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Income Investing

Your Questions Answered

By Roger S. Conrad, on Oct. 20, 2014

Elliott Gue and I returned after spending several days of talking to subscribers and giving presentations at the World MoneyShow Toronto. Here’s a sampling of questions that came up during our talks.

Q:  Closed-end fund Aberdeen Asia-Pacific Income (NYSE: FAX) pays a great dividend but has lost ground recently. What caused the pullback? Have these factors changed your outlook for the fund?

A: Aberdeen Asia-Pacific Income focuses on government and corporate bonds from issuers in Australia and East Asia.

Although the closed-end fund disburses a monthly dividend in US dollars, 56.2 percent of its portfolio holdings pay interest in a foreign currency—predominately Australian dollars (42.7 percent of its currency exposure).

Here’s the breakdown of the fund’s remaining currency exposure:

  • South Korea (3.4 percent);
  • Philippines (0.1 percent);
  • Singapore (0.2 percent);
  • Thailand (0.9 percent);
  • Indonesia (1.4 percent);
  • China (3.4 percent);
  • India (3.3 percent); and
  • Sri Lanka (0.7 percent).

The fund’s eight largest positions (25.4 percent of its portfolio) consist of bonds issued by Australia’s state and federal governments. All told, bout 85 percent of its holdings carry an investment-grade rating.

Aberdeen Asia-Pacific Income boasts a long record of stable dividends and net asset value.

Management uses leverage to boost investment income, primarily in the form of bonds and preferred stock with staggered maturities that range from three to 10 years. This capital structure limits the fund’s exposure to short-term swings in interest rates.

The closed-end fund’s recent slide reflects weakness in the Australian dollar, which has slipped in value to about US$0.87 today from US$0.94 in early September.

Although the downdraft in the Australian dollar affects Aberdeen Asia-Pacific’s net asset value, the fund still trades at a 9 percent discount—in line with its 52-week average.

In the past, currency fluctuations of a greater magnitude haven’t forced the fund to reduce its monthly dividend of $0.035 per share. Nor does the latest move in the exchange rate appear likely to affect the payout.

Aberdeen Asia-Pacific Income won’t be able to fund 38 percent of the dividend from return of capital forever. However, the closed-end fund has done so in the past and has the resources to maintain the dividend in this way for some time.

US investors looking for low-risk currency diversification and exposure to Australasia should consider the fund.

China’s slowing economic growth has weighed on the closed-end fund’s stock price, but Australia’s new pro-business government should provide a boost in the near term. And the country’s abundant resource base and proximity to India and China provide a compelling long-term growth story.

Q: Pembina Pipeline Corp (TSX: PPL, NYSE: PBA), Energy Transfer Equity LP (NYSE: ETE) and Enterprise Products Partners LP (NYSE: EPD) all pulled back during the recent selloff. Are they worth buying today?

A: Prior to the pullback, readers often asked if we planned to raise our buy targets on these popular names; investors had piled into these stocks and bid them up to frothy levels.

The recent selloff created an excellent buying opportunity for investors.

Nevertheless, although these popular midstream names have rallied since early last week, all three still trade below our buy targets.

The price action in Enterprise Products Partners underscores the stock’s vulnerability to panic selling of popular exchange-traded funds (ETF); the blue-chip master limited partnership figures prominently in the Alerian MLP Index and many fund products that focus on this security class.

We raised our buy target on Enterprise Products Partners after the firm announced the proposed purchase of Oiltanking Partners LP (NYSE: OILT), a deal that gives the acquirer ample dock space to ramp up ethane, condensate and refined-product exports from the Gulf Coast.

In our Model Portfolios, we sold Oiltanking Partners for more than a 100 percent gain over a roughly 12-month holding period.

As for Energy Transfer Equity, Enterprise Products Partners and Pembina Pipeline, investors who have held these stocks for a long period and are sitting on big gains should consider taking some of their profits off the table periodically to rebalance their portfolios.

Q: You’ve rated SeaDrill (NYSE: SDRL) a sell for a while now. Is there a price point at which you would consider upgrading the stock to a speculative buy?

A: SeaDrill’s stock has dropped considerably since we removed the name from Energy & Income Advisor’s Focus List in fall 2013.

Rather than focus on the share price, we’re more concerned about the company’s open rig capacity and the deteriorating supply and demand picture in the market for jack-up and floating drilling units.

Far too many investors recall SeaDrill’s past glory and appear eager to try to catch this falling knife without considering the business cycle in the rig market.

My colleague Elliott Gue explained the risk of this shortsighted thinking in last week’s installment of Energy Investing Weekly, Five Myths about SeaDrill That Could Cost You Real Money.

We prefer SeaDrill Partners LLC (NYSE: SDLP), a publicly traded partnership that stands to benefit from SeaDrill’s plan to accelerate drop-downs of interests in its rigs that operate under long-term contracts.

Q: I know you don’t hold Crestwood Equity Partners LP (NYSE: CEQP) in any of Energy & Income Advisor’s Model Portfolios, but the stock has been hit hard of late—what are your most recent thoughts on this name?

A: Crestwood Equity Partners owns the general-partner interest in Crestwood Midstream Partners LP (NYSE: CMLP).

Both stocks pulled back after Crestwood Equity Partners announced that the firm had postponed the drop down of Tres Palacios, a facility that stores natural gas liquids (NGL), to Crestwood Midstream Partners.

Narrowing seasonal price spreads have weighed on the cash flow generated by this asset, eroding Crestwood Equity Partners’ cash flow and dropping its distribution coverage ratio.

The market also remains concerned about the Crestwood Midstream Partners’ elevated debt levels and renegotiated gathering and processing contracts with Quicksilver Resources (NYSE: KWK) in the Barnett Shale. Management indicated that gains in throughput volume would offset the reduction in fees; however, the market appears skeptical.

Both companies also reduced their full-year cash flow forecasts, implying further downside to distribution coverage ratios.

All this adds up to questions about Crestwood Midstream Partners and Crestwood Equity Partners’ ability to grow their payouts. We’ll have a chance to evaluate management’s turnaround plan when the MLP and its sponsor report third-quarter results.

On the plus side, Crestwood Equity Partners could be a takeover target for a larger midstream operator looking to build a foothold in the Niobrara Shale or a private-equity outfit looking to monetize complementary assets.

Crestwood Equity Partners is only suitable for speculators.

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