for this dirt-cheap stock. Hopefully, there is little downside left. We’ll see. HOLD
Intel Corporation (INTC)
Next ex-div date: November 4, 2022, est.
ONEOK, Inc. (OKE)
Yield 6.4%
This midstream energy company is up only slightly this year and has lagged the returns of the overall energy sector as well as the midstream subsector. That’s probably because the stock returned over 68% in 2021 and didn’t have the slack some of its peers did. While earnings and revenues are expected to increase 7.9% and 11%, respectively, for the year, that’s not very sexy considering overall energy sector earnings have grown 299% this quarter.
But ONEOK’s earnings aren’t recovering from the pandemic abyss. They actually continued to rise through the pandemic amid resilient demand for natural gas. This stock should be solid in any environment going forward with resilient demand and inflation protection built into the contracts. Investors are realizing that fact as the stock is sharply higher over the past couple of weeks and may be poised for a run back to the high. BUY
ONEOK, inc. (OKE)
Next ex-div date: October 29, 2022, est.
Rating change “HOLD” to “SELL”
One Liberty Properties, Inc. (OLP)
Yield 7.0%
The industrial REIT has recently lost the gains it made in the market rally off the June low. It reported earnings that were flat versus last year and below expectations due to higher costs and recent share issuances. Although it fell more than most of its peers during the selloff in cyclical stocks, GSL didn’t benefit as much as most from the cyclical rally. Recession concerns should continue to weigh in the months ahead and it’s unlikely that OLP will perform well.
As of Monday’s close, our total return on the stock is -10.53%. But there was a call sold on this position for a premium that was 4.94% of the purchase price, making our overall total return -5.59%. SELL
One Liberty Properties, Inc. (OLP)
Last ex-div date: September 17, 2022 est.
Star Bulk Carriers Corp. (SBLK)
Yield 26.2%
Ditto most of what I said about GSL. Earnings were spectacular with 60% EPS growth for the quarter and 127% revenue growth over the same periods last year. Also, new shipping rates secured for next quarter are just slightly below this quarter despite the slower global economy. The supply/demand dynamic remains strong, and the selling has likely been overdone. The company also raised the next dividend, payable on September 16, from $1.36 last quarter to $1.65 per share. The quarterly dividend alone is 5.3% of the purchase price. HOLD
Star Bulk Carriers Corp. (SBLK)
Next ex-div date: August 24, 2022 (today!)
Qualcomm Corp. (QCOM)
Yield 2.1%
Technology has been getting slapped around again recently on renewed fears of higher-than-anticipated interest rates and inflation. But, despite Monday’s selloff, technology has been the second best performing market sector over the last three months after being the worst performer in the earlier part of the year. That behavior insinuates a good likelihood that technology will recover before the overall market after leading it lower.
Earnings were again spectacular, but the company warned of lower smartphone sales in the second half of the year. The likelihood of slowing phone sales has pressured this stock lower for most of the year. That’s why QCOM is still well off the high. But those slower sales haven’t even materialized yet, and the company still expects 23% year-over-year revenue growth for the rest of the year. The stock sells at 12 times forward earnings, which is cheap for this level of growth. BUY
Qualcomm Inc. (QCOM)
Next ex-div date: August 31, 2022
Visa (V)
Yield 0.7%Visa’s earnings knocked it out of the park. It beat expectations on both earnings and revenues, which were up 33% and 19%, respectively. The company continues to benefit from increased global business from the ending of Covid restrictions despite slower global growth.
The stock tends to move up and down with the fortunes of more cyclical stocks but also tends to be among the first to rise when the environment gets friendly. V should actually be higher but is being held back by the threat of a new bill in the Senate that will limit credit card fees. We’ll see what the bill looks like and gauge the chances of passage. In the meantime, business is still booming despite inflation and recession. HOLD
Visa Inc. (V)
Next ex-div date: November 12, 2022, est.
Existing Covered Call Trades
Sold QCOM Sep 16 $145 calls at $11.75 or betterThese call were sold after QCOM mounted an impressive 25% rally. The in-the-money calls were sold at a high premium with skepticism that the rally would last in this cranky and uncertain market. QCOM has fallen below the strike price on the recent market weakness. QCOM should be a solid stock longer term and these call premiums provide a massive 8.63% income based on the purchase price.
Income Calendar
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Income Advisor for an explanation of how dates are estimated.
The next Cabot Income Advisor issue will be published on September 28, 2022.
