Exelis (NYSE: XLS) is a top-tier defense, aerospace, and technical services company with a very diversified set of product and service lines. Headquartered in McLean, Va., the company employs about 20,000 people and generated 2012 revenue of $5.5 billion. Some of the industries where the firm is a major force are communications, surveillance, electronic warfare, navigation, air traffic solutions and information systems.
The company is on the cutting edge of 21st-century warfare technology. It has developed equipment for detecting and disarming improvised explosive devices (IEDs) and is one of the leaders in producing the night-vision goggles used by military personnel around the world.
The stock has been somewhat underrated because a lot of its business comes from defense contracting, and everyone knows that the federal budget "sequester" has put a squeeze on Pentagon spending. But the company's diversified portfolio enables it to survive temporary downturns in any one segment. Also, Congress and the president have been talking about replacing the sequester system with a more measured approach to budget cutting.
Exelis recently reported third-quarter 2013 revenue of $1.1 billion, compared to $1.4 billion in the third quarter of 2012. Operating income was $133 million and net income was $0.41 per diluted share, compared to $143 million and $0.47 per diluted share during the same period in 2012.
Orders received in the third quarter of 2013 totaled $2 billion, a 48 percent improvement from the third quarter of 2012. Highlights from the quarter include announced awards of more than $140 million in communication systems and night vision equipment for international customers and low rate initial production orders totaling $60 million for carriage and release systems for the F-35 Lightning II. Also announced during the quarter was the delivery of an integrated, super-spectral payload to DigitalGlobe for the WorldView-3 satellite.
"During the third quarter, we demonstrated success in utilizing our installed base to drive strategic new orders," said Exelis CEO David Melcher, a former three-star general. "In spite of complex economic pressures, our customers continue to value our ability to deliver mission critical and affordable products and services. We continue to align our business to the dynamic market environment and enable future investment in our growth platforms."
Exelis is a recognized leader in its field. About six months ago, President Obama met with a dozen top CEOs to discuss growing concerns about cybersecurity, and to enlist their support for proposed legislation to combat the threat of computer warfare. Among the select group were Jamie Dimon of JPMorgan Chase, Randall Stephenson of AT&T – and David Melcher of Exelis.
The company's Information and Technical Services third-quarter 2013 revenue was $643 million, compared to $750 million in the third quarter of 2012, primarily due to decreased activity on Afghanistan contracts, partially offset by increased activity in Federal Aviation Administration programs. Segment operating income for the quarter was $64 million, compared to $59 million for the same period in 2012, driven by contract productivity improvements and strong contract performance resulting in higher award fees.
The company anticipates generating free cash flow in excess of $225 million after making pension contributions of approximately $146 million.
As the Pentagon spigot has been closed somewhat, Exelis has increased its efforts to find global customers for its military solutions. It was awarded a contract valued at $28 million to provide i-Aware Tactical Mobility Night Vision Goggles to an international customer (the identity of the customer is classified). Delivery is scheduled to take place during 2014.
The i-Aware product is an advanced, multipurpose night vision goggle that connects individuals to the larger battlefield network, enhancing situational awareness for both the soldier and command and control elements. Other features include video import and export capability, view ing GPS, mapping, command text messages and target information with video input from weapon sights to view around corners.
Additionally, even in an era of relatively restrained U.S. military allocations, Exelis has been adept at winning new contracts. It was recently awarded a military sale contract valued at $115 million to provide an existing international customer with additional communications equipment, spare parts, ancillary devices and operator training.
Communications equipment acquired under the contract includes the SpearNet radio system with accessories, the RT-1702 SINCGARS (Single Channel Ground and Airborne Radio System) in the VRC-90 System, and the VRC-92 Dual Long Range Radio System configurations with installation kits and spares to support both systems. Also included in the purchase are PRC-119 Manpack Radio Systems with GPS and Spearhead handheld radios systems with accessories. Spare parts for all radio systems are included along with SpearNet training for both the vehicular and soldier radio systems.
