Saturday, November 1, 2008

Late Friday Buys: LNC and GXP

In a prior post, I confess to being guilty to some hyperbole when I said the main reason for owning the common stock of a REIT rather than the preferred was the possibility of dividend increases. Notable News 10 30 2008  This is an overstatement.  It is one important reason.  With the reductions in  common stock dividends occurring frequently now, and given the preference rights of the preferred issues and their cumulative nature, the preferred dividends at the currently depressed prices look far more attractive to me than the common stock dividends for an income investor.  As I said in that post, the common stock dividend would have to be eliminated before the preferred stock dividend could be reduced or postponed, and the company still owes the postponed preferred dividend.  Before the REITS began their current meltdown in prices, many of them were selling for more than their properties were worth according to evaluations made by independent firms such as Green Street Advisors.  I do not have access to their numbers.  I would strongly suspect that most of the REITS are now selling far below the value of the properties unless they were forced to sale those properties in the current depressed market. Last week, First Industrial, had a market capitalization of  only 250 million before doubling in price before the close.  If I had a few hundred million lying around, earning treasury bill rates, which I do not of course, I would have bought all of the shares that I could find in the low 5 dollar range with the intention of building up a sizable stake.   So the other benefit of common stock is that you have an equity interest in the business.  If someone came in next week and offered 15 for FR, the common shareholder who bought at 5 would benefit. The preferred shareholder might be worse off particularly if the buyer is leveraging up the company to make the purchase.  All of the common stock could be acquired and the preferred shareholders would receive nothing other than their dividend.  The preferred shares might even stop trading on the exchange after the completion of the acquisition which happened a few years ago when Innkeepers, a hotel REIT, was acquired.   Any sale of Innkeeper's preferred now would have to be by private appointment on the pink sheets.  So I engaged in a little hyperbole about the reasons for holding the preferred over the common.  You do have to remember that a preferred stock is treated as equity rather than debt on the balance sheet but a preferred shareholder has no equity in the business.  Instead,  preferred stocks simply has  preference rights over common stocks as to their respective claims on dividends and in the event of bankruptcy.   

I added to my existing position in Great Plains Energy (GXP), an electric utility operating in Kansas and Missouri, at 19.25.  With interest rates falling, the dividend yield paid by this electric utility looks attractive.  At my 19.25 cost, the current yield is about 8.7%, significantly above most utilities.   I can find many investments now that would give me that yield or even higher that would not have the favorable tax rate currently associated with common stock dividends which is 15%.  At 15%, the after tax yield of 8.7% is 7.395%.   Interest would be taxable at the highest marginal rate.  For someone at the 30% marginal tax bracket, you would have to find a security paying an interest rate of more than 10% to equal the after tax yield of the dividend from Great Plains.   This is one consideration.  Another is that I can reinvest the dividends to buy additional shares at no cost to me, and I would do this as long as the price stayed below 25.  The current price was touched during the last bear market in September 2002. By February 2004, the stock had rallied to almost 35 from 19.25.   Interestingly, the bottom prior to the low in September 2002 occurred in June 1994 at around 19.12.  While I am not a chartist, I do note that this level has held twice over the past twenty years and rallied significantly off the low 19 level in both 1994 and 2002.   Earnings for next year are estimated at $1.72GXP: Analyst Estimates for GREAT PLAINS ENERGY - Yahoo! Finance  If that holds true, it is certainly a drawback, not so much on a P/E basis but on the basis of dividend coverage.  Almost all of the earnings are going to dividend payments so there is no room for dividend increases and the possibility of a dividend cut can not be ruled out.  That is the rub. 

I have several reports on GXP that I reviewed prior to making this last add.  Argus has a buy on the stock with a $31 price target.   I am certainly willing to hold until it gets to around 30 and that is my long term goal for this position, collect the dividends for 3 to 5 years, reinvest them until the price exceeds $25  and then take them in cash, and lastly sell all shares whenever the stock approaches or reaches 30.  If that occurs within five years, I will be satisfied.  I would be very happy if it happened in two years.    That is my plan but plans change.  I try to have a plan going into any position which may of course be modified by subsequent events of sufficient importance to cause a change in the plan.  Argus does have a higher estimate for 2009 than the consensus.  I also reviewed the Ned Davis report and that company has a buy on GXP too.  Value Line is much more negative on GXP with a very low estimate of $1.55 in earnings for 2009, but Morningstar has it rated four stars.   

