Two weeks ago, the deflation of the oil market created an excellent buying point for the preferred shares of energy companies. I've written about my holdings in preferreds of Gastar Exploration (GST-A, GST-B), GreenHunter Resources (GRH-C),Magnum Hunter Resources (MHR-C, MHR-D) andMiller Energy Resources (MILL-C, MILL-D) in the past, and I've been doing more work on Callon Petroleum (CPE-A), as well.
I quite literally could not believe my screen two Tuesdays ago as these preferreds were absolutely eviscerated in the market's oil-price panic. Miller's preferred series C, which as recently as Oct. 2 was trading at a premium to par, plummeted below 70 cents on the dollar.
So, within the space of two weeks, the world had become awash in oil and the U.S. shale boom had ended. I've been doing this long enough to know that commodities markets don't change that quickly, so I pounced.
In my clients' accounts I sold lower-yielding preferreds and some common stocks to raise cash to buy the aforementioned preferreds. I run my income-seeking clients' portfolios to maximize yield, so with almost zero cash allocation. Thus, I had to sell some of my favorites, but this opportunity could not be foregone.
As is my wont, I created a model portfolio to track performance, and with the yields I was seeing, I had to think of a legendary line-up. So, I dubbed this portfolio "Murderers' Row." Much like the 1927 Yankees, this is a line-up that I believe will provide stellar returns.
Murderer's Row is based on an initial investment of $100,000 divided equally among the eight preferreds I selected. The portfolio's yield is 11.56% and each security was trading at a discount to par when purchased. This gives what I call "natural call protection," which is especially relevant since three of the preferreds are currently callable.
In the event of a call, we lock in a capital gain and I will reinvest in preferreds of other companies. That said, I believe calls are unlikely, as each of these companies have aggressive capex programs, and the only way a call would come into play, in my opinion, is in the event of a change of control.
The Holy Grail for an income investor is to create a portfolio with an attractive yield and scope for capital gains. That is exactly what has happened with Murderers' Row. My buying has produced a 9.63% capital gain since inception two weeks ago, and I still believe each of these securities is undervalued at today's price.
And, yes, Captain Obvious, this is not a diversified portfolio. It's not supposed to be. At the end of the day, income investing is about collecting and re-investing payments, and constantly re-analyzing a company's ability to make those payments.
Of course, lower commodity prices mean lower cash inflows for these companies, but hedging programs and volume increases can offset that, and my modeling is showing me these companies are still credit-worthy with oil at $81 per barrel and natural gas at $3.60 per mmBTU. I believe another 10% decline in commodity prices could easily be withstood by these companies (and their preferreds) as well.
I will provide regular updates on my Murderers' Row portfolio in this space. The yields are locked in and the first payments (Callon and Miller pay quarterly, next in December, the rest pay monthly) come on Nov. 3.