HQH - Big Opportunity In The Panic: 2 Fat Yields Up To 9%

2023-04-10 08:00:00 ET

Summary

• Legendary fund manager John Neff was a fan of big yields.
• Investment success does not require glamour stocks or bull markets. - John Neff.
• Mr. Neff saw healthy dividend income as a defense against market swings.
• We are buying 2 deeply discounted dividends with up to 9% yields during this panic.
• For income investors, it is a great way to boost your income!

Co-produced with Hidden Opportunities

John Neff managed Vanguard's Windsor Fund for 31 years (from 1964 till his retirement in 1995). Under his watch, Windsor Fund outperformed the S&P 500 in 23 out of 31 years with a 13.7% annual return, with dividends making a notable influence.

Though The Vanguard Group and its founder John Bogle are associated with autopilot index funds and often preached that fund managers seldom beat the market, Mr. Bogle made a notable exception for John Neff's focus on ignored cyclical industrial stocks that paid large dividends to shareholders.

"We almost always have insisted on a good yield on cyclicals. It gives you some kind of bulwark in case you're wrong." – John Neff

Dividends played a starring role in the Windsor Fund, and Mr. Neff liked his portfolios concentrated in stocks that paid steady (preferably rising) dividends. He was also known to prefer market sectors and companies that he called "dull stuff."

During 1994-1995, the Fed pursued a monetary policy tightening cycle where Chairman Greenspan led the FOMC almost to double the Fed funds rate with just seven increases. Investors were concerned that this might end the decades-long economic expansion ( not unlike today's climate ). Here was Mr. Neff's response in an interview from February 1995.

.....All these people are captives of historical parallels, and say the average postwar expansion lasted so long, and this one is near an end…

[Then, speaking about his picks that fell hard following record earnings and dividend raises]

….this is about as good as you get, and of course, they're increasing the dividend nicely - John Neff, Feb 1995

We are going to be income buyers in bull and bear markets. Structurally high-yielding securities are selling-off in fear and trading at cheap valuations. We will use this opportunity to boost our passive income and inch closer to our retirement goals.

Two value picks up to +9% yields, as Mr. Neff said, "buy on the sound of cannons."

Pick #1: HQH - Yield 9.1%

The United States spends more on health care than any other high-income country. This highly non-cyclical sector provides a defensive tilt to the portfolio amid market turmoil. The demand for medicines is relatively inelastic; people will cut down on fancy dinners and vacations but not on their pills. That should allow Big Pharma companies to maintain their profitability during economic slowdowns. Further, the fundamentals for the industry remain strong, making it suitable for long-term investment.

More than 131 million people (66% of all adults) in the U.S. use prescription drugs. Utilization is exceptionally high among older people and those with chronic conditions. Notably, over 50% of these expenses are out-of-pocket. Source

According to a report from the Administration For Community Living, ~17% of people in the U.S. (more than 1 in 6 Americans) were 65 or older in 2020.

That represents 55.7 million people, an increase of 15.2 million since 2010. The report further projects the numbers to climb to roughly 80.8 million people above 65 by 2040!

The American population is aging fast, and the healthcare industry will be more critical than ever. With an increasing number of Americans purchasing prescription drugs yearly, don't you want to collect your cut?

Tekla Healthcare Investors ( HQH ) is a healthcare-focused CEF with 77% of its portfolio comprising leading biotechnology and pharmaceutical companies. Source

HQH is well-diversified across 150 holdings. This positions investors well to benefit from the long-term tailwinds for the industry while providing adequate protection against some notable industry risks from a concentration position, such as steep regulatory fines, lawsuits, and patent expirations.

*HQH has a managed distribution policy permitting the fund to make quarterly distributions at a rate of 2% of its net assets. Since NAV varies based on market conditions, so are HQH's distributions. But the fund has rewarded investors with reliable income over time. Looking at the past ten-year performance, we see a 12% average annual income. Data Source: Portfolio Visualizer

HQH trades at a massive 14% discount to NAV, presenting an attractive opportunity to initiate/ add to your position. Management recently announced a share repurchase program allowing HQH to purchase up to 12% of its outstanding shares through July 14, 2023.

