BME - BME: Historically One Of The Best Times For Entry

2023-11-28 15:57:17 ET

Summary

• BlackRock Health Sciences Trust aims to generate total returns through a combination of current income and long-term capital appreciation.
• BME employs a covered call strategy, resulting in a high dividend yield of 6.7% that has not been cut since switching to a monthly distribution.
• The fund's portfolio consists of profitable and large-cap companies in the health sciences sector.
• The price currently trades at a discount to NAV of 7%, which is a historical high for the fund.

Overview

BlackRock Health Sciences Trust ( BME ) is a CEF (Closed End Fund) that primarily aims to generate total returns by combining current income, immediate gains, and long-term capital appreciation. To achieve this objective, BME aims to invest a minimum of 80% of its assets in equity securities of companies involved in health sciences and related industries, as well as equity derivatives linked to the health sciences sector. What makes BME unique is that they employ an option strategy as part of its approach to supply the high dividend yield of 6.7%.

I really like BME because of its solid portfolio of holdings, the consistent income it provides, and the superior total return compared to its peers. Also, the covered call strategy that is implemented makes this a unique fund that has a dividend yield high enough to produce a sizeable stream of passive income. The most recent factsheet showed that they used this overwrite strategy on 35.15% of the fund. Unlike some funds that use call-writing on entire indexes, they do it on individual positions in their portfolio. This approach limits the potential for unlimited losses. All of these factors combined with a current discount to NAV, makes BME a strong buy in my opinion. I believe entry here has the ability to provide superior returns against the broader healthcare market.

Portfolio

The top sectors of BME are Pharma, Biotech, and Life Sciences which make up 55.2% of the total portfolio. This is followed by Health Care Equipment and Services making up 41.2% of the portfolio. The remaining 3.6% consists of cash and derivatives. The fund only has a total of 121 holdings but I like the makeup of BME because almost 90% of the companies they have exposure to are large cap companies with market capitalizations greater than $10 billion. Their portfolio has top tier companies that are profitable, growing revenues, and produce comfortable levels of free cash flow. As of October 31st, the top ten holdings are as follows:

I really like this top ten holdings because of how profitable and highly rated these companies are. For example, UnitedHealth Group ( UNH ) recently revised their EPS outlook as they beat estimates in Q3. They had revenue from Optum, a service provider to the global healthcare market, grow revenue 21% year over year. Eli Lilly ( LLY ) also posted great earnings for Q3 and their revenues from a diabetes treatment rose 22% YoY. Merck ( MRK ) which I also previously analyzed and rated as a buy, posted positive earnings with a 6.7% YoY revenue growth and a dividend yield that has an average growth rate nearing 10%.

Something that stood out to me is that the fund doesn't use any borrowing or preferred offerings. This adds a layer of stability and less risk which is great when talking about healthcare companies that are within tightly regulated and everchanging sectors. The gross expense ratio is quite conservative as well at only 1.09%. BlackRock has found a strategy that works and this is proven by the track record. See for yourself: including distributions, BME has outperformed the S&P 500 ( SPY ) over the last 10+ year period.

Dividend

As of the latest declared dividend of $0.213/share, the yield comes in slightly above 6.7%. One of the unique parts of the dividend is that it is paid on a monthly basis which is a nice bonus for investors who rely on the income their portfolio produces. An attractive aspect of the distributions is that they have been fairly consistent over time. Looking back, the dividend wasn't cut over the 2020 crash and the dividend has been consistent and slowly growing since 2016.

The 5-year dividend CAGR is on the lower end at 1.27% but in my opinion, this can be dismissed since the upfront yield is large and the distributions have proved to be sustainable. If you invested $10,000 upon inception and reinvested all dividends, your income would have tripled from through the time frame from $1,069 up to $3,397. At the same time, reinvesting only dividends and not contributing any additional money, BME would have grown your $10,000 into $60,000 whereas the S&P ((SPY)) would have only grown your money to $47,000. As a dividend investor, I like investments that I can hold for extended periods of time and provide that sleep well at night feeling. BME's track record fits this criteria, and I plan on scooping more shares down here and holding for the long term.

The high dividend yield is easily achieved by the fund's inclusion of an option strategy. BME employs a strategy focused on selling call options on the underlying equities. This approach involves the fund receiving premiums from buyers of these call options, which is where the income generation comes from. By selling call options, BME seeks to cap the potential upside for specific stocks in its holdings, thus mitigating the impact of sharp price increases on the overall portfolio.

While this strategy helps manage risk and secures a safe dividend yield, it comes with the trade-off of potentially missing out on some gains if the prices of the underlying assets rise is price. However, I do think the higher dividend yield can make up for some lost footing in this area. As long as the distributions stay consistent, it's a trade-off that I am willing to make as I am prioritizing income here with BME.

Valuation

Since BME is a closed end fund, a good reference for valuation would be the relationship between the price and the NAV (Net Asset Value) of the fund. We can reference the historical averages of the premium or discount to create a better visual of the price action.

As we can see from the visual below, BME's price more commonly trades at a premium to the NAV than it does at a discount. Each brief period of trading at a discount to NAV was followed by a sharp movement upward. Over the last 3-year period, the average relationship between the price and NAV resulted in the price of BME trading at an average premium of 0.14%.

At the moment, I believe we have an extremely attractive buy opportunity since the price currently trades over a discount of 7%. For reference, when the market sharply dropped in March of 2020, the discount only amounted to 5% at the time.

For all of the past year, healthcare, pharma, biotech, and life science companies haven't performed too well. However, I believe that entry here has the potential to set you up with returns that will outperform the broader healthcare market. From a price to NAV perspective, this might be the absolute best time to buy BME in the last decade. As the sector begins to stabilize, combined with a steadying interest rate, I believe we will see upward price movement in the near future and a growing stream of income.

Takeaway

In conclusion, BlackRock Health Sciences Trust stands out as a compelling investment opportunity to create a sizeable income stream from the healthcare sector. BME employs a covered call strategy, contributing to a substantial dividend yield of 6.7%.

BME's consistency in dividend payouts, even during challenging times, underscores its reliability for income-seeking investors. Despite a slightly lower 5-year dividend CAGR, the fund's high upfront yield and sustained distributions make it an attractive income generator. BME's valuation, trading at a discount of over 7%, presents a favorable entry point, historically leading to upward price movements.

In a healthcare sector showing signs of stabilization, BME emerges as a strong buy, poised to outperform the broader market, offering both capital appreciation and a growing stream of income from a portfolio of top tier holdings.

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