2 Dividends To Buy And Hold Forever

Infinite dollar (new bill)

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Co-produced with “Hidden Opportunities”

You are not alone if you have dared to peek at your investment portfolio lately and cringed at the results. Let me ask you a question. Do you worry about the price of your house every week?

Billionaire investor Warren Buffett teaches us not to fall prey to daily price quotes on our investment securities by comparing these assets to farmland.

The only thing you have to do is remember that this guy next door is there to serve you and not to instruct you. You bought the farm because you thought the farm had the potential. You don’t need a quote on it. – Warren Buffett

During the beginning of the COVID-19 pandemic, he continued his tutelage to the investment community by saying that it is critical to focus on business fundamentals and not on market action.

If you really like the business and you like the management, and the business hasn’t fundamentally changed, then the stocks have an enormous advantage. You still can bet on America. – Warren Buffett

We are seeing a big disconnect between market prices and the dividend payability of several of our portfolio companies. Fundamentally, some of these companies are at their best yet, and we should take advantage of the sell-off. Today, we discuss two picks you can buy with the intent to hold forever. I know that the forever word isn’t to be thrown loosely, but you will see that these picks fit the bill due to their attractive valuations and the long-term sustainability of their distributions. Without further ado, let’s review our picks.

Pick #1: ORCC – Yield 10.9%

If you are an income investor, you should consider having Business Development Companies (‘BDC’) in your portfolio. These companies are structurally designed to provide vital capital for small and medium-sized businesses, collect interest payments, and pay high yields to investors. BDCs are closely involved in mentoring and developing the companies in their portfolios because it is in a BDC’s best interest to help them become successful.

Owl Rock Capital Corporation (ORCC) is the third largest public BDC with $5.7 billion in net assets. ORCC is well-positioned to grow its Net Investment Income (‘NII’) in this rising rate environment since it has 54.3% floating-rate debt but 98.8% floating-rate assets.

ORCC Floating Rate Assets and Floating Rate Debt

Fitch Ratings

Allow me to explain this more. BDC’s assets are the secured loans they give out, and their liabilities are their borrowings. When rates go up, we want the interest collected (on the assets) to be greater than the interest we pay (on the debt). This is exactly what is happening with ORCC. Simulating rate increases, we can see that the higher the increase, the more favorable the divergence between ORCC’s income and expenses. In this rising rate environment, ORCC will see NII growth and provide improved dividend coverage.

ORCC NII change with rate increases

Author’s calculations

ORCC maintains an investment-grade ‘BBB’ balance sheet as rated by S&P and Fitch. Moreover, this BDC’s asset quality is remarkable, with an 88% senior-secured portfolio comprising 73% first-lien loans. This means that the majority of the borrowing entities have their business as collateral and are strongly motivated to stay current on their payments. It is noteworthy that ORCC has maintained a splendid 13 bps annual loss rate since its inception in 2019.

ORCC Investment Portfolio

ORCC Investor Presentation August 2022

During Q2, ORCC reported its per share NII as $0.32, up from $0.31 from the previous quarter. These quarterly NII cover the BDC’s quarterly $0.31 distribution, and we expect coverage to improve in Q3 and beyond as the rate increases materialize. BDCs must regularly monitor their portfolio non-accruals to identify issues in the economy. During Q2, ORCC saw a noticeable improvement in its tier 2 and below as measured by its investment rating system.

ORCC Investment Ratings

ORCC Investor Presentation August 2022

ORCC Investment Ratings - Legend

ORCC Investor Presentation August 2022

It is noteworthy that ORCC has no debt maturities until April 2024, which provides tremendous flexibility with its balance sheet. ORCC ended Q2 with significant liquidity, with $1.7 billion of cash and undrawn debt capacity.

ORCC Debt Schedule

ORCC Investor Presentation August 2022

ORCC currently trades at a 25% discount to its book value from June 30, 2022, and presents an attractive opportunity to build a position. This BDC has adequate liquidity and is well-positioned to grow NII during these turbulent times. As the economy experiences more uncertainty, small and medium-sized businesses will look to BDCs for much-needed capital. ORCC is a blue chip BDC with a very attractive valuation and yield to help you sail through the turbulence.

ORCC reports earnings on November 2nd.

