Riding the Fed Higher

In This Issue: Riding the Fed Higher Kinder Consequences a Question of Timing Canada's Economy Gains Traction Last Chance to Get Into This Cash Machine at the Original Low Price! The most reliable cash-generating service we have ever offered is closing August 24. Why are we shutting down such a popular service? Precisely because it is so popular. We've had a surge of new subscribers in the past few months and are nearly at the 1,000-subscriber limit we imposed to make sure every subscriber gets personal attention. Learn more about how 972 current subscribers collect extra income like $1,300, $1,950, or $2,700 several times a month. Click here before it's too late. Riding the Fed Higher 8/22/2014 By Benjamin Shepherd While we have no way of knowing for certain when the Federal Reserve will begin hiking interest rates, we all know it's coming. The minutes from the latest Fed meeting, released earlier this week, showed officials debating an earlier-than-expected move as the employment situation continues to improve and inflation is ticking up. Since rates have nowhere to go but up, Fed Chairwoman Janet Yellen said that her emphasis is "naturally shifting" to when, rather than if, to raise them. That's good news for insurance companies, whose shares have generally lagged the broader indexes since the market bottomed in March 2009 precisely because rates have been so low. Instead of sitting on the premiums they collect and hoping for the best, insurance companies invest that cash mainly in highly rated bonds. As a result, their earnings are mostly derived from the spread between their investment returns and what they pay out in claims, known as the float. Needless to say, earnings have been under pressure for more than five years, especially as insurers have been competing fiercely for business. Chubb Corp (NYSE: CB) is one of the largest property and casualty insurers in the US, collecting more than $11 billion in premiums each year for more than a decade now. In an average year, more than half of Chubb's net income is made on from the float on its bond portfolio, with about a third coming from its underwriting activities and less than 10 percent from capital gains. Given Chubb's reliance on its float, it should be little surprise that its 5-year average net income growth has fallen from more than 20 percent in the aughts to -11.3 percent in 2012 and 5.4 percent last year. Catastrophe losses have also pressured earnings, particularly in the wake of Hurricane Sandy. The company has fared better than most of its competition though, using its rock solid balance sheet primarily to cater to high net worth individuals for their home and auto insurance and who face high switching costs when changing insurers. The company has had some challenges though, reporting an 8 percent sequential decline in its net income for the second quarter, coming it at $2.03 per share. Chubb's combined ratio -- a measure of profitability made up of incurred losses and expenses dividend by earned premiums -- also rose from 88.8 percent to 90 percent on a year-over-year basis largely because of catastrophe losses. The real drag, though, was a sharp drop off in investment income, falling from $361 million in the same period last year to $345 million as yields on everything from corporate bonds to Treasuries remained compressed. Municipal bonds, which make up about half of the company's portfolio, have also had their ups and downs so far this year, further impacting portfolio performance. Those stumbles prompted management to reduce their full-year income per share guidance from between $7.10 and $7.40 to $6.75 to $6.95. Second quarter earnings weren't all bad news though, with premium revenue up 5 percent on a constant-currency basis as U.S. premium revenue grew 5 percent and international premiums were up 1 percent. The company expects premiums will continue growing between 2 percent and 4 percent for the full-year, largely in line with the historical average. The real upside to the recent selloff is the slight boost in yield it has created, taking it up to about 2.2 percent. While net income might be off, that dividend is secure considering the company has a payout ratio of just 27 percent. It has also demonstrated a strong commitment to its dividend, increasing it for 32 consecutive years now, including the worst years of the financial crisis. It has also repurchased about 6 percent of its outstanding shares over the past year. Chubb has stuck to its tight underwriting standards, resulting in lower insured losses than many of its competitors, since it hasn't taken on more risk just for the sake of income growth. Thanks to the generally conservative approach management takes, it consistently generates strong returns on both assets and equity than its peers. Return on assets over the trailing 12-months comes in at 4 percent as compared to the industry average of 2.4 percent, while return on equity popped up to 12.8 percent, though its average peer returns just 9.8 percent. Considering that Chubb continues to show strong premium growth and has a consistent track record of being shareholder friendly, it's only logical to establish a position now before rising interest rates propel both earnings and market interest in the company. Chubb Corp is a bargain right now up to $100. Are You Paying TOO Much for That Stock? Yes, the stock market is having a banner year. But the simple truth is: It's overheated – especially dividend stocks. The first half of 2014 saw almost $30 billion in dividend increases alone. As a result, eager investors have plowed into these U.S. stocks and prices have skyrocketed. That's a problem. You could be overpaying by 60% on your next stock purchase. But…amazing, cheap income opportunities still abound if you're willing to think globally. I have 5 income opportunities that are still available at bargain prices with big dividends…such as $4 a share, $2.84 a share, $2.47 a share and more. They're worth a look. Details here. Kinder Consequences a Question of Timing 8/21/2014 By David Dittman If you first bought Kinder Morgan Energy Partners LP (NYSE: KMP) in May 2014 after we wrote it up in that month's Utility Forecaster Income Spotlight the recent surge in the unit price is clearly a positive development. If you established your position in August 2013, when we added it to the Personal Finance Income Portfolio, you're also in a pretty good spot. But if you were in on the master limited partnership (MLP) way back in March 2011, when we added it to the UF Income Portfolio Aggressive Holdings, your situation is a little more ambiguous. And those who've held Kinder Morgan Energy Partners (KMP) since its inception way back in 1997 likely have to face up to the fact that their long-term loyalty to Richard Kinder and his innovative use of the publicly traded partnership structure as a vehicle for not just income but substantial growth as well is being paid back in the form of a hefty tax bill. Indeed, the Aug. 10, 2014, announcement that Kinder Morgan Inc (NYSE: KMI) will consolidate an energy infrastructure empire that includes KMP, Kinder Morgan Management LLC (NYSE: KMR) and El Paso Pipeline Partners LP (NYSE: EPB) has catalyzed a significant surge in value for the entire Kinder complex. KMP closed at $80.34 on Aug. 8, the last trading day before the Sunday evening acquisition announcement. It surged to $94.12 on Aug. 11 and is currently priced at $98.28. That's a 22.3 percent surge. Kinder Morgan Management (KMR), which manages KMP, is up 30.1 percent, while El Paso Pipeline (EPB) is up 26.3 percent. And Kinder Morgan Inc (KMI) is up 14.2 percent. Mr. Kinder's mere announcement that he will reverse engineer a financial structure that he, as much as anyone, helped perfect unlocked about $18.7 billion in value across the four companies. And it accomplishes an objective we had flagged in recent write-ups about in UF and PF, the elimination of incentive distribution rights (IDR) paid by KMP to its parent KMI. KMP had to pay the highest IDRs in the MLP space, a bad burden that made its cost of capital prohibitively high. According to management's presentation, KMI's IDRs ate up 46 percent of KMP's revenue. That Richard Kinder is a sort of genius should no longer, if it ever was, be in dispute. Management forecast that KMI will pay a dividend of $2 per share in 2015, a 16 percent increase over the anticipated 2014 dividend of $1.72, with annual dividend growth of approximately 10 percent per year from 2015 through 2020 and excess cash coverage of more than $2 billion. The new KMI will be the largest energy infrastructure company in North America and the third-largest energy company overall, with an estimated enterprise value of approximately $140 billion. Its midstream business will be well positioned amid a rapidly growing North American energy infrastructure sector. But this $18.7 billion of "new" value in the Kinder complex is coming from somewhere. And here's the rub for long-term KMP unitholders. Tax accounting for the transaction involves taking a stepped-up tax basis in the KMP and EPB assets that KMI is acquiring, giving the enterprise large future tax deductions. Although Mr. Kinder is abandoning the tax-advantaged MLP structure, KMI will actually be saving money on taxes--according to management's presentation approximately $20 billion over 14 years. We had expected a less dramatic transaction, one along the lines of what Enterprise Products Partners LP (NYSE: EPD) executed in 2010 by acquiring Enterprise GP Holdings and eliminating its IDRs. Enterprise Products continues to add assets and grow its distributions for unitholders in a tax-favorable way. But Mr. Kinder has proven himself, going back to the early 1990s when he broke ranks with his colleagues at ill-fated Enron Inc so he could build a business focused on fee-generating assets, an aggressive innovator. The Art and Science of the Deal Here's how the acquisition--which, if all goes according to plan, will close during the fourth quarter of 2014--will work. KMP unitholders will receive 2.1931 KMI shares and $10.77 in cash for each KMP unit held. As of the close of trading on Aug. 21 that's a price of $101.24. KMR shareholders will get 2.4849 KMI shares for each share of KMR held, or $102.50, while EPB unitholders will get 0.9451 KMI shares and $4.65 in cash, or $43.64 per unit. Both KMP and EPB unitholders will be able to elect cash or KMI stock consideration subject to proration. The $71 million transaction value incudes $40 billion in KMI equity, $4 billion in cash and $27 billion in assumed debt. We're not tax experts at Utility Forecaster. Please