September 2012 portfolio review

I’ve been thinking about writing an income investing newsletter at some point….but haven’t quite committed to that concept yet. Baby steps, baby steps….so, with that in mind I thought I’d start out with a monthly commentary on the positions I hold or have held throughout the month. Feel free to comments and let me know what you think. For my current long positions I’ve linked to my last relevant post on the topic. Here it goes…

Current long positions:

EPD – my largest position and has been for quite some time. This company is firing on all cylinders. The strength and resiliency of its business were quite evident Q2 2012. While many if not most MLPs showed declining DCF coverage ratios during the quarter due to falling commodity prices, EPD’s coverage ratio held firm. It has a ton of capital projects under construction, all organically built, which bodes well for future growth. MLPs have been relatively weak this year but EPD is one of the few beating the S&P500 YTD. This is a long term holding for me. I expect about 10% annual returns going forward from today’s prices, 5% forward yield plus 5% growth.

WPZ/WMB – Never discussed this position before so this will be new. I own both the general and limited partner in this case. Williams is primary a gathering and processing MLP, with a growing midstream business. I first bought WMB before the WPX spinoff – what a sweet deal that was. I sold WPX right after the spinoff and continue to hold WMB. I then added WPZ after a pretty steep selloff to enhance the yield and return of the position. WPZ is one of those MLPs that was hurt in Q2 from the drop in commodity prices, primarily ethane, but as is typical with most MLPs the business models are resilient and they stayed committed to their dividend and planned dividend increases. I think there is a nice potential catalyst for shares coming before the end of the year with the planned Geismar cracker dropdown from WMB to WPZ. I expect 20%+ returns for WMB and 15% returns for WPZ going forward for the next 2-3 years.

KMI/KMR – my last MLP holding. Again I own both the general partner and the limited partner. Kinder Morgan is the oldest MLP and still one of the best. It probably has the most diversified business model of any MLP. Its recent acquisition of El Paso bodes well for the future as well. KMI is the best play here for future returns, approx 16%, with the catalyst of drop-downs from KMI to both KMP/KMR and to EPB over the next 2 years. KMR offers returns of 13% going forward with a slightly higher yield than KMP. KMR tax filing is also a ton easier than KMP. Share prices for the family of companies has been hurt by commodity prices and offer a good risk/reward at these levels.

AFL – I love the duck. What a great company trading at such cheap valuations. The stock has has a great run the last few months from about $40 to $48 mainly due to the improving outlook for Europe. With only about a 2% of book value exposure to the risky parts of Europe the stock trades unduly on European news. The company pays about a 3% dividend growing at about 10% a year and buys back a good amount of shares. It earns mid 20s return of equity and trades a single digit P/Es. The stock can run to $60 and still be cheap. It can be volatile and European news so an investor needs to take that into consideration.

FRFHF – Fairfax Financial. This is another long term holding and one I consider my disaster hedge. As stocks continue to do well this one has under performed. They still have their entire equity portfolio hedged 100%. It yields about 2.5% and is a very conservative holding. It won’t do well as long as the general market is higher. To me this is a way better disaster hedge than gold or TIPs, etc…

IVY portfolio – posted on this may times. It’s the way I manage my family’s IRAs. Simple, automatic, no great thinking required.

Munis – Have you sold your munis yet? There is so much hype and misunderstanding in this space. Its great for opportunistic investors. I group several muni CEF holdings into one. I own NZF, NXZ, and NPI. These are leveraged muni CEFs. They currently yield about 5.8% on average. That yield is exempt from federal taxes so that is a tax equivalent yield of about 8% in the 25% marginal tax bracket. That’s better than high yield bonds and a better value. Oct and Nov are historically months where there is a good deal of muni issuance so prices may weaken in those months presenting a good buying opportunity. The big concern in this sector, defaults, is way over hyped and priced in and I the odds of a tax status change are very very low.

Recently closed positions. These were all trades, not sells of longer term positions:

AAPL – closed my AAPL trade last week for a nice gain. The stock broke out of a large wedge formation on 8/13 at about $630. The target of this breakout is $720. These big breakouts have other short term patterns on their way up. Currently APPL looks to be in a consolidation pattern as long as it holds above $650-$658. Looking to get back in on a continuation of the move up still with a target of $720.

TWO – as I posted recently on mreits, TWO is one of those mreits with a recent huge run. The gains were quicker than I expected and I think the sector is not cheap. Not saying it can’t go higher but I find better risk/reward elsewhere.

That’s it for my first in depth portfolio review. Hope that gives you some insight into my investments and how I approach them.

Note: I estimate all future returns with the magic dividend formula: Total expected return = Dividend yield + Dividend growth + expected change in valuation.