JEPI - 2 Great Dividend Picks With 7% Plus Yields Income Boost To 15% With Options

2023-09-30 09:00:00 ET

Summary

• EPD is a relatively safe choice for income investors with a 7.3% yield and consistent distribution increases.
• JEPI is a diversified ETF with a 7.5% yield and potential for growth from its non-covered call holdings.
• Using deep in-the-money covered call options can boost income to 10-15% while protecting against downside risk.

In this article, we are going to discuss two dividend securities that we think are great for income investors. We think these two picks are reasonably safe choices that yield nearly 8%. As such, an 8% yield should suffice the needs of most income investors, but we recommend that you use/withdraw 5% to 6% and reinvest the rest to ensure growth in the portfolio. If you do not need the income today, you could reinvest the entire income and use the power of compounding to achieve great long-term results.

We will also present an alternative choice for those who want an income yield even greater than 8%. With this method, instead of outright ownership of the stock, you could use buy-write call options to earn as much as 10% to 15% income. In addition to the income boost, the buy-write option will allow you to lower the cost of ownership and downside risk in case the stocks go down immediately after you buy. However, this requires some extra work and some knowledge of trading Options.

First Dividend Play: Enterprise Products Partners L.P. ( EPD )

First, we want to clarify that EPD is not a typical corporation but is structured as a partnership. Most readers would be aware that a partnership issues a K-1 tax form rather than a 1099-Div at tax time.

That said, EPD is one of the most popular mid-stream energy Master Limited Partnerships [MLP] due to its solid past record, consistency in distributions, capable management, and the ability to fund its growth internally. The company has a vast energy infrastructure in the US that is irreplaceable to a large extent. Even then, it is not a growth company, so it should mostly appeal to income investors.

1. In the mid-stream energy sector, it is one of the only two companies that have increased distributions for more than 25 years (the other one being Enbridge Inc. ( ENB )). In the year 2023, it has also increased the distribution by 5.3% (compared to the year 2022). As they say, 'the safest dividend is the one that has just been increased.'
2. Most recent quarterly results: The last quarterly results show that EPD has performed very well, even though it missed the consensus estimates slightly on both the top and bottom lines. It has performed well in terms of DCF (distributable Cash flow) and Adjusted Cash Flow From Operations. It generated $1.7 billion of DCF in the 2nd quarter, covering the increased dividend by 1.6x, leaving ample money to fund future growth.
3. Growth consistency: EPD has a past record of internally funding its growth from retained cash. That means that it generates enough DCF (distributable Cash flow) consistently that not only covers the distributions but also leaves money to fund future growth.
4. Balance sheet: EPD has a solid balance sheet, and in recent years, it has brought down its debt leverage to 3.0x, which has resulted in the S&P upgrade to its credit rating to A- (highest in the mid-stream business). It has a liquidity of nearly $4 billion, which covers most of its maturities for the next four years. Over 96% of its debt is at fixed rates (4.6% weighted average).
5. Insider holdings: The management and insiders have nearly 33% holding in the company's stock. That shows their interests are aligned with common unit holders.
6. Distribution coverage: EPD's 2023 DCF (distributable Cash Flow) is expected to cover its distributions by 1.7x. This leaves ample scope for increases in the coming years. As per Analyst's forecasts, the distributions are expected to grow by about 5% annually for the next 3-5 years. The current yield is 7.3%. With a 5% CAGR in 5 years, it should climb to 9.3% on the cost basis.
7. The company has several growth projects under development/construction and in the pipeline that are largely being funded internally. This will enable the company to increase its DCF continually to be able to support increasing distributions.

Second Dividend Play: JPMorgan Equity Premium Income ETF ( JEPI )

JEPI is an interesting and highly popular ETF (Exchange Traded Fund) with retirees and income investors. While it offers many attractive features to income investors, just like any other security, it also has its shortcomings. We will go over both.

1. It is an ETF (Exchange Traded Fund) that is highly diversified. Currently, it holds nearly 138 positions, while the top 10 positions account for only 15% of the fund.

2. As you can see, the fund is diversified in many sectors, with roughly 17% allocated to the Technology sector.

3. The fund writes covered-call options with its proprietary strategy (using ELNs: Exchage-Linked-Notes) to generate income but only uses about 15% of its portfolio for this purpose. On a 12-month trailing basis, it has paid a highly attractive yield of 9.88%. However, the dividend is variable, and the monthly payout has been falling for most of 2023. But even with the most recent payout of $0.3382 per share, it should work out to be a 7.50% yield, assuming it stays at this level or goes higher. A 7.5% monthly payout from a fund that is highly diversified in mostly large blue-chip companies is very tempting. Further, it can still draw ample growth from 85% of the portfolio (which is not used for covered calls). Below is the comparison of the total performance (all dividends reinvested) of JEPI with S&P500 and Schwab U.S. Dividend Equity ETF (SCHD). However, we must add that the S&P500 is not a good benchmark for JEPI, as JEPI has a defensive portfolio strategy.

4. JEPI invests mostly in low-beta stocks. A beta lower than one means the stock is less volatile than the S&P500. The average beta of JEPI holdings is less than 0.75, which is fairly conservative compared to the S&P500. It should outperform the S&P500 in a bear market, but in a bull market, it is likely to underperform. But we must remember that we are investing in income security, not growth security. If the goal is to achieve high growth, then JEPI is not the right security.

Income Boost by Deep In-The-Money Covered-Call Options:

Both of the above securities are income investments with some scope for capital growth. Let's assume we are active investors and want to earn much more income than these securities offer; we think we have a reasonable and relatively safe way to do it. However, it will require active management and a few hours of work every month or two. We will present an Options strategy with both EPD and JEPI, using a Deep-ITM (Deep-In-The-Money) covered-call options. In this strategy, instead of outright ownership of the stock, you will use buy-write call options to earn as much as 10% to 15% income. In addition to an income boost of 50%, this will allow us to lower the cost of ownership and the downside risk.

EPD: (Income Boost)

We will write a "BUY-WRITE" option with EPD underlying security. BUY-WRITE means that we will open two transactions simultaneously. In the first transaction, we will buy 100 shares of EPD (for one contact). At the same time, we will sell one call-option contract with a Deep-In-The-Money strike price. We could do this for multiple contracts if we so desire. For example, to be able to sell ten contracts, we will need to buy 1,000 shares of the underlying security, EPD in this case. We opened one such pair of transactions (as of 09/25/2023); details are as below:

From the above transaction, we purchased 100 shares of EPD with a net investment of $2,488 (after subtracting the premium we would receive for the call option). There could be two scenarios:

1. The market price stays above $25.00: The strike price of $25.00 is nearly 9% lower than the current price, and if the price stays above $25.00, our shares are going to be called away. We are going to make a tiny profit of $12 based on a buying cost of $24.88. However, between now and Nov. 17th, we are likely to receive the quarterly dividend payment of $0.50 per unit towards the end of October (a total amount of $50 on 100 shares). So, our total profit will be $62 ($12+$50). On our holding period of 54 days, the annualized profit will be 16.84%. We could now repeat the process.
2. The market price falls below $25.00: EPD is unlikely to fall 9% as energy prices are still rising. However, there are no guarantees, and if that happens, more than likely, our shares will NOT be called away. Our buying cost is $24.88, which is nearly 9% lower than the price if we had purchased the shares outright. So, the DEEP-IN-THE-MONEY call option would come in handy in limiting the downside to a great extent.

JEPI: (Income Boost)

We will write a "BUY-WRITE" option with JEPI underlying security. As explained in the first example, BUY-WRITE means that we will open two transactions simultaneously. In the first transaction, we will buy 100 shares of JEPI (for one contact). At the same time, we will sell one call-option contract with a Deep-In-The-Money strike price. We could do this for multiple contracts if we so desire. For example, to be able to sell 10 contracts, we will need to buy 1,000 shares of the underlying security, JEPI in this case. We opened one such pair of transactions (as of 09/22/2023); details are as below:

From the above transaction, we purchased 100 shares of JEPI with a net investment of $4,690 (after subtracting the premium we received for the call option). There could be two scenarios:

1. The market price stays above $47.00: The strike price of $47.00 is nearly 14% lower than the current price, and if the price stays above $47.00 (a likely scenario), our shares are going to be called away. We are going to make a tiny profit of $10 based on a buying cost of $46.90 a share. However, between now and Nov. 17th, we are likely to receive two (2) monthly dividend payments of roughly $0.33 per share (a total amount of $66 on 100 shares). So, our total profit will be $76 ($66+$10). On our holding period of 56 days, the annualized profit will be 10.56%. We could now repeat the process.
2. The market price falls below $47.00: It is a highly unlikely scenario as it is 14% lower than the current price, but it can certainly happen in an extreme case of the entire market going down 10-15%. In this scenario, shares are NOT going to be called away. Our buying cost is $46.90, which is roughly 14% lower than the price when we opened the transaction, covering a lot of downside risk. We can now wait for the market to recover somewhat and collect JEPI's high dividend in the meantime.

Concluding Remarks:

This article is focused on income investors. The first part is for passive investors, where you would own these securities outright for roughly a 7.5% income yield.

The latter part of the article is for more active and aggressive investors who also want an income yield north of 10%. We have demonstrated the use of 'Deep In-The-Money' buy-write call options. This strategy particularly suits these two securities and generates income ranging from 10% to 15% while protecting against downside risk.

For further details see: