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How am I doing? #2 July 3, 2009

Posted by shaferfinancial in Finance, Uncategorized.
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In my last post I talked about Berkshire Hathaway which makes up the majority of my equity portfolio.  Today I will talk about the other two I own.  Now I own Berkshire for capital appreciation and it pays no dividends so causes no tax obligations until it is sold at a profit.  But I have come to appreciate that for retirement income it is much easier to track dividend payments and makes much more sense if this is your goal to consistently move wealth into income producing products.  This should accelerate as you get older and closer to retirement.  This means that when the opportunity appears to buy fundamentally sound companies that give decent dividend yield growth you should avail yourself on these opportunities.  The obvious downside is that dividends cause taxation.  A Roth IRA can protect you against this taxation.  So if you are buying small amounts you could put it inside a ROTH and avoid taxes.  Make sure you have this planned well as their are rules and regulations to get your money back once put inside a ROTH.  In my case I have  some shares inside a ROTH and some outside which I pay taxes on.

Health Care REIT is one I have owned for 10 years.  I have recently added on to my shares since the price has gone down significantly.  For those who don’t know a real estate investment trust (REIT) invests in real estate and does not have to pay corporate income taxes.  By law a REIT must pay out 90% of income to its investors.  This provides the dividend yield.  HCN has paid out 152 straight quarters of dividends and it has increased its quarterly dividend from $.55 to $.67 (+22%)  since I have owned it.  Currently my dividend yield is 11% based on my cost.  The price of the stock is up 9% this last quarter but down 25% over the last year.  As I mentioned I did buy some more earlier this year.  If you bought at today’s price your dividend yield would be 8.2%.   I reinvest my dividends so that has ended up also purchasing some more shares at what I consider cheap prices over the last 3 quarters.

As to the particulars of the REIT, it invests in health care facilities ranging from acute care hospitals to retirement campuses that include housing, professional office buildings, assisted living, nursing homes and some times even hospitals, stand alone nursing homes, professional office buildings, etc.   Most of this real estate has long term leases associated with them.  My analysis points out that there is a large demographic reaching retirement age and as we go along an increasing need for these type of health care facilities.  The company has been moving from stand alone facilities to campus’s that retirees buy into. As they age they can avail upon themselves the various services as needed.  In other words they start out living in stand alone homes and apartments and as they age move into assisted living then nursing home/hospital facilities are used as needed.  These continuing care retirement communities (CCRCs) are becoming very popular because they solve many of the practical problems people face as they age.  At the same time HCN has lowered its ownership of freestanding nursing homes to 20% [38% in 2003].  The fund is leveraged at about a 1 to 1 level.  This fund has had no problems with their debt and have it guaranteed years into the future by the banks.  They have been acquiring more properties every year with 2008 acquiring $1.2 Billion in additional real estate.  From 2003-2008 they grew from $2.9B to $7.6B in enterprise real estate value.  The first quarter of 2009 brought $174million on board.  However, with the credit markets tough and expensive the rapid growth will be curtailed for 2009 and probably 2010.  The company will bide its time, horde cash, waiting for better capital markets and only take advantage of the best opportunities with identified financing available.   The debt service is 2 to 1 a very conservative ratio.  The FFO [funds from operation] for the 1st quarter was $.81 compared to $.79 from the year before.  So profits increased even in the recessionary environment.  Recently HCN was included in the  S&P 500.  This conservatively run REIT continues to perform well.  I will continue to purchase additional shares going forward at these prices.

The second investment is a new ownership stake for me.  The company Magellan Midstream Partners (MMP) is a master limited partnership which also avoids corporate taxation and passes on income directly to the investor.  There is also a depreciation write off to investors.  Therefore these are generally not good investments to put into tax deferred accounts.  I made a small investment in MMP at $30.50 earlier in the year.  The yield was 9.4% based on my purchase price.  Current price is $34.60 a gain of 13%.  But remember I am looking for yield more than price appreciation.  This partnership transports, stores and distributes refined petroleum products.  It has almost 10,000 miles of pipeline,  7 marine terminals and 27 inland terminals for storage of product.  The partnership has payed out quarterly income since it went IPO in 2001.   The payout is currently $.71 quarterly up 179% since IPO.  The main revenue generator is tariffs [amount of product flowing through the pipelines], of which approximately 40% of MMPs are determined by the government based on producer price index + 1.3%.  The other 60% is determined by market factors. The rest of the revenue is from storage fees and profits [or losses] between the arbitrage of buying and selling product [hedged with future contracts].  The company has added significantly to its storage capacity over the last few years.  In 2008 $265M was spent in adding storage capacity and additional pipeline.  There is also a serious investment being considered in a dedicated ethanol pipeline which would be have certain guarantees by the government backing it,  in conjunction with another pipeline company.  We will be looking for a decision on that toward the end of 2009.  2008 saw revenues decrease significantly due to the recession, but still revenue was $1.20 for every $1.00 paid out to investors.

My analysis points out that demand for petroleum products will be strong as we recover from the recession.  The partnership revenue comes more from volume of products rather than price so the huge variation of price we have seen is not particularly damaging to revenue as it is in traditional energy companies.  Seeing how the government has made ethanol production a large part of its policy the potential for an ethanol only pipeline could bring significant revenue increases in the future.  Long term the growth in petroleum products might slow down as the cafe standards come on board, but the product mix is not solely dependent upon gasoline sales but includes diesel, jet fuel, ammonia, etc.  As additional refinery capacity comes on board [and it is coming on board] Magellan has been able to connect it with both storage and pipeline to Houston, Dallas and Denver areas.  I expect the income payout to remain steady for the next 5 quarters and then start increasing again at that point.   I am considering additional purchases going forward as my cash flow allows.  However,  I consider this a more risky investment than either Berkshire or HCN.  But I see great potential for double digit returns in the 12-18% range just from yield in the near future from this investment.

So with those three investments [BRK, HCN, MMP] I believe I am diversified by asset, yet concentrated enough to earn well above average returns.  Berkshire alone has retail products, insurance and other financials, manufacturing around the world, and energy.  HCN is  specialized real estate for a large aging demographic.  And Magellan is petroleum volume oriented.  I welcome any comments on my analysis either macro or specific to the three companies.

I believe all three of these companies bought at these prices have a great margin of safety built in them.  Since they are all creating great cash flow during this down period of time for our economy and represent products and services with superior growth potential as our economy comes out of the recession, I am extremely comfortable owning them.

Note: saw this post on diversification from a financial planner.  Seems I am not the only wolf howling at the full moon of diversification nonsense.

Next post will discuss the rest of my investments.

***************This blog and this post represent my thinking on personal finance/investing.  It is for the amusement of the author and its readers only and does not in any way reflect actual investment advice.  Do not ever invest based on advice from any blog or any financial advisor.  Always do your own due diligence and make decisions based on your own analysis.*******************************

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Comments»

1. Joshua - July 6, 2009

Another great post! I really like how you summed everything up at the end to show how the true diversification works.

Will the next post for the “rest of your investments” be in regards to real estate purchases or the possibility of such?

2. investmentblogger - July 6, 2009

Great post David. Its good proof that one can be concentrated in a few stocks, but still be somewhat diversified (which doesn’t necessarily mean owning 10+ stocks). I look forward to your next post, which I’m sure will include other non-stock investments to show what REAL diversification is (not what is spoon fed to the public – own 10+ stocks or diversified mutual funds)!

3. shaferfinancial - July 7, 2009

Thanks, after reading the next and final post give me some feedback on specifics. I am always looking to learn and discuss.


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