Pick #2: CEQP-, Yield 9.4%

We talk a lot about sustainable income generation. Today, we will discuss an opportunity that is both sustainable and perpetual. Crestwood Equity Partners LP, 9.25% Preferred Partnership Units (CEQP.PR), is a unique preferred security that cannot be called.

Notes: (full details here)

  1. CEQP- preferred shareholders will receive a Schedule K-1 for tax purposes.

  2. CEQP- (CUSIP: 226344307) is identified with different ticker symbols by various financial institutions and services (CEQP-P, CEQP-, CEQP.PR). Please confirm the correct symbol in your investment account.

CEQP- offers adequate shareholder protection through structural design and partnership fundamentals:

  • No call provision: CEQP- is convertible into common units, but the company cannot force conversion until the common shares close above $136.91 for 20 out of 30 consecutive days. This requires a massive 350% upside from current levels.

  • Voting rights: In most cases, preferred equity holders do not have voting rights in corporate matters. But CEQP- preferred shareholders get to vote on all matters as common shareholders, which is a rare benefit. This is important as it helps ensure that if CEQP undergoes a change of control, the terms are favorable for preferred investors.

  • Missed distribution penalties: You have probably heard of “cumulative” distributions, which cause the unpaid amount to accumulate and are mandatory to be paid in full before the common unitholders can receive anything. CEQP- provides additional protection by taking this a step further. The preferred prospectus describes the implementation of a penalty for missed payments. If a single distribution is missed, the distribution immediately increases 22% to $0.2567/quarter. Additionally, any accrued and unpaid distributions will be increased by 2.8125% each quarter. This harsh penalty structure incentivizes management not to miss any distribution.

You may wonder why CEQP- enjoys these protections. Initially, these preferred units were created as a private placement for large institutional investors associated with a corporate merger. But the company took a different route and had it listed. As such, CEQP- enjoys unique structural protections in the world of preferred securities. Now let’s look at the partnership’s business fundamentals that further strengthen our outlook on this preferred.

Crestwood’s Business Fundamentals

The importance of hydrocarbons in our energy mix is being increasingly proven amidst geopolitical tensions. CEQP is a master limited partnership that owns and operates midstream assets in strategic basins in the U.S. (Source)

CEQP Midstream Assets

CEQP Investor Presentation September 2022

The partnership’s operations are more oriented around the storage, transportation, and processing of Natural Gas and NGLs, which are vital commodities experiencing growing demand in this energy-hungry world with a growing population. 81% of the business is structured with fixed-fee contracts, making their operating cash flow less sensitive to commodity price volatility.

CEQP Revenue Mix

CEQP Investor Presentation September 2022

Since we are speaking about the preferred securities of CEQP, let’s focus on the numbers. It costs CEQP $60 million annually towards preferred distributions and $250 million towards common unit distributions. With the partnership’s FY2022 EBITDA guidance between $800-$840 million and Distributable Cash Flow (‘DCF’) between $505-$545 million, it is safe to say that the preferred distributions are adequately covered. Additionally, CEQP has tremendous flexibility with its cash flow, with no debt maturities until 2025.

CEQP Debt Profile

CEQP Investor Presentation September 2022

The preferred’s $0.8444/share annual dividend calculates to an impressive 9.4% yield. Since the security is not callable, the preferred has no par value.

CEQP- Preferred Analysis

Author’s calculations

This means the price you pay is for the yield you lock in. CEQP- is a unique preferred that is a must-have for income investors. Structurally and fundamentally, CEQP- ‘s distributions are well protected, making it a safe investment with perpetual income prospects during volatile market conditions.

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Getty

Conclusion

Have you watched “The Price is Right”? You may have heard about someone winning a lifetime supply of Kraft Mac and Cheese. What does lifetime supply really mean? It isn’t an unlimited supply but an ample supply of goods that will last many years, if not decades.

Similarly, there are no true “forever” stocks. Various economic and business changes can create a ceiling on the timeframe, but at HDO, we believe in the long-term approach to investing. Our income method is built on the premise of approaching the financial markets with repeatability and consistency to generate long-term income. We work to identify opportunities we can buy and hold for income for several years (if not decades).

Want a lifetime supply of income? We have two picks with their prices right for the taking. With up to 11% yields, these securities are well-positioned to fuel your passive income needs for the foreseeable future.

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