2023-04-03 11:45:35 ET
Summary
- With a likely recession on the horizon and interest rates still at high levels, the bar for income stocks has been raised.
- Investors need to insist on higher starting yields that are likely to hold up through a recession.
- We share five picks that are trading at attractive valuations and offer sustainable 10%+ yields.
With a recession on the horizon and interest rates still at high levels, the bar for income stocks ( DIV ) has been raised. Investors need to insist on higher starting yields that are likely to hold up through a recession. This is because the risk-free income yield that can be obtained through FDIC-insured savings instruments like savings accounts and certificates of deposit or even from short-term U.S. Treasuries ( SGOV ) is high enough that it takes a really mouth-watering income yield to entice income-focused investors to take on the added risk of an equity. Moreover, the payout needs to be quite safe given that the impending recession will likely put pressure on the company's cash flows.
In this article, we share five picks that are trading at attractive valuations and offer 10%+ yields that have a good chance of holding up during a recession.
#1. Energy Transfer LP ( ET )
ET is a midstream business ( AMLP ) that offers a forward distribution yield of ~10% that is expected to be covered ~2.2x by distributable cash flow in 2023.
Moreover, its cash flows are considered to be quite stable given that the vast majority of its EBITDA comes from long-term fixed fee take-or-pay contracts, and only ~10% of its EBITDA is considered to be impacted by short-term commodity price volatility.
Third, its balance sheet is in increasingly strong shape, with an investment grade credit rating that is likely to get upgraded in the future given that management remains focused on aggressively paying down debt (as discussed in a recent exclusive interview with ET).
Finally, with a well-diversified business model by geography and energy commodity exposure along with numerous growth avenues at its disposal, ET is pretty well insulated against commodity and geography specific risks and should be able to continue generating growth for years to come.
With a distributable cash flow yield and an EV/EBITDA multiple that are well below peers' and its own historical averages, ET looks to be a compelling bargain along with being one of the safest double-digit yielding common equities right now.
#2. Blackstone Secured Lending Fund ( BXSL )
BXSL is a business development company, or BDC ( BIZD ), that offers investors a forward yield of 11.2% that is expected to be covered 1.3x by normalized earnings per share this year.
Its investment portfolio is in phenomenal shape, as nearly all of its holdings are senior secured debt at floating interest rates. As a result, shareholder capital has several degrees of protection:
- Senior debt must be met first before all other liabilities on the balance sheet, so even if the company faces financial distress, BXSL's investments should be made whole before any other investors or lenders to the companies in its portfolio.
- If inflation runs high (as it has been lately), interest rates also tend to rise in tandem (which they have been). As a result, BXSL's net income (and, therefore, its dividend) tends to rise when inflation rises, helping to preserve the buying power of the shareholder's income stream from the stock.
- Even in the event of a severe economic downturn that leads to BXSL's counterparties defaulting on their senior loans from BXSL, the secured nature of these loans means that BXSL is likely to recover much - if not all - of its capital eventually.
On top of that, it has an investment grade balance sheet, giving it access to debt capita at relatively attractive interest rates which it can then re-invest into opportunities at wide spreads, leading to high returns on equity for shareholders.
Last, but not least, it is backed by Blackstone ( BX ), a world-leading alternative asset manager with nearly $1 trillion in assets under management, including a large presence in credit and direct lending. This provides BXSL with access to an enormous treasure trove of industry-specific data to guide its investment decisions. Moreover, it provides it with superior deal flow as well as access to a large and talented underwriting and recovery team that can lead to outperformance over time.
BXSL offers an attractive and sustainable yield along with the 4% discount to NAV at present in the share price. As such, BXSL looks like an attractive and relatively conservative way to invest in a sustainable double-digit yield, as further elaborated on in our full investment thesis .
#3. Vornado Realty Trust Preferred ( VNO.PM , VNO.PL )
The office real estate investment trust, or REIT ( VNQ ), space has been crashing over the past year, with Vornado Realty Trust ( VNO ) stock crashing alongside peers like Boston Properties ( BXP ) and SL Green Realty ( SLG ):
The selloff has not been without warrant, as the concerns for the sector are very real:
- Overbuilding in some markets being exacerbated by the increasing shift to work from home, reducing demand for office space.
- A slowing economy leading to growing layoffs at many firms, further reducing demand for office space.
- Higher interest rates and tightening lending standards pushing office property cap rates higher while also increasing the risk of defaults on asset-level loans along with more challenging and costly debt refinancings.
That said, VNO is one of the blue chip office REITs with trophy properties in one of the world's greatest cities (New York City). As such, many of its assets are still enjoying strong occupancy numbers with lengthy lease terms from creditworthy tenants and are well-positioned to weather a recession.
It also has an investment grade balance sheet and is in position to weather upcoming debt maturities. The company is trying to sell off some assets that it believes it should fetch a pretty decent valuation for. In a worse case scenario in which these properties fail to catch a bid, VNO can always hand some property keys back to lenders and lean more heavily on its credit facility as it has plenty of liquidity.
While a bad scenario playing out could impair the value of the company and limit the amount that VNO common stock might recover in the future, the preferred shares offer far greater security and a very well-covered ~10% dividend yield to boot. Furthermore, the preferred shares could see near 100% upside in the event that they eventually recover to par. For more on the challenges facing office REITs right now, check out our recent real estate update here .
#4. NuStar Energy L.P. Preferred ( NS.PC , NS.PB )
These floating rate preferred equities have performed exceptionally well in recent months as their rising distribution rate reflects the rapid rise in interest rates over the past year. As a result, they offer a distribution yield well north of 10% and the preferred unit price has appreciated substantially as well.
While it no longer offers the meaningful discount to par value that it once did, the total return profile remains attractive given the yield. As such, they continue continues to serve as a source of very safe and lucrative current income as well as a way of hedging against rising interest rates given that its yield increases with interest rates. Moving forward, we expect the distribution to only grow safer as management continues to focus on deleveraging the balance sheet.
In Q4, NuStar Energy L.P. ( NS ) management continued to progress on its balance sheet strengthening efforts by redeeming more of its Series D preferred units while its strong EBITDA performance resulted in further reduction in its leverage ratio. As management stated in the Q4 results:
We ended the fourth quarter of 2022 with a debt-to-EBITDA ratio of 3.98 times. Our total debt balance was $3.3 billion, and our revolver facility availability was over $775 million of the facility’s $1 billion capacity.
In November, we were able to repurchase about one-third of our Series D preferred units while keeping our debt-to-EBITDA ratio under 4 times for year-end 2022. As we mentioned last quarter, we are now positioned to accelerate our timeframe for addressing the Series D preferred units by completing the redemption in 2024, which is several years ahead of our previously scheduled timeframe. This redemption is another important step in our ongoing optimization and will meaningfully increase our cash flow over the next few years.
The reduction of its outstanding Series D units and the expected completion of this redemption in 2024 is a significant boost to the safety of the NS.PB distribution because by reducing the outstanding preferred units - even from a different series - the overall distribution payout burden at the preferred distribution level is reduced, thereby improving the coverage ratio for the preferred distribution meaningfully. For a further nuanced analysis of the safety of the preferred distribution, check out our full investment thesis here .
#5. Oaktree Specialty Lending Corporation ( OCSL )
Finally, OCSL is a business development company that - similar to BXSL - invests largely in senior secured loans to middle market businesses.
OCSL also offers a very attractive dividend yield of 11.9%, trades at a discount to its net asset value, and is expected to cover its dividend 1.11x with normalized earnings per share this year.
Given its exceptional underwriting (powered by the legendary Howard Marks' team at Oaktree and its new ownership by world class alternative asset manager Brookfield ( BN , BAM )), conservative portfolio positioning with the vast majority of its investments in senior-secured debt, and investment grade credit rating, OCSL is better positioned than many other high yielding common equities to weather an economic downturn and support its dividend.
Another big reason to be optimistic about the safety of OCSL's dividend is that the company has raised its dividend so aggressively for an extremely impressive 11 consecutive quarters. After speaking with management recently, we are even more confident in the company's conservative approach to underwriting and managing its balance sheet.
Investor Takeaway
While interest rates are high and the economy appears to be teetering on the edge of a recession, high yield investors still have plenty of opportunities before them.
At High Yield Investor, we are investing in dozens of opportunities similar to the five discussed in this article, which we believe will continue to generate attractive income for us in the coming years while also fueling continued outperformance .
For further details see:
Buy Alert: 5 Sustainable And Undervalued 10%+ Yields