"This is a key award for Exelis," said Nick Bobay, the president and general manager of Exelis Night Vision and Tactical Communications Systems. "Our widely fielded and combat-proven SINCGARS continues to be the communications backbone for this force, and they are now integrating our SpearNet into their network as well. This is a tremendous vote of confidence in the breadth of communications equipment that Exelis offers."
The company has also been awarded a $20.6 million contract by General Atomics Aeronautical Systems Inc. of Poway, Calif., to produce the BRU-71/A ejector rack for the Predator B/MQ-9 Reaper remotely piloted aircraft. Under the contract, Exelis will produce more than 500 BRU-71/A units for deployment on U.S. Air Force MQ-9s.
Exelis has a long track record of finding markets for its products and solutions, which makes the stock a strong investment.
Tom Scarlett is an investment analyst at Personal Finance and its parent web site Investing Daily.
Then compare it with the 1,136% total return of Enterprise, a gas utility.
Comparisons like this make a clear point: "Boring" power and water utilities offer giant gains and high-yield dividends for the investor that outdo "exciting" tech companies — even Yahoo, IBM, and Amazon.
Management of Atlantic Power Corp (TSX: ATP, NYSE: AT) reported third-quarter and nine-month operating and financial results that in a vacuum were solid.
But management's prepared remarks and answers to analysts' questions during the company's third-quarter conference call on Friday, Nov. 8, leave very open the distinct possibility of another dividend cut announcement in early 2014.
Project-adjusted earnings before interest, taxation, depreciation and amortization (EBITDA) for the third quarter were up 32.7 percent compared to the prior corresponding period to USD76.2 million, and the nine-month total was up 24.9 percent to USD213.3 million. Both figures were slightly ahead of management expectations.
Cash available for distribution for the quarter was USD37.9 million, up 33.9 percent from USD28.3 million a year ago. On a year-to-date basis distributable cash was up 8.8 percent to USD109.9 million, already topping management's full-year guidance of USD85 million to USD100 million.
The quarterly payout ratio was 29 percent, down from 120.1 percent a year ago. For the first nine months of 2013 the payout ratio was 42.9 percent, down from 98.1 percent for the prior corresponding period.
Atlantic has also narrowed its 2013 project adjusted EBITDA guidance to USD260 million to USD275 million, at the upper end of a prior range of USD250 million to USD275 million. Distributable cash is tracking to USD85 million to USD100 million; management expects a negative figure in the fourth quarter due to the timing of interest payments and stepped-up capital expenditures.
Distributions for the year will be approximately USD60 million, for a full-year payout ratio of 75 percent to 75 percent.
As for operations, Atlantic reported an availability factor of 94.9 percent for the third quarter and 94.3 percent for the year to date, both down slightly compared to 2012 due to scheduled outages at several projects and low initial availability at the Piedmont biomass facility in Georgia, which came online in April 2013.
Generation increased 44.2 percent in the third quarter to 2,184 net megawatt-hours (MWh) and was up 40.3 percent to 6,173 MWh for the first nine months of the year due to the addition of new projects, including Canadian Hills, Meadow Creek and Piedmont.
Output from the Canadian Hills and Meadow Creek wind projects were lower than forecast for the third quarter, but management noted strong wind conditions at Canadian Hills in October.
The Curtis Palmer hydro facility reported high water levels in June that continued into the third quarter, though Mamquam experienced lower water levels and a scheduled outage. Generation from Nipigon and Morris was limited by scheduled outages.
Overall, on a year-to-date basis, generation from Atlantic's wind, hydro and thermal facilities are slightly ahead of expectations.
The rub is that we're dealing now with an investment thesis that's dramatically different than the one that Atlantic Power supported as recently as November 2012, when CEO Barry Welch indicated the then-current annualized dividend rate of CAD1.15 was sustainable, based on the company's ability to re-contract now-sold Florida projects.
The short story, including a downturn in the Ontario wholesale power market and additional re-contracting difficulties for the New York-based Selkirk project, is that in February 2013, along with its announcement of 2012 results, management cut its 2013 project-adjusted EBITDA guidance and eviscerated its dividend.
The new, lower guidance and the 65.2 percent reduction in the annualized dividend rate to CAD0.40 per share blew several holes in multiple aspects of the Atlantic Power story, most importantly destabilizing its position as a retail-investor-focused dividend payer and undermining the credibility of senior management.
At the time of the February 2013 dividend cut we identified five benchmarks that would guide our continuing evaluation of Atlantic Power and its position in the Canadian Edge and Utility Forecaster portfolios.
(Because of the payout cut we did move the stock from the UF Income Portfolio Aggressive Holdings to the Growth Portfolio Aggressive Holdings and from the CE Portfolio Conservative Holdings to the Aggressive Holdings.)
The five criteria were:
Successful completion of the sale of the Florida plants at the stated price.
Successful syndication of the Canadian Hills financing.
At least one new project announcement.
Successful completion of the Path 15 power line sale.
Payout ratio in line with guidance.
Management has hit four of the five criteria, but, as we noted when Atlantic reported second-quarter earnings in August, there is not likely to be a new project announcement anytime soon. Management's focus is on "optimizing" performance at existing projects, with more than 100 potential projects with investments ranging from USD10,000 up to the USD11 million project at Nipigon identified.
Atlantic plans to invest approximately USD20 million during 2013 and 2014 on these initiatives and expects an EBITDA contribution on a run-rate basis in 2015 of at least USD6 million.
With all necessary approvals in hand, Atlantic is proceeding with the aforementioned Nipigon project, which involves the upgrade of a steam generator at the 40-megawatt combined cycle project in Ontario. CAPEX for this project is budgeted at USD11 million, with approximately USD2 million of to be spent in the fourth quarter of 2013. The outage to do the majority of the work is scheduled for the early fall of 2014.
Atlantic has also committed to expediting the installation of required upgrades at its North Island project in California, which recently secured an increase in interconnection capacity from 38 megawatts to 42 megawatts. Management plans to begin cash outlays for this project during the current quarter.
All told major maintenance costs for 2013 are expected to be approximately USD40 million, up from USD30 million to USD35 million previously.
Re-contracting in New York for Selkirk and in Ontario for the Tunis project remains problematic. A proposal for the former has been submitted, and preliminary discussions on the latter have been held. Power-purchase agreements covering both projects expire in 2014.
Atlantic Power's share price got hammered on the Toronto Stock Exchange (TSX) and the New York Stock Exchange (NYSE) last Friday and again on Monday because during management's conference call to discuss third-quarter results, it emerged that yet another dividend cut is among the potential outcomes of management's ongoing consideration of alternatives as it seeks to reduce debt and strengthen the balance sheet.
Management was reticent to discuss details of its still-evolving strategy to improve Atlantic's ability, noting that it's "considering a variety of options to address" near-term debt maturities, improve financial flexibility, reduce debt levels, optimize assets and reduce expenses.
Because they're "still in the process of evaluating all those potential alternatives" and "do not know which, if any" they'll be able to implement, those who participated in the call on Atlantic's end didn't want to reveal too much.
Management did note that one or more of the options being considered would, if implemented, result in a "significantly" higher 2014 payout ratio. The priority for management right now, however, is the balance sheet. And "these or other actions" it may take to achieve what it wants to achieve its financial objectives "could have an adverse impact on the dividend level."
Atlantic passed on an opportunity to provide 2014 payout ratio guidance. Management did note that it expects to provide an update on its plans during the first quarter of 2014. Also, as has been disclosed during previous quarterly reports, approximately USD37 million of cash available for distribution this year is from discontinued assets and won't recur in 2014.
Some balance-sheet flexibility could from the conversion of USD76.6 million of construction debt related to the Piedmont project to term financing before year's end. But Atlantic management, based on discussions with its lenders, expects to have to put additional cash into the project for credit enhancement until certain issues are resolved.
Among these issues is a dispute with the project's contractor, which is now in the discovery phase leading up to arbitration.
And following the anticipated conversion Piedmont won't be able to distribute cash until certain reserves are fully funded. Management maintains its USD6 million-to-USD8 million guidance range for cash distributions on a run-rate basis but doesn't' expect cash flow from the project to be significant in 2014 due to the needs of the project to fund these reserves.
A critical point that management mentioned during the second-quarter conference call remains unresolved: the company's outlook for compliance under its debt covenants.
Atlantic noted in August that it doesn't expect to meet the fixed-charge coverage ratio required under a restricted payments covenant on its senior unsecured notes beginning in the third quarter of 2014. Management did note that if it was to implement one or more the options currently under consideration, its ability to remain in compliance through the third quarter of 2014 might be impacted.
Non-compliance with the covenant doesn't constitute a default. But it does limit Atlantic's ability to pay common dividends in the aggregate to the greater of CAD50 million or 2 percent of net assets, which is currently CAD68 million. It would be at the discretion of the board of directors to continue with dividend payments through the use of the "restricted payments basket."
During the question-and-answer portion of the company conference call CEO Barry Welch emphasized that Atlantic hasn't "finalized any of these plans" and hasn't "looked at, or taken any decisions, with respect to the dividend."
In August Mr. Welch indicated that he didn't necessarily see the need for more dividend cuts. But management reiterated that its primary focus remains on its "high priority financial objectives," resolving its near-term debt maturities, establishing financial flexibility and reducing overall debt levels over time.
The secondary focus is asset optimization; management is investing in projects to boost generation capacity as a means of achieving some growth. But these efforts are putting an additional strain on cash flow.
Management reported unrestricted cash of USD171 million as of the end of the third quarter, which is net of the USD75 million required cash reserve under its amended credit facility. This USD171 million is up approximately USD50 million from June 30, 2013, adjusted to exclude the USD75 million cash reserve.
Additional liquidity is provided by the entire amount of the USD25 million borrowing capacity under its senior credit facility. As of Sept. 30, 2013, Atlantic had USD91 million of letters of credit issued but not drawn, with remaining availability of USD59 million as long as no borrowings are outstanding. Management expects year-end cash to be approximately USD145 million, building in the equity contribution to Piedmont and the cash outlays for optimization projects.
In the August 2013 Canadian Edge Portfolio Update, following management's release and discussion of second-quarter results, we noted that Atlantic has a solid collection of power-generation assets that could be attractive to a larger entity with a low cost of capital and low administrative expenses.
As of that writing the stock was trading at a price-to-book value of just 0.70 times. I noted that we would keep the stock in the CE Portfolio, advising investors with a long-term horizon to hold it but suggesting that those who opted to sell should do so into strength.
The stock price did bounce to as high as CAD5.43 on the TSX on Oct. 18 but has come crashing again in the wake of third-quarter results and management's discussion about 2014. On Monday it established a 52-week low of CAD3.89 before closing at CAD3.96.
As recently as Jan. 23, 2013, Atlantic closed above CAD13 on the TSX. The price-to-book value today, however, is just 0.68.
The best outcome would be for a better-capitalized entity to scoop up the portfolio in whole.
In difficult times, you want strong investments to withstand economic turmoil. One overlooked investment has clobbered the S&P 500 and led to wealthy retirements for savvy investors. For the past 10 years, they have crushed the market ELEVEN TIMES OVER.
For every $10,000 invested in the past 10 years, you'd have $39,100 today. That same $10,000 invested in the S&P 500 would be worth only $7,100.
These investments not only throw off huge yields but these yields are growing rapidly.
There were 14 MLP IPOs in 2007. Until this year, that was the record, but so far in 2013 there have been 15 MLP IPOs with perhaps more to come before year end. One of the more recent IPOs was Sprague Resources (NYSE: SRLP), which debuted on Oct. 25.
Sprague Resources is engaged in the purchase, storage, distribution and sale of refined petroleum products. The partnership also provides storage and handling services for a broad range of materials. Sprague is one of the largest independent wholesale distributors of refined products in the Northeast US, owning and/or operating a network of 15 terminals located throughout the Northeast. These have a combined storage capacity of 9.1 million barrels for refined products and other liquid materials, and 1.5 million square feet of materials handling capacity.
