BUI - BUI: Solid Yield Via Dividends And Covered Calls

2023-07-05 22:13:21 ET

Summary

• BUI generates a nice yield in the Utilities and Infrastructure arena using covered calls and underlying dividends.
• You can like the yield but that is not the best part.
• The lack of leverage is what will warm your soul as you navigate through the next recession.

In the midst of the current market mania, the utilities sector has been looking relatively interesting. This sector can still become cheaper despite having already taken the one-two punch from higher interest rates and the general disdain for defensive investments. However, it has become one of the better sectors to look at for those wanting to be "fully invested" at all times.

We have a few companies in mind and have written about a couple of Canadian ones recently . Both ATCO Ltd. ( OTCPK:ACLLF ) ( ACO.X:CA ) and Canadian Utilities Limited ( OTCPK:CDUAF) ( CU:CA ) Ltd. are solid companies but owning one versus the other is more favorable and we have expanded on that in the aforementioned article. Rather than investing in individual businesses, some may prefer to get the diversification offered by a closed-end fund or CEF that invests in a basket of securities in this sector. Not a bad idea, however, what we want to avoid, despite the allure of this sector, is to invest in CEFs that take on leverage like the Reaves Utility Income Trust ( UTG ) and Cohen & Steers Infrastructure Fund ( UTF ). So today, we revisit one that does not.

The Fund

BlackRock Utilities, Infrastructure & Power Opportunities Trust’s ( BUI ) aims to shore up the current income and gains, along with long term capital appreciation for its unitholders. BUI employs covered calls to enhance current income and reduce portfolio volatility, a strategy we are a fan of. At last count , calls were written on about a third of the portfolio, which comprised 56 securities. Sector wise, it targets the utilities and infrastructure businesses across the spectrum, primarily those with a market capitalization of more than $10 billion.

The fund invests in eligible companies across the world. As of May 31, while primarily invested in North American companies, it had fair bit of diversification across Europe, and to a smaller extent Asia.

Non-US names show up four times in the top 10 holdings list as at May 31.

Lastly and to reiterate, BUI has not given into the temptation of borrowing funds to enhance returns in remaining true to its defensive objective. You can see that below as total common assets and total investment exposure are almost identical.

As a result, it does not have the unpredictability of interest expenses eating into its bottom line, unlike almost all of its peers. This makes it a good fit for investors that are aiming for respectable rather than earth shattering returns and dislike volatility.

Prior Coverage

We have written on BUI a few times now oscillating between a neutral and buy rating in those outings. The last time around, we upgraded it from a hold to a buy as the sector had reset sufficiently in our opinion at the time. Still collectively trading at 20X forward earnings, while the sector was not cheap by any standard, it was definitely better valued than in the recent past. We had compared BUI to UTG then and the former came out ahead in terms of both valuation and pricing. Despite that, both got a ratings upgrade from us, just not a buy for UTG. We explained the rationale in our verdict.

But taking a cursory look at the XLU yield will tell you that neither fund (UTG or BUI) is funding that distribution yield from underlying holdings. So there is a built in capital appreciation requirement that is there to pay distributions while preserving NAV. Here we give the advantage squarely to BUI. BUI is virtually unleveraged (compared to 18.5% for UTG) and we think this will help if valuations press the stocks lower in the short term.

Finally, BUI does sell covered calls on its positions and that will help in the current high volatility environment. So we have 4 points in favor of BUI (including the discount to NAV) and that allows us to stamp this with a buy rating. For UTG, we see the drop in price and valuation compression, but remain overall unimpressed at this point. We are still upgrading it to a hold though, and canceling out the prior Sell/Short Sell call.

Source: UTG Moves To A Hold, BUI To A Buy

Our confidence in BUI paid off and it has outperformed UTG since that piece.

Some of this outperformance can be attributed to the unwinding of the premium that UTG traded at this time last year.

BUI also benefitted from a stronger performance of the Euro vs the US Dollar and to some extent from intelligent covered call writing.

Verdict

The Utilities sector has got cheaper since our previous article and is trading close to its historical multiple of 16X forward earnings. There are still notable headwinds here and that the biggest one comes from a rising 10 Year Treasury rate and 5.25% Fed Funds rate. The latter is likely to go higher as well. There is a non-trivial risk that the earnings multiple on utilities compresses further and we can see a 15% further drawdown. We don't think we will get notable upside until the Fed pivots to rate cuts and that is not in the cards for the next 12 months at least. Even in that scenario, one must be aware that more downside is possible if the rate cuts are because of a severe recession. The positive aspect for us is that the sector is one of the cheapest in the S&P and we could see funds flow from managers who need to fully invested at all times.

Paying 12.1 cents a month, BUI now yields 6.5%. Within the group of CEFs that cater to this sector, BUI is one of the better choices due to its defensive strategies of employing no leverage and selling options to reduce volatility. We also believe this level in relation to its NAV is sustainable over the medium to long term and continue to rate it a buy.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: