RILYP - Insiders Are Loading Up On These 2 Big Dividend Stocks

2024-01-11 07:35:00 ET

Summary

• Insider ownership and accumulation tells us a lot about management’s confidence in the business model.
• We discuss EPD and RILY for robust cash flows backed by high insider ownership.
• +7.6% yields from economically insensitive fee-based businesses.

Co-authored with “Hidden Opportunities.”

When investing in public companies, most of us individual investors have access to data that the company makes available. But there's one class of investors that knows about undisclosed details like an upcoming merger or acquisition, hiring freezes and layoffs, entry into new markets, or the effectiveness/ success of internal strategies. Company insiders are these special investors with better visibility (and potentially oversight) into the operations.

According to the Securities Exchange Commission, an “insider” is an officer, director, 10% stockholder, and anyone who possesses inside information because of their relationship with the company or with an officer, director, or principal stockholder. This group of investors has some special rules regarding buying and selling shares.

• Most companies don’t allow insiders to “trade” the stock.

• Companies require Directors and Officers to pre-clear all trades and often employ a window where transactions are not permitted.

• Corporate insiders are required to report their transactions within two business days of the date the transaction occurred.

When we find companies where insiders own a significant number of shares, it tells us something. Legitimate insiders are interested in long-term gains, not quick fixes. Moreover, if a stock is known for its generous dividends, then high insider ownership makes a compelling case for payment sustainability and reliability through prudent strategy and execution.

"Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise." – Peter Lynch.

Insiders buy because they see great potential or simply because they think their stock is undervalued. We will now discuss two excellent dividends where management has our back through massive insider ownership in the stock. Let’s dive in!

Pick #1: EPD - Yield 7.6%

Enterprise Products Partners L.P. ( EPD ) owns and operates an integrated energy infrastructure network providing midstream energy services to producers and consumers of natural gas, natural gas liquids, crude oil, refined products, and petrochemicals.

Note:

• EPD is a Master Limited Partnership that issues a Schedule K-1 to investors.

• Partnership issues are called units, and investors are termed unit holders. But to keep the discussion consistent and understandable, we will utilize conventional terms like shares and shareholders.

EPD maintains an A-rated balance sheet with peer-leading leverage of 3x and ample liquidity to support shareholder commitments and infrastructure expansion initiatives. The partnership ended Q3 with $3.8 billion in liquidity, including available credit capacity and unrestricted cash. 95.8% of EPD’s debt is at fixed rates, and the partnership’s total debt carries a 4.6% weighted average interest rate.

The management's significant 32% ownership stake in EPD stock is a critical factor that should not be overlooked. With substantial insider ownership and consistent accumulation, EPD's management is not just at the helm, but also personally vested in the company's success, ensuring prudent strategies to enhance shareholder value. Source .

The common assumption that high yield comes at the cost of growth is swiftly debunked by EPD, which defies this logic from the outset. Source .

53% of EPD’s CFFO (Cash Flow From Operating Activities) was distributed, and 3% was utilized towards share buybacks. In June, the partnership made its 25th consecutive annual distribution increase by declaring a $0.50/share quarterly payment, a 5.3% YoY increase. With that, EPD joins the Dividend Aristocrat club, well-positioned to reward shareholders in the years to come. And then it followed up with a 3% raise to $0.515 this week. Notably, in TTM Q3 2023, EPD repurchased ~8.5 million shares for $213 million under the partnership’s $2 billion share buyback program from 2019 ($823 million has been utilized to date).

EPD’s operations are primarily fee-based, bringing relative insensitivity to commodity price fluctuations.

With an ongoing expansion of monetizable assets, distribution growth, share buybacks, and substantial insider ownership, EPD ticks all the boxes for value investors. It offers a well-covered 7.6% yield, making it an enticing choice to ride along as the world increasingly seeks reliable energy storage and transportation.

Pick #2: RILY Bonds, 7%-9% Current Yields – Up To 20% YTM

B. Riley Financial, Inc. ( RILY ) is a financial services firm with a beaten-up stock and an ironic specialty in salvaging beaten-down companies. Born in 1997, RILY focuses on smaller companies that don’t get much attention from Wall Street. The firm has a birth-to-death business model that includes stock and bond offerings, consulting, restructuring, mergers, turnarounds, bankruptcies, and retail liquidations.

RILY common stock has an uncomfortably-high short interest, and has lost more than half of its value in recent months largely due to exaggeration of the situation with one of its investments, and an overall misunderstanding about the company’s operations.

We discussed in our November Earnings Update about the unproven allegations of financial fraud against Franchise Group CEO Brian Kahn at his former workplace. Since then, Franchise Group experienced a credit downgrade further spooking the investor community. Recently, Franchise Group completed an investigation and announced that it found no ties to the company and Prophecy Asset Management.

RILY, operates in diverse business segments, where investing is just one component. The rest are all fee-based businesses that generate the lion's share of the company’s EBITDA and largely support its dividend policy.

• B. Riley Securities focuses on financial services like brokerage, underwriting, and advisory, collecting fees for services rendered.

• Financial Consulting provides advisory services, relying heavily on fee-based revenues.

• The Liquidation division handles turnarounds, bankruptcies, and retail liquidations, experiencing a surge in business due to economic stress.

• The Wealth Division offers financial advice to high-net-worth clients, managing $24 billion in assets, charging fees based on AUM. As such, the earnings are influenced by market conditions.

• The Communication Segment owns several small companies providing digital solutions and services to businesses in exchange for a fee.

• Targus , a recent addition, faces sales challenges due to the cyclical nature of its products, but anticipates a rebound from the upcoming equipment refresh cycle and also sees tailwinds from the rising demand for AI-oriented digital services.

• Brands - RILY owns a portfolio of 9 brands with largely royalty-type assets. As such, profit margins are very high as seen from the low operating expenses which for this unit are very low, and often > 80% of the royalty income flows to EBITDA for distribution to shareholders.

Below is the breakdown of the fee-based businesses and their contribution to the Adj. EBITDA.

Before we even get to the investing business, it is clear that debt, preferred, and common shareholder obligations are satisfied by the earnings from RILY’s fee-based businesses.

RILY’s Investing Business

The investment portfolio is $1.6 billion in size, and RILY often takes board seats to work collaboratively with management to ensure their investment objectives are met. RILY seeks cash flow generation from its holdings, and the portfolio is underwritten and turned over every three years. RILY investments are primarily placed in public equity, private equity, and credit markets. Within credit, since 2019, RILY has made 53 total loans, and 38 have been paid back with a weighted average IRR of 12.7% and 15 remain outstanding. Franchise Group ((FRG)) is one of RILY's private placements.

Franchise Group represents 40% of the private equity business, or only 16% of the firm’s Adj. EBITDA. Following the take-private transaction, RILY owns 31% stake and a board seat in Franchise Group, putting them in a position of heavy influence to benefit from the strategies pursued and decisions made.

It is also noteworthy that insiders maintain a substantial 32% position in RILY, with CEO Bryant Riley owning 7.17 million shares (a 23% stake). Insiders continue their buying spree amidst the selloff and negative sentiment, and we expect decisions around dividends and other strategies to have close alignment with investor expectations. Source .

RILY's Baby Bonds

• 5.0% Senior Notes Due 12/31/2026 ( RILYG ) - YTM 21%

• 5.5% Senior Notes Due 3/31/2026 ( RILYK ) - YTM 20%

• 6.375% Senior Notes Due 2/28/2025 ( RILYM ) - YTM 17%

• 6.5% Senior Notes Due 9/30/26 ( RILYN ) - YTM 20%

• 6.75% Senior Notes Due 5/31/2024 (RILYO) - YTM 16%

• 6.0% Senior Notes Due 1/31/2028 ( RILYT )- YTM 19%

• 5.25% Senior Notes Due 8/31/2028 ( RILYZ ) - YTM 20%

We notably like RILYZ with 9.3% current yield and 82% upside to par. RILYT is also a reasonable contender, offering a 9.1% yield and 54% upside. All of the bonds have a Yields-to-Maturity 16-20%, with a wide range of maturity dates.

RILY ended Q3 with $254 million in cash and cash equivalents. In 9 months of FY 2023, RILY spent $6 million on preferred dividends, and $140 million interest expenses. The company’s $267.8 million operating EBITDA during this period provided adequate coverage for these commitments and common stock dividends.

RILY runs a primarily fee-based business with several sources of predictable or recurring revenues. These service fees are more than adequate to cover debt and preferred dividends Moreover, RILY’s investing business is well-diversified across multiple customers to minimize impact from valuation impairment on any single entity. RILY bonds are attractively priced to lock in big dividends for years ahead while waiting for the markets to discover the value proposition of RILY's cross-market-cycle business model.

Conclusion

High insider ownership typically signals confidence in a company's prospects and ownership in its shares. Insiders might buy because they see great potential or simply because they think their stock is undervalued. When a dividend-paying stock has high insider ownership, management has a stronger incentive to prioritize the sustainability of the payments while focusing on long-term value creation.

Our Investing Group focuses on buying businesses that can maintain profitability and pay our share through thick and thin. Our “model portfolio” holds +45 dividend-paying stocks with an overall yield of +9%. With over 30% insider ownership, EPD and RILY are prominent firms with well-established codes of conduct for insiders regarding stock purchases and disposal. Insiders continue to be net buyers of the common stock, and this significant insider holding translates to management believing in the long-term potential of the business and being incentivized to deliver value to shareholders. These companies sport high yields and contractual fee-based business models, helping them thrive through economic cycles and protecting our financial well-being through generous dividends.

As cash flow buyers, we ensure our income stream is reliably recurring, whether the markets are up or down. This is the beauty of income investing.

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