TTFNF - BGR: Solid Yield And Valuation May Appreciate Later This Year

2023-05-22 15:04:27 ET

Summary

• BlackRock Energy & Resources Trust invests in a portfolio of energy companies to provide its investors with a high level of total return.
• Lately, there has been an inverse relationship between energy prices and the market, as energy prices account for a significant portion of the CPI.
• The IEA is predicting a crude oil shortage later this year, which could drive energy prices upward and benefit this fund.
• The fund yields 6.73% at the current price, and this is very sustainable.
• The fund is trading at a very attractive discount to the net asset value today, so the price looks reasonable.

Over the past several weeks, I have seen many people upset about the returns of the S&P 500 Index (SP500), which is almost certainly the most widely held stock market index in the world. The index has actually not been performing too badly this year though, as SPDR® S&P 500 ETF Trust (SPY) is up 9.93% year-to-date:

As MarketWatch points out , however, nearly all of that return is due to the outsized performance of a handful of technology stocks. This is evident in the fact that the ten largest companies by market cap account for fully 29% of the index, which is the highest weighting in history. Of these ten companies, seven of them are technology companies. This has a lot of analysts and others worrying about the durability of the market rally that we have seen this year. This is especially true today, as most signs point to the fact that the U.S. Treasury will need to issue a substantial amount of new Treasuries once the debt ceiling is raised, as it almost certainly will be. That will reduce the amount of liquidity in the market and likely cause a broad market selloff, especially in those technology stocks.

As has been the case for quite some time, the energy sector continues to lag the market. This is partly due to crude oil prices being somewhat weak, although the International Energy Agency projects that this may change in the second half of the year. This could create an opportunity for astute investors, particularly since the traditional energy sector looks significantly undervalued at today's levels.

One way to play this opportunity is to purchase shares of a closed-end fund, or CEF, that specializes in energy. These funds are unfortunately not discussed very often in the investment media, so it can sometimes be difficult to obtain the information that we would really like to have to make an informed investment decision. This is a shame because these funds offer a number of advantages over open-ended and exchange-traded funds. In particular, they have the ability to employ certain strategies that can boost their yields well beyond that of anything else in the market. This is something that should be appealing to us as income-focused investors.

In this article, we will discuss the BlackRock Energy & Resources Trust ( BGR ), which is one closed-end fund that can be found in the traditional energy sector. As of the time of writing, this fund boasts a 6.73% yield, which is not quite as high as we would normally like but it is still higher than inflation and high enough to provide an acceptable level of income. We have discussed this fund before, but a few months have passed since that time so obviously a few things have changed. This article will focus specifically on those changes, as well as provide an updated analysis of the fund's financial condition. Let us investigate and see if this fund could be a good purchase today.

About The Fund

According to the fund's webpage , the BlackRock Energy and Resources Trust has the stated objective of providing its investors with a high level of total return. This is not surprising considering that this is an equity fund. In fact, currently, all of the fund's assets are invested in common equities except for a small amount of cash:

This is in line with the fund's own description of its investment strategy. The webpage describes it thusly:

BlackRock Energy and Resources Trust's investment objective is to provide total return through a combination of current income, current gains, and long-term capital appreciation. The trust seeks to achieve its investment objective by investing, under normal market conditions, at least 80% of its total assets in equity securities of energy and natural resources companies and equity derivatives with exposure to the energy and natural resources industry.

The fact that the fund invests in common equities makes the focus on total return understandable because common equities are by their nature a total return instrument. After all, investors typically purchase common stock in order to earn an income via the dividends that these securities pay out as well as benefit from capital gains as the issuing company grows and prospers. This is exactly what this fund is attempting to accomplish.

Unfortunately, the fund has not had much success at its objective year-to-date. The fund's share price has declined by 3.86% since the start of the year:

The biggest reason for this is the weakness that we have seen in energy prices. After all, West Texas Intermediate crude oil is down 8.7% year-to-date:

Natural gas at Henry Hub is down a much more substantial 43.20% since the start of the year. In the case of both commodities, the price weakness is due to a perceived supply glut and fears of a near-term recession. Natural gas is also suffering from a warm winter and the shutdown of Freeport LNG during the second half of last year, which removed a significant amount of demand from the market. As I mentioned in the introduction, though, the Organization of Petroleum Exporting Countries cut crude production earlier this month and China's demand for crude oil is recovering more rapidly than the market expected, which could very easily result in a global shortage of crude oil later this year. That would undoubtedly drive crude oil prices up, but natural gas will take much longer to recover.

