BUI - BUI: I Was Early But I'm Still A Bull On Infrastructure And Utilities

2023-11-16 10:38:54 ET

Summary

• The BlackRock Utility & Infrastructure Trust (BUI) is currently undervalued and sitting in correction territory.
• BUI's discount to NAV has expanded to over 8%, suggesting that investors have disproportionately sold off the fund.
• Despite a 12% loss in share price, the widening discount is a positive sign and indicates that BUI may start moving upward soon.

Main Thesis & Background

The purpose of this article is to evaluate the BlackRock Utility & Infrastructure Trust (NYSE: BUI ) as an investment option at its current market price. The fund is managed by BlackRock, and its objective is to "provide total return through a combination of current income, current gains, and long-term capital appreciation". BUI does this by investing in equity securities in the Utilities, Infrastructure, and Power sectors and by utilizing an option writing strategy.

This is a fund I got bullish on during the middle of July when I decided to add to my position. Unfortunately, my call was a bit early. While I have continued to see value in this CEF throughout Q3 and Q4, the net result has been some losses since my July review :

With BUI sitting in correction territory it made me wonder if I should adjust my rating going forward. After consideration, I remain steadfast in my belief that this is an under-valued sector and - as a result - see BUI as an under-valued fund. I am therefore reaffirming my "buy" rating on it, and I will explain why in more detail below.

Valuation Screams "Buy Me"

The first attribute to consider at the moment (in my eyes) is the fund's valuation. As my followers know, I love CEFs at a discounted price, and BUI has a history of shifting back and forth between premiums and discounts. For those who follow the fund closely, getting in and out at the right times can often provide "alpha" for this sector.

Unfortunately, a discount is not always a guarantee of gains ahead. The performance since July confirms this. At that time BUI had a discount to NAV near 2% and it still has pumped out a fairly sizable loss since that time. So we always need to remember this is just one of many factors to consider before buying (or selling) this type of security.

But the good news is that BUI's discount has expanded substantially since mid-summer. What once was a 2% discount has widened to over 8%:

This actually makes me more confident in the fund, despite its above-average drop in share price since my last article. While a 12% loss is never "good", this discount widening helps explain almost half of that loss. I see this as a positive sign because it suggests that investors have disproportionately sold this fund off, rather than broader underlying weakness in the sectors and stocks that BUI holds. To me this says it is only a matter of time before BUI starts making a move upward in order to narrow this premium. That is more of a tailwind that on waiting for an underlying sector to rebound to push up the price of any CEF - since a sector rebound is not something we can always count on!

Inflation Headwind Is Diminishing

Of course, a positive valuation metric is only as good as the broader outlook for a sector. Buying in to a "discount" if a sector/fund/stock is about to plummet in the months ahead is not a coherent strategy! With this in mind, it is important to understand the why behind why Utilities may offer a reasonable return to wrap up 2023.

A key backdrop item from this perspective is inflation. As followers of the Utilities space surely know, this is a sector that can often be very rate sensitive. While this relationship is not always perfect, they do tend to move in the inverse of each other. This is because when inflation goes up, the outlook for interest rates goes up to - hurting the income-oriented Utilities sector. This has been the case for most of the past twelve months, but October's CPI readings has changed the story on this front:

The takeaway from this is that investors began to greatly shift their outlook for interest rates going forward. The CPI reading showed that inflation has cooled substantially off its high, and October's numbers reflect some sustainability to this trend. The net result has been that the "higher for longer" mantra has been replaced by the optimism of potential rate cuts in 2024:

This is where my outlook gets to be more of a projection. The disclaimer is that nobody knows for sure what interest rates will be in 2024 - and that probably includes even the Fed!

We have to respond to our own individual outlooks, but also what the rest of the market expects. This is because even if I personally disagree with the dovish outlook projected in the prior graphic (which I do), my personal outlook is only a part of the equation. I can profit off a sector (such as Utilities) if I front-run what other investors expect. And if that expectation is lower rates in 2024, then Utilities are likely to move higher as a result of crowd-buying.

We Have To Acknowledge Utilities Recent Run

My next point is one of a little bit of caution. This is not meant for double-speak: I am a Utilities bull and I stand by that call. But those who read my articles know I do not pump investments or make wild calls/assumptions. I am fact-based and rational, even though this doesn't make me as flashy of a writer.

With that in mind, I'm not one of get overly aggressive on Utilities here. Do I think it is a buy? Yes I do. But that has been the case for over a month now. In fact, I alerted my followers to what I saw as a clear buy signal in the Utilities sector back in early October. Since then, the Vanguard Utilities ETF ( VPU ) which I highlighted in that review has performed very well:

The fact is that a 9% pop in less than six months is a sign that a lot of good news is starting to be priced in. So proceed optimistically but with caution.

But the reality here is that BUI has not participated in the sector rally quite as strongly. That is central to why I like buying this CEF here, as opposed to continuing to add to my VPU position. VPU has rallied handsomely, but BUI has fallen short - this ties back to the 8% discount to NAV I discussed earlier. So while the Utilities sector may seem more limited gains, BUI has a stronger chance of out-performing. This is my opinion due to its potential for narrowing its recent gap with passive ETFs like VPU.

There Continues To Be A Need To Diversify

My next point is more of a macro one. It reinforces why I have liked Utilities for a long time - both BUI and VPU - due to my need to diversify. My portfolio is very US-centric and very S&P 500 heavy. This has served me well over the years as this particular index has done quite well. But it also leaves me prone to concentration risk. This is the net result of a handful of high-flying Tech stocks continuing to do well year after year.

In Q4 2023, this remains the case just as boldly as it ever has. To see why, let us examine the weighting of the "Mag 7" (NVIDIA Corporation ( NVDA ), Meta ( META ), Tesla ( TSLA ), Amazon ( AMZN ) Microsoft ( MSFT ), Alphabet ( GOOG ), and Apple ( AAPL )) within the S&P 500 index:

To me, this is a no-brainer on why I have a continued need to branch out in to alternative ideas. The S&P 500 is just too top-heavy to keep plowing more and more money in to it year after year.

But deciding to diversify a bit is only half the battle. Investors have a plethora of options when it comes to moving beyond the S&P 500 or Info Tech as a whole. This includes other major indices (non-US included), bonds, alternative asset classes, materials and commodities, and, of course, sector investing. The latter is my primary way to invest. I continue to enjoy large-cap US stock exposure and getting access to under-represented sectors such as Utilities is central to that strategy. Going forward, I see value in Utilities specifically because it is priced well below the broader S&P 500:

This helps to explain why I want to diversify and why I want to use Utilities as a way to do it.

Furthermore, with respect to BUI in particular, its call writing strategy works best when the underlying stocks are not appreciating rapidly. This is because BUI writes call options - which will get "called away" when the underlying shares rise in value. But when the share prices are declining (or moving in a narrow range) many of those options expire worthless. That allows BUI to collect the premiums without losing out on too much upside. This strategy during a rough year is what has helped BUI to deliver consistent high income:

This all adds up as a win-win for me. BUI allows me to round out my portfolio in a productive way and current valuations suggest there is a lot of merit to using this as an opportunity to add to my position.

Bottom Line

Utilities have seen a bit of a boost but BUI's part in this has been lagging. Rather than give up on this CEF, I see that as precisely the reason why I should be adding. BUI is under-valued here, and Utilities as a whole are benefiting from the recent inflation numbers and resulting expectations of a more dovish Fed. While I personally think the market is getting too optimistic with its outlook for rate cuts, I see an opportunity in the next few quarters to profit off this expectation through buying income-oriented sectors. This includes Utilities, which I see as a buy now and in the months ahead. Therefore, I am reaffirming my bullish rating on BUI and suggest that my followers give the idea some thought at this time.

For further details see: