Sunday, August 16, 2020

The flight to quality - Northrop Grumman

Well it took us forever, some might say a ridiculous amount of time considering how long it's been since the March lows but we finally made it.

We opened up a sizable position in Northrop Grumman (NOC)

By rights we should have just got on with it back in March and been done with it but it was just a high price to pay, it was too off-putting to pay that much. Or so we thought back then.. So what changed our minds and convinced us to to buy it in the low 300's? Way more than the 280 we should have got it for?

A fresh mindset change has a lot to do with it, a major brain shift away from companies that have just gotten too frustrating. I think we're still just a little fatigued with our investments in companies where the business model has been affected so rapidly by the pandemic and if we're being honest at 170 companies the portfolio was getting a little portly and could easily shed a few pounds.

Something we can also point to is perhaps more of a fundamental investor maturity shift too. I think you can only mutter the line "phew, in-line dividend for another quarter" so many times before you genuinely start to ask yourself aren't we all better than this? Personally it's getting old checking for or trying to predict the next dividend reset.

But the type of high quality stocks we're talking about don't honestly pay a fraction in yield to our outgoing REIT's and big oil. Sorry, it is what it is.

Yes, but that's where they got us anyway. It was pretty much a fools errand to look at that high yield in resetters like WELL, EPR and VTR and believe they were going to weather a condition as extreme as this pandemic. But for each of these you have an OHI, NNN or NHI hanging in there pretty well. So yes, agreed it's a lot harder to pick longer term winners nowadays than it looks, they might look the same but they don't taste the same.

A lot of the trades from back in March have now actually been dropped (in the green thankfully) to continue purchases in what we view as higher quality names. Additional to our Honeywell, Raytheon, L3, Parker-Hannifan, Norfolk Southern, Wisconsin Energy and Home Depot purchases back then we have now added more utilities like PEG, AVA, Hawaiian Electric Preferred's (HAWEL and HAWEM) not to mention more names such as US Bancorp (USB) , Automatic Data Processing (ADP) and the Preferred's of Popular Bank in Puerto Rico (BPOPM and BPOPN) as well as Becton Dickinson (BDXB)

The backbone of the portfolio has to be strong otherwise the entire thing just flops over..

The advantage of BPOPM and BPOPN being that these are monthly payers which means we see a more regular dividend flow like we get from the Gladstone family of Preferred's (GOOD,GAIN and LAND) love those monthly payouts.

The Preferred's in these cases trade extremely thin and can go weeks with 0 volume but it seems like that's life with these, they just aren't your run of the mill regular trades covered by the TV networks and Seeking Alpha pundits and comments section rotten tomato throwers.

But getting back to Northrop Grumman. I realize we're getting emotional about stocks again, but it has to be said, awesome company. Started out as Grumman Aerospace which produced some stellar military aircraft some of which transitioned to become Gulfstream aircraft under General Dynamics. Having spent time on the old G450 production line I can vouch that Grumman produced some outstanding product which GAC then proceeded to build it's name on, over-Engineered if anything. The type of over-Engineered quality we now ourselves figuratively look for in the portfolio.

But like us in many respects Northrop then dropped the volatile, cyclical side of the portfolio to focus on it's core competencies. Pretty much the same thinking that gave Lockheed it's current success, they dropped the civil side and kept the gold mine. This is likely to make GD itself a screaming buy if and when they choose to spin off Gulfstream in our opinion. Same for Boeing Defense and Space, the place is like a flowing money stream getting dammed by the volatile passenger aircraft side. It's hard to summon up the interest in BA until we can get our hands on BDS alone and that X-37 not to mention that AWACS fleet. Now there's a poster child for a quality dividend!! Salivating at the thought...

Post Gulfstream though the company has become a solid and well diversified military player alongside the likes of Lockheed Martin, L3, General Dynamics and Raytheon with stellar cashflow and a conservative dividend to boot.

As with all these diversified military corporations though does the current 1.71% dividend set the world alight? No but that is the key reminder that Covid has re-iterated, diversified cashflow and lots of it with a conservative longer term growing dividend and low debt are the components we need to still see in all our investments moving forward. Fact is they always were but to our discredit the guard dropped in the euphoria of FIRE passive income and a lofty stock market, we can now never let our guard drop through greed from the lure of a tasty yield ever again. Quality quality quality..

The only further question, valuation will only be resolved with a decision on the occupant of the oval office which could initially affect valuation to the positive or negative making NOC a buying opportunity or a long term hold. Without the benefit of a crystal ball we really cannot answer that one right now.

Long NOC, LHX, GD, RTX, PH, HON, NSC, WEC, HD, BDXB, ADP, PEG, AVA, OHI, NNN, NHI, HAWEM, HAWEN, BPOPM, BPOPN, GOODN, LANDP.

Happy investing!

Love to all,

DD4L










Thursday, August 6, 2020

Oil's well that ends well?


It's an interesting and dynamic world we live in from an investor perspective, it's like the ground is constantly shifting beneath you. The main challenge seems to be adapting your portfolio to the changing dynamic while trying to not be too fearful and triggering an over-reactive sell or series of sells that you may later regret.

Well, that might just have happened here at DD4L but the following maybe will turn out to be the right decision, only time will tell.

This quarter we sold out of all oil stocks, even the historically strong balance sheet widows and orphans stocks that you would think could stand the test of time. Companies like Chevron, Phillips66, Marathon, heck even BP and Exxon weren't spared the big sell. Not even partial sells, this was the whole lot gone.

With respect to BP though they did follow suit from Royal Dutch Shell and cut the payout in half so that sell was inevitable under our new rules.

But per the title of our last post we can't help feeling this time it's different...so here's the reasoning..

The whole oil landscape has a lot of moving parts going on, the switch away from taking fossil fuels out of the ground is seemingly happening at an accelerated rate under the Covid shakeup which as we know by now has led to wholesale dividend resets.. Think more Biomass, Wind and Solar, sucking carbon dioxide out of the air to make fuel rendering it a carbon neutral process.

Whatever your belief system though all this is happening and all our oil majors are getting on board, the UK and EU companies have just been first in line but we can't help believing in the fullness of time this is the path the US will take under an eventual democratic presidency, be it next term or the term after that. The decision is do you get on board now and take the pain of removing that income stream or wait for it to be forced on you? Looking at Dominion Energy it's already happening in some areas there too regardless of the political landscape.

Covid has also accelerated the slow death by a 1000 cuts of the oil majors' free cashflow by forcing worldwide corporations, who maybe wouldn't have otherwise to realize the economic advantages of having employees work from home. Ok so maybe not everyone will adopt this new way of working longer term, some corporations will always want to micromanage their workers and stand over their shoulders 24/7 to get their money's worth but some percentage will inevitably stick. The cost advantages dictate it has to to some degree.

The issue with staying long the oil majors is this exact point, it only takes a certain percentage take up of the work from home model on a longer term basis to disrupt gasoline and oil revenues on a more permanent basis. We've all heard the return volley that the world will always need plastics and this is true but those are not the key source of revenue for big oil, you driving your car to and from work is.

So the gamble seems to be on the investor to decide the future vision of how many commuters there are going to be on the roads and what percentage of corporations are going to be happy to let employees pay the office rent/electricity/water/bathroom cleaning bills at home rather than have them on the hook for it. It's a question of if the new habit sticks or not.

You can easily see how tricky the whole decision becomes. If a few corporations see a huge benefit then it's likely you'll be working from the spare bedroom for the rest of your career, maybe show up at a much smaller office, even a Starbucks twice a month for face to face meetings?

Add to this trend the transition to renewable energy and a reset with a subsequent new lower cashflow norm and the days of the big dividends are then most likely behind us. We pretty much accelerated the next 20 years of demise into a concentrated couple of months. Wow, that was fast.

So where to go next? What does life look like beyond big oil if you choose to not stay the course as the long term transition occurs?

From our own perspective the transition has been to simply pivot from oil to quality utilities and their Preferreds. This is purely based on the fact that the work from home economy requires more electric and natural heating gas versus gasoline/oil, same goes for the longer term transition over to Electric Vehicles.  It is just our opinion that longer term the regulated utilities will be more critical to the economy moving forward than the oil majors, the way we see it we can either tear off that band-aid now or do it later when the latter has a potentially even lower stock value.

Even with Elon Musk are EV's there right now? Not really but with the lower cost automotive majors committing to zero hydrocarbon vehicles by specific dates then it's just a matter of time before the EV becomes the mainstream. Companies like Honda motor have already made the commitment and you know they will keep to it.

Ironically as far as Royal Dutch Shell goes no sooner had we dropped the name from the portfolio when back it comes into our life...

For our new life here in Isle of Wight UK we are using Shell Energy as our Electric and Gas utility, using 100% renewable energy and they are the cheapest supplier in the country right now. The irony is not lost on us, we lose a dividend and gain a cheap utility supplier..

Along with the oil majors we have also utilized the same thinking to address our investments in Cracker Barrel (CBRL) and Las Vegas Sands (LVS) and the shopping malls of Simon (SPG) and Tanger (SKT). In a similar thought pattern it's worth giving some thought to whether these segments will see the same traffic volumes due to enforced new Covid habits. In lockdown a lot, maybe some who would never have bothered with online shopping before have now been forced down that path such that they now see the convenience more than pre-Covid. Will this new habit stick in the post-Covid world is the question and therefore risk? As an investor the question is whether you are happy to carry that risk from here.

We don't doubt for a second that these businesses will bounce back post-Covid and the revenues will return somewhat, it is just a question of to what degree and if they will ever reach pre-Covid levels again? If the baby boomer generation or anyone deemed unhealthy in some way continues in the new habit form of refusing to take the risk and doesn't return then to what extent will revenues be affected longer term and will the younger generations make up for those numbers? Picking winners that suit the younger, healthier demographic will be critical.

These uncertainties led us to sells in not only the oils but also the malls, gaming and certain non-younger, millennial generation friendly (ie doorstep delivery service) restaurants. Did these moves cost us some level of diversification? A wholehearted yes to be honest and that part is a little concerning since we feel that diversification has really aided us through the Covid crisis.

In conclusion it is understandable that our sells in these areas could be deemed an overreaction which we perhaps could live to regret but in retirement we seem to have become considerably more risk averse when it comes to loss of income streams and the need to sell down the line at a lower price.

If this means that we choose to play it safer with the regulated utilities and Preferred shares from here then so be it. It's a whole new world we are now potentially adapting to, one that we never could have predicted back in the first couple of months of this year and definitely nothing we have been forced to adapt our thinking to in our lifetimes. Sitting tight through it and doing nothing may not be a good enough response anymore like back in the housing crisis of 2008.

Love to all,

DD4L