This article is the second in a series of writings highlighting potential income investments in the current market. My first article, "A Quest for Higher Yield, Part 1" provided some unique ideas, but since then more interesting names have popped up on the radar. Much like the first article my intent is to examine stocks and funds that will represent a broad spectrum of companies and strategies. This is to provide a well-diversified list of potential candidates for the readers. Not all the tickers listed in this series of articles will be appropriate for every portfolio, but should provide a well-rounded list of ideas for further examination at a later time.
With the European debt crisis still looming and the overall economic woes in the Americas, many income investments have been sold to attractive levels. The price of oil keeps dropping and natural gas prices are still parked in the basement. That being the case, here is a list of 3 more potential names for income generation.
Credit Suisse High Yield Bond Fund (DHY)
Anyone who read my first article knows that I am a fan of closed-end funds (CEFs). I realize they are not for everyone and there are potential risks involved with them. That being the case, a new fund I found is DHY. This ticker will not be nearly as popular as the other names mentioned in this article, so we shall present it first to add a bit of fresh air to the mix.
This closed-end fund is a non-diversified, closed-end fund whose shares are listed for trading on the Amex. DHY's principal investment strategy is to seek high current income, while also seeking capital appreciation as a secondary objective. The fund will invest at least 80% of its assets in fixed income securities of U.S. issuers rated below investment grade quality (lower than Baa by Moody's Investors Services) or lower than BBB by Standard & Poor's. The fund will generally not invest in securities rated at the time of investment in the lowest rating categories (Ca or below for Moody's and CC or below for S&P) but may continue to hold securities that are subsequently downgraded.
What we are basically talking about here is junk bonds. At this point you the reader might be tempted to skip on to the next ticker, but let's look a bit deeper. DHY's total net assets as of March 2012 were $237.1 million and the outstanding shares were 55,731,189. The fund pumps out monthly distributions, which currently yields 10.4%. The source of these distributions is derived via income off the portfolio, and there has been no return of capital reported since 2010. To get this high yield though the fund does employ quite a bit a leverage, which currently runs as 29%.
The average nominal maturity is 5.5 years and the shares currently sell for $3.04 per share. This is a popular fund and it usually does sell at a premium to net asset value. Currently that premium is 6.2%, and it will fluctuate.
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This fund is not one to bet the farm on as it does carry lots of risks, but it does currently have some very attractive aspects going for it. This income investment is definitely one to consider for those looking to add a high yield player to the mix. Listed below are more specifics about this fund for those interested.
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Linn Energy, LLC (LINE)
In this current series of income articles I have stayed away from the oil and natural gas sectors. As most investors already know the commodity prices related to energy still remain volatile. A never-ending flow of bad economic news continually punishes most names in this sector. That being the case, now might be the time to take a position is good income investment candidates like Linn Energy.
Linn Energy is an independent oil and natural gas company that engages in the acquisition and development of oil and gas properties. The company's properties are primarily located in the Mid-Continent, the Permian Basin, Michigan, California, and the Williston Basin in the U.S. As of Dec. 31, 2011, it had proved reserves of 3,370 billion cubic feet equivalent of oil and gas, and natural gas liquids, as well as operated 7,759 gross productive wells. The reserve life index is more than 21 years.
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So the question for the income investor is why should one buy LINE while most other energy names are hurting? The answer to that is wrapped up in Linn's management and its business strategy. The company does a very good job within its extensive hedging programs. For example, the current expected natural gas production is hedged at 100% through 2015. For the oil side of the house it is hedged at 100% through 2013 and 80% in 2014, and 2015. Now these hedges were not just thrown on at the last minute in some desperate attempt to stabilize the company. These hedges are well thought out and put into place to attempt to provide some stability for the company and investors.
If the hedging was not enough of a draw, then income investors also need to consider LINE's dedication to future growth. Consider that in 2012, which has been a shaky time for the energy sector, LINN has executed a total of approximately $1.8 billion in acquisition and joint-venture agreements. Many of the new holdings are mature long-life assets, which have a low decline rate of less than 10 percent, and most are immediately accretive to distributable to the cash flow per unit.
Let's take a look at some of these new assets that are coming online. Recently the company completed a $1.2 billion acquisition in the liquids-rich Kansas Hugoton field. So basically LINE now has a presence in one of the largest conventional natural gas field in the U.S. This added proved reserves of approximately 730 Bcfe and liquids-rich production of approximately 110 MMcfe/d. The company has also identified approximately 500 recompletion opportunities and 800 future drilling locations.
LINE's next growth strategy is in conjunction with the well-known energy name Anadarko Petroleum Corporation (APC). In this closed joint-venture agreement Linn will participate as a partner in the CO2 enhanced oil recovery development of the Salt Creek field, located in the Powder River Basin of Wyoming. Anadarko assigned Linn 23% of its interest in the field in exchange for future funding of $400 million of Anadarko's development costs. The Salt Creek field is expected to deliver 10 years of steady production growth while, at the same time, providing a low base-decline rate. This joint venture is interesting in that LINE is going to get exposure to APC's utilization of CO2 to develop these fields. It seems that APC has been using this method since 2004 with outstanding results.