Location of Sprague Resources LP's terminals. Source: SRLP SEC filing
In the IPO, Sprague sold 8.5 million common units initially priced at $18, but the price has slipped since. The partnership forecasts a minimum quarterly distribution of $0.4125 per unit, or $1.65 per unit annually. As the most recent closing price of $17.60, that translates into a minimum annual yield of 9.4 percent.
Arc Logistics Partners (NYSE: ARCX) opened for trading on Nov. 6. This midstream partnership was formed by Lightfoot Capital to own, operate, develop and acquire a diversified portfolio of complementary energy logistics assets. The partnership is engaged in the terminalling, storage, throughput and transloading of crude oil and petroleum products. It intends to grow the business through the optimization, organic development and acquisition of terminalling, storage, rail, pipeline and other energy logistics assets that generate stable cash flows.
The 6 million common unit IPO opened flat at $19. ARCX plans to pay a minimum quarterly distribution of $0.3875 per unit each quarter, or $1.55 on an annualized basis. At the recent closing price of $19.04, this translates into an annual yield of 8.1 percent.
Midcoast Energy Partners (NYSE: MEP) is an Enbridge Energy Partners (NYSE: EEP)-backed LP that went public on Nov. 7. The partnership is a pure-play US natural gas and NGL midstream business with a 39 percent controlling interest in Midcoast Operating, a limited partnership that owns a network of natural gas and NGL gathering and transportation systems, natural gas processing and treating facilities and NGL fractionation facilities primarily located in Texas and Oklahoma. Midcoast Operating also owns and operates natural gas, condensate and NGL logistics and marketing assets that support its gathering, processing and transportation business.
The business primarily consists of gathering unprocessed and untreated natural gas from wellhead locations and other receipt points, processing the natural gas to remove NGLs and impurities at processing and treating facilities and transporting the processed natural gas and NGLs to intrastate and interstate pipelines for transportation to customers and market outlets. The partnership also markets natural gas and NGLs to wholesale customers.
The IPO raised $333 million by offering 18.5 million shares at $18. This was below the expected range of $19 to $21. MEP's partnership agreement provides for a minimum quarterly distribution of $0.3125 per unit for each whole quarter, or $1.25 per unit on an annualized basis. At the recent closing price of $17.83 this equates to an annual yield of 7.0 percent.
The Refining MLP Bloodbath
I warned last week that refiners would report relatively poor earnings for Q3, and refinery MLPs could take a hit, presenting a buying opportunity. On Nov. 6 Alon USA Partners (NYSE: ALDW) reported a loss for the third quarter of $16.1 million, or ($0.26) per unit, compared with net income of $120.4 million for the same period last year. Paul Eisman, CEO and president, cited the deteriorating margins that I discussed in last week's issue: "Our third quarter results were impacted by a volatile and deteriorating margin environment resulting primarily from decreasing discounts for West Texas crude oil."
As a result, the partnership announced that there would be no money available for a quarterly distribution. Unit prices fell nearly 10 percent immediately after the earnings release, and continued to drift lower from there before today's 9 percent rebound.
Calumet Specialty Products Partners (Nasdaq: CLMT) also reported a net loss for the quarter of $34.8 million, or ($0.54) per diluted unit, compared with net income of $42.4 million, or $0.69 per diluted unit, for the same quarter in 2012. Units traded down nearly 13 percent for the week.
Northern Tier Energy (NYSE:NTI) will report earnings this week. The partnership closed last week down less than 1 percent, but interested investors should find a cheaper entry point this week as earnings will undoubtedly be disappointing.
The government reports inflation at 1.8%. But it's really 9.4%. Here's why this is a big, BIG deal – your money's buying power is being robbed. 9.4% real inflation makes mincemeat of the pathetic returns on Treasuries, CDs and money market accounts. It even wipes out (if you're lucky enough to have them) solid 4%... 6%... and 8% dividend yields. All told, your money's purchasing value is shrinking 5x faster than the government admits. Upset? You should be.
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