Other considerations that need to be evaluated are that GXP recently acquired another electric utility, Aquila, so there may be integration problems; and  Aquila also had higher cost debt than GXP which had to be assumed in the merger.   Other issues include the following. The current price is around book value.  GXP is also building a large 850 megawatt coal plant that may end up costing 2 billion at current estimates.  This kind of massive capital expansion can have cost recovery issues down the road with the regulatory commissions that have to approve these additions to the rate base.  Earnings for the last quarter were less than reassuring.Great Plains Energy Announces Second Quarter Results: Financial News - Yahoo! Finance  Part of last quarter's problem was an outage at the Wolf Creek Nuclear plant which caused the company to purchase power at higher costs on the market.  Outages for nuclear plants, forced or for routine maintenance, happen regularly.  So, like a lot of investments, this one has pros and cons and for me the pros outweigh the cons.  My view would change in the state regulatory commission disallowed significant parts of the capital costs GXP intends to incur over the next four years, the size of these expenditures might double its existing plant.

I also bought, and I am not ashamed to say this, 30 shares of Lincoln National (LNC) at 16.93, as a starter position. (I do have a starter position of 50 shares in Walgreens per my earlier post but the price has risen above my plan for adding more, which is how I approach everything now with a lot of discipline, see post from October 17th: SARAH and the Cook Inlet Beluga Whales/WALGREENS AND REFINERS).  I digress.  This is part of my discipline.  I will buy more on the way down to reach 100 or 200 shares with these issues but I am not going to chase anything up.    For Lincoln, I will average down with 1 more 30 share purchase at 14 and the final 40 share purchase at 10 to 12.  Otherwise, if those targets are not hit, I will just hold onto my 30 shares.  I take some comfort in having 250 positions, bonds, stocks, mutual funds, etfs, closed end funds, plus cash.  I am not trying to hit a home run or even a double with any single position.  A max position for me is not so much based on the number of shares but the total value, with a maximum value of $10,000 in a single position.  That is the most that I am willing to lose by making a bone headed decision.

The dividend yield at my cost is close to 5%.  In mid 2007, Lincoln was over 70 dollars a share. You have to go back to early 1995 to find it selling for $17 bucks.  Does this start to sound familiar?  I read all of  the reports from S & P, Morningstar and Value Line.  I am familiar with the problems in the life insurance industry now, particularly those companies like Lincoln that sell variable annuities. MarketWatch  Part of the problem  is related to the rapid and steep decline of the stock market and investments gone bad in corporate bonds.  If you think the stock market will continue to suffer significant declines, then life insurance companies with significant variable annuity businesses are not the best place to go shopping.  Just read the recent news about Hartford and Prudential.  The analysts ask them about the adequacy of their capital and basically they say they do not know.   While these answers may be accurate with the severe downturn in the market, the arcane nature of insurance accounting for variable annuity contracts, and the unwillingness to predict what may happen next, they scare the pants off institutional investors as judged by the recent stock price declines in these companies.Seeking Alpha This is an opportunity for me to buy in small increments and then wait to see what happens next.  

   I am not a financial advisor but an individual investor trying to navigate my way through a mind field. In these posts, I am acting as an unpaid financial journalist and an occasional ornery political commentator.   I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine.  Any discussion made by me of particular securities  is not a recommendation to buy or to sell.  Trade at your own risk.  Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons.  The sale may before or after the post.  Before buying or selling any stock, even one recommended by a trusted financial advisor,  please research it and make up your own mind which is what I always try to do.  Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news.  In this post, and all others by me, I am merely describing my reasons for purchasing  or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale.  The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile.  Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments.    

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