Finally investors must look at LINE's new definitive purchase agreement where it acquired properties located in East Texas, for a contract price of $175 million. These assets added proved reserves of approximately 136 Bcfe, which is 100% proved developed. The company anticipates the acquisition will close on or before May 1, 2012, and will be financed with proceeds from borrowings under its revolving credit facility. In this acquisition, Linn has derived approximately 430 wells on approximately 19,800 contiguous net acres.
Energy is still a risky business right now, but if an income investor is interested then LINE is definitely a name to consider. Currently LINE distributes an 8% yield and is paid out on a quarterly basis.
Pengrowth Energy Corporation (PGH)
If we are going list a name like LINE then we might as well stay in the energy sector a bit longer and examine a riskier income investment named Pengrowth Energy (PGH), which engages in the acquisition, exploration, development and production of oil and natural gas reserves in the Western Canadian Sedimentary Basin. It primarily explores for crude oil, natural gas, and natural gas liquids in the provinces of Alberta, British Columbia, Saskatchewan, and Nova Scotia. Here is a recent chart of the stock's performance.
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As one can see PGH's stock price and its investors have taken a beating in the current economic environment. To add to the woes for the company one has to look no further than the recent dividend news that was release from Enerplus Corporation (ERF). ERF announced that it is reducing its monthly dividend from CDN$0.18 per share to CDN$0.09 per share, which basically turns out to be a 50% cut. From a quick comparison both ERF and PGH look very similar in nature, so it is evident that many investors believe that PGH will have to follow ERF's lead as energy prices stumble.
Before we lump PGH onto the scrap heap like so many other investors have, let's take a closer look at the company. The production profile is evenly balanced between crude oil and liquids with a reserve life of over 10 years on a proved plus probable basis. This means that the current production mix is actually 50% liquids and 50% gas. The main problem until recently was the gas. Natural gas prices have been really soft and any company with exposure is going to feel the effects. The perceived answer was to try and shift production to the liquids side of the house, namely oil. The problem now is that oil is starting to demonstrate similar weakness when it comes to the price on the open market. The real question is if the price of oil will continue to erode, or is this just a temporary price fluctuation.
PGH is hoping that oil prices will rebound in short order. If so, the company has enough fuel in the tank to make the transition. It has a substantial inventory of current well locations and an undeveloped land base of approximately 960,000 net acres. To develop this PGH is going to have to spend quite a bit of cash. As a result, in the first quarter of 2012 PGH's total capital spending, excluding acquisitions, was $153.7 million versus $140.7 million in the first quarter of 2011 and $142.1 million in the fourth quarter of 2011.
The increase capital spending is a good step, but unfortunately it does not always yield immediately results in the financial statements or in investors' dividend distributions. As a result PGH is also moving in another direction in the form of strategic combinations. In this endeavor PGH entered into an arrangement where it would combine with NAL Energy Corporation. Final negations yielded an understanding where NAL shareholders would receive 0.86 of a Pengrowth share for each NAL share held.
After the combination, PGH has expanded its asset base of the conventional and unconventional opportunities. PGH's production should be over 100,000 barrels of oil equivalent (BOE) per day of current production and 434 million boe of proved plus probable reserves. Prior to the combination PGH has reported total production during the first quarter of 75,618 boe per day, and its reserves on a proved plus probable basis were approximately 318 million boe.
Now comes the tough part for income investors. The assets from NAL should have an immediate effect on the company, but the volatility of oil/natural gas prices is still playing havoc with the markets. This is easy to see as it manifests itself in the company's funds flow from operating activities. During the first quarter the funds flow was approximately $114 million when compared to $147 million in the first quarter of 2011 and $171 million during the fourth quarter 2011. It should be known though that some of the weakness came from issues with pipeline capacity constraints into major refining hubs in the United States and the growing Bakken light oil production in North Dakota, resulted in a substantial discount for Canadian crude oil.
On a positive note the company announced that its July 16, 2012 cash dividend will be Cdn $0.07 per common share. This means that the company is holding steady on its distribution rate that has remained constant from 2011 to 2012. It should be noted though that the actual amount received by U. S. income investors will be different based upon actual Canadian/U.S. dollar exchange rate in effect on the payment date.
Basically it boils down to seeing if oil prices can stabilize in the near future. If so then PGH, and its dividend should be fine and buying shares at these depressed prices might be a great deal. Currently the yield on the shares is running at 11.3%, which is quite tempting for those who think PGH can weather the storm. A risky proposition, but one that could prove interesting for those out there looking for ideas.
In conclusion, I have presented 3 more fascinating names for further investigation for those interested in income investing. Once again, not all are right for every portfolio but having a flow of new ideas makes for better investing. As I continue to search and find more interesting ideas I will present them in follow-up articles.
Disclosure: I am long DHY, PGH, LINE.
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