As my long-time readers are no doubt well aware, I have devoted a considerable amount of time and effort toward discussing various traditional energy companies here at Seeking Alpha over the past decade. As such, most readers should be familiar with the largest holdings in the fund's portfolio. Here they are:

This very quickly reveals the reason why crude oil prices are so important to the fund's market performance. Exxon Mobil Corporation ( XOM ), Shell plc ( SHEL ), TotalEnergies SE ( TTE ), BP p.l.c. ( BP ), ConocoPhillips ( COP ), Chevron Corporation ( CVX ), Canadian Natural Resources Limited ( CNQ ), and EOG Resources, Inc. ( EOG ) all have their revenues and cash flows vary significantly with crude oil prices. Indeed, crude oil prices are generally the biggest determinant of financial performance for all of these companies. I have proven that in various past articles analyzing their earnings results for a given quarter. The Williams Companies, Inc. ( WMB ) and Valero Energy Corporation ( VLO ) are not, strictly speaking, as dependent on crude oil prices, but energy prices still impact their performance in the stock market. Thus, the weakness that we have seen in energy prices so far this year has impacted the market performance of all of these companies, which has naturally affected the value of the fund's portfolio.

The largest positions in the fund's portfolio are identical to the last time that we discussed this fund, although the weightings have changed fairly significantly. That may be caused by one stock outperforming another in the market though, and is not necessarily indicative of the fund's management actively changing the portfolio's weightings. The fact that there have been so few changes may lead us to believe that this fund has a very low turnover. In fact, the BlackRock Energy and Resources Trust had a 76.00% annual turnover last year, which is slightly higher than average for an equity closed-end fund. The reason that this is important is that it costs money to trade stocks or other assets, which are billed directly to the fund's shareholders. This creates a drag on the fund's performance and naturally makes management's job more difficult. After all, the fund's management must generate sufficient returns to cover the added expenses of the trading activity and still produce enough excess returns to satisfy the shareholders. There are very few management teams that manage to accomplish this on a consistent basis, which is one reason why most actively managed funds underperform their benchmark indices. For its part, this fund managed to deliver very strong returns in 2021 and 2022 but it has generally underperformed the S&P 500 Index over the past decade:

The fact that the BlackRock Energy & Resources Trust generally underperformed the S&P 500 Index prior to 2022 is not surprising. The entire energy sector generally underperformed in the market. That is one of the reasons why some American shale oil producers are reluctant to increase production and are instead paying out the majority of their cash flows to their investors as dividends. This is an attempt to address shareholder concerns about low returns relative to the production growth that occurred over the past decade. The strategy has worked somewhat as traditional energy substantially outperformed the broader market in 2022, and as we can see above this fund is one of the few that delivered a positive total return over the course of the year.

At this point, there may be some readers that point out that the high returns in 2022 were primarily driven by high energy prices. That is true, but as I pointed out in a recent blog post , energy prices are a component of the consumer price index that is used to measure inflation. Thus, rising energy prices push inflation higher and thus prompt the Federal Reserve to raise interest rates. As we saw over the past year, rising interest rates tend to cause bond and stock prices to fall. While historically, rising interest rates have not caused a stock market decline, the past decade of free money has severely distorted price discovery in the market. In short, it appears that there is an inverse correlation between energy prices and the S&P 500 Index right now. This fund could thus serve as something of a hedge that helps to reduce the volatility of your portfolio. That is something that should be appealing to any investor.

Distribution Analysis

As mentioned earlier in this article, the primary objective of the BlackRock Energy and Resources Trust is to provide its investors with a high level of total return. One of the components of that total return is current income, and the energy sector is one of the highest-yielding in the economy due to numerous traditional energy companies using dividends as a way to make up for poor capital gains performance over most of the past decade. As such, we might expect the fund to boast a fairly high distribution yield. This is certainly true as the fund pays a monthly distribution of $0.0657 per share ($0.7884 per share annually), which gives it a 6.73% yield at the current price. The fund has unfortunately not been particularly reliable with its distribution over its history, but this is changing, as it has raised the payout twice in the past twelve months:

The fund's recent history is better than most closed-end funds, but prior to this period, things were not so good as we see a steady history of distribution cuts starting in 2015. That is not surprising though, since 2015 was a bear market for crude oil prices as the Organization of Petroleum Exporting Countries was deliberately oversupplying the world with crude oil in an effort to crush the emerging American shale industry. The distribution cut in 2020 was also expected as the pandemic-related lockdowns greatly reduced the demand for crude oil and sent it to multi-decade lows. Fortunately, we can see that the fund has started to reverse those cuts now that the energy industry has largely recovered. Despite the fact that the fund's distribution history largely makes sense, it may still prove somewhat discouraging to any investor that is seeking a safe and consistent distribution to use to pay their bills or otherwise finance their lifestyles. With that said, anyone buying today will receive the current distribution and the current yield and does not have to worry about the fund's past history. Thus, the most important thing is how sustainable the current distribution is likely to be. Let us investigate this.

Fortunately, we do have a fairly recent document that we can consult for this purpose. As of the time of writing, the fund's most recent financial report corresponds to the full-year period that ended on December 31, 2022. This is nice because it should give us a good idea of how well this fund managed the turbulent market of 2022. During the full-year period, the BlackRock Energy and Resources Trust received $16,828,579 in dividends from the assets in its portfolio and surprisingly no other income. We need to net out the money that the fund paid in withholding taxes, which gives it a total investment income of $15,983,162 during the period. The fund paid its expenses out of this amount, leaving it with $12,071,039 available for shareholders.

That was, unfortunately, not enough to cover the $16,501,763 that the fund paid out in distributions over the year but it did get closer than might be expected. However, the fact that the fund's net investment income was insufficient to cover the distribution might still be concerning to many investors.

However, the BlackRock Energy & Resources Trust does have other methods through which it can obtain the money that it needs to cover the distribution. For example, it might have been able to generate capital gains that can be paid out. As the energy sector was the best-performing sector in 2022 and one of the few to deliver positive returns, the fund enjoyed a great deal of success here. During the full-year period, the fund achieved net realized gains of $34,809,940 and had another $66,906,553 net unrealized gains. Overall, the fund's assets increased by $84,989,114 after accounting for all inflows and outflows during the period, including a share buyback that cost the fund more than $12 million. The fund thus easily earned enough money to cover its distribution for several years, especially considering that net investment income was close to enough to cover it. Overall, investors should have little need to worry here as this fund can easily maintain its distribution for quite some time.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a closed-end fund like the BlackRock Energy and Resources Trust, the usual way to value it is by looking at the fund's net asset value. The net asset value of a fund is the total current market value of all the fund's assets minus any outstanding debt. It is therefore the amount that the shareholders would receive if the fund were immediately shut down and liquidated.

Ideally, we want to buy shares of a fund when we can obtain them at a price that is less than the net asset value. This is because such a scenario implies that we are purchasing the fund's assets for less than they are actually worth. This is, fortunately, the case with this fund today. As of May 19, 2023 (the most recent date for which data is currently available), the BlackRock Energy and Resources Trust had a net asset value of $13.45 per share but the shares traded for $11.72 each. This gives the fund's shares a 12.86% discount on the net asset value. That is quite a bit larger than the 11.64% discount that the shares have averaged over the past month, so the price of BlackRock Energy & Resources Trust certainly looks pretty good today.

Conclusion

In conclusion, the BlackRock Energy & Resources Trust appears to be a good way to gain exposure to the energy industry and earn a high income today. The fund's performance is somewhat dependent on energy prices, but there are reasons to expect that crude oil prices will go up in the second half of this year and benefit this fund. The BlackRock Energy & Resources Trust fund currently has a respectable 6.73% yield and a very attractive valuation. As this yield looks to be sustainable, it could make sense to take advantage of the discount and accumulate shares of BlackRock Energy & Resources Trust.

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