HQH does not utilize leverage in its investment strategy, making it suitable for investors worried about leveraged funds in a rising rate environment. Since the CEF's distributions are variable, and including our distribution projection of $0.405 for May, we calculate an impressive 9.1% yield.

The U.S. healthcare industry has maintained inelastic demand through varying market conditions. Tekla's HQH provides opportunities to invest in healthcare with a complete focus on current income production. Long-term fundamentals support the industry, and HQH is a sector-focused and deeply discounted CEF offering a 9.1% yield.

Pick #2: AM - Yield 8.6%

With recession fears and demand concerns, energy prices continue to exhibit volatility in 2023. However, infrastructure that supports the hydrocarbon industry is differentiated from other energy sub-sectors by its largely fee-based business model. This drives more stable cash flows regardless of commodity price fluctuations, and these cash flows support generous dividend payouts to shareholders.

Being a cleaner fuel, natural gas is essential in achieving global net-zero targets. And midstream companies (MLPs and C-Corps) are critical to ensure the secure storage, transportation, and processing of vital energy commodities. Due to the current political landscape, regulatory pressures, and high initial investment costs, few companies own and operate much of America's critical midstream infrastructure, making existing players vital for energy independence.

Antero Midstream Corporation ( AM ) owns and operates an integrated system of gathering pipelines, compressor stations, and processing and fractionation plants in West Virginia and Ohio. In addition, the company owns and operates two independent water handling systems that support completion activities. These midstream assets primarily serve Antero Resources ( AR ), the second-largest Natural Gas Liquids ('NGL') producer in the U.S.

Note: AM is a U.S. C-corp issuing a 1099 for investors. It is a suitable high-yield midstream company for investors who shy away from MLPs issuing K-1s.

100% of AM 's contracts are fee-based and have contractual escalators to provide inflation protection. AM's assets primarily provide midstream support to AR, and both companies have a symbiotic relationship; AR owns about 29% of AM. AR itself has a strong balance sheet with ~$1 billion in debt and an industry-low leverage of 0.4x. It expects leverage to rise slightly to 0.7x by year-end 2023. AM's 3.7x leverage ratio is significantly lower than industry peer groups, and is projected to be even lower by 2024. Source

AM expects to produce $1-1.3 billion in cumulative Free Cash Flow "After Dividends" through 2027. For FY 2023, the company projects a 7% increase in Adjusted EBITDA through organic growth from the QL Capital Partners Drilling Partnership and a full-year contribution of its recent acquisitions. At the same time, the company guides a 23% decrease in capital expenses.

"The ability to generate EBITDA growth with declining capital is truly unique in the midstream space and illustrates the significant operational leverage our assets have." – Brendan Krueger, CFO

AM expects to use FCF after dividends to reduce leverage further, declining to 3x by the end of 2024. The company also has a comfortable debt schedule with no maturities until 2026.

While wind, solar, and hydrogen may play a part, natural gas will continue to be vital in generating more electricity to support the growing world population for the foreseeable future. At its current price, AM provides an attractive 8.6% yield. Declining leverage, shrinking Capex, EBITDA growth, and big well-covered dividends – AM has it all, making it an excellent midstream pick for a fearful economy.

Conclusion

John Neff was a buyer of cheap and predictable businesses that paid big dividends. Most importantly, he was a contrarian who often questioned (and profited significantly from) the market's herd mentality and purchased the most unloved companies. Mr. Neff's success can largely be attributed to dividends paid by his picks, a notable reason for his market outperformance. At High Dividend Opportunities, we maintain a diversified portfolio of 45+ dividend payers with an average yield of +9%. With a yield at this level, your income, like Mr. Neff's investment success, doesn't have to depend on meme stocks and bull market confirmations.

You can wait to buy when the market bottoms. Or, you can buy periodically while collecting handsome dividends. I prefer the latter since I like to pursue my preferred hobbies during the day instead of watching price charts and market news. This method works for me and gives me regular paychecks to redeploy into the market's discounted segments. Two picks with up to 9% yields to grow your income in this skeptical market.

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