consult your tax advisor for advice specific to your situation. We can, however, off the following general guidance based on management's presentation of the deal's specifics. By folding the MLPs KMP and EPB into the traditional "C" corporation KMI, KMI will be establishing a stepped-up basis for the assets acquired. And KMI gets the benefit of re-depreciation on the newly stepped-up basis of the pipeline assets. But for KMI to get the stepped-up basis, tax must be paid on the spread between the old and new values. KMP is organized as a partnership that benefits from substantial deductions, and the taxes on its substantial quarterly payouts were deferred. When the units are sold or exchanged--as they will be in the reorganization--the deferred taxes come due. The tax rate on the exchange of units for cash and shares depends on your overall income. But most of the gains on this transaction will probably be taxed at higher rates for ordinary income, which top out at 39.6 percent, rather than at lower long-term capital-gain rates, which top out at 20 percent. According to estimates released by the company, the tax owed by an average investor in KMP units could range from $12.39 to $18.16 per unit, depending on the individual's tax rate. The estimates also assume that passive losses haven't already been used by the investor and that the KMI price per share is between $36.12 and $44.44. The impact on individuals will vary depending on when you purchased units. But long-term unitholders will get hit hardest. And anyone who bought the units with the ultimate aim of passing them down to their heirs with a stepped-up basis will have to pay the tax. Kinder Morgan expects to distribute $10.77 of cash per unit of KMP, which won't cover the tax bill for an average investor cited above. According to estimates released by the company, the tax owed by an average investor in KMP units could range from $12.39 to $18.16 per unit, depending on the individual's tax rate. The estimates also assume that passive losses haven't already been used by the investor and that the KMI price per share is between $36.12 and $44.44. As for investors who hold KMP in retirement accounts, when an MLP is sold the portion of the proceeds that's taxed as ordinary income in a taxable account could be liable for UBIT (unrelated business income tax). And if an MLP has been held in an IRA for many years, this tax liability could be substantial. As for selling KMP now to take advantage of the recent surge, keep in mind that only the cash portion of the deal is fixed in value. KMP unitholders are being offered 2.1931 shares of KMI plus $10.77 in cash per unit at closing. At the time of the announcement KMI had last traded at $36.12, resulting in a per-unit deal value for KMP holders of $89.98, a 12 percent premium to KMP's Aug. 8 closing price. So the far more substantial portion of the deal is based on a ratio whose underlying value will fluctuate with KMI's share price. There's no assurance that this trend will persist through the deal's close, which could be four months or more in the future. If you are inclined to sell now keep in mind the following. KMP will likely make one more quarterly distribution before closing, with an ex-date in mid-October. Most that final distribution--which will be at least $1.39 per unit--will likely be taxed according to ordinary income rates (assuming a majority of the payout is derived from depreciation) following the sale or exchange of KMP units. Selling now will get you the certainty of generating tax consequences in 2014. At the same time, you'll give up the possibility of deferring tax consequences for another year. Please consult with your IRA custodian and/or your tax advisor to accurately determine your liability. Kinder management has argued that the synergies gained from the deal will allow them to pay out larger dividends in the future, something that makes taking a tax bill today worth it. But the short term certainly favors KMI rather than long-term KMP unitholders. This article originally appeared in the Utility & Income column. Never miss an issue. Sign up to receive Utility & Income by email. Is This the Next Disney? The Walt Disney Company is an epic stock market success story. Starting as a one-man cartoon-maker in 1923, it's now a $144 billion global entertainment icon. Just as Walt Disney built dreams for millions of children – and made the investors who followed him rich – this new stock I've discovered is ready to make dreams come true. Canada's Economy Gains Traction 8/22/2014 By Ari Charney More evidence that Canada's economy is gaining traction came from the country's latest wholesale trade data. According to Statistics Canada (StatCan), June wholesale trade climbed 0.6 percent month over month, to CAD53.0 billion, beating the consensus forecast among economists by a significant two-tenths of a percentage point. Wholesale trade is considered an economic bellwether, so it's an area that we've been monitoring closely for clues about the trend of the overall economy. June was the third consecutive month in which wholesale trade increased, which augurs well for second-quarter gross domestic product (GDP) growth. StatCan observes that five of the seven subsectors it tracks posted gains in June. That was enough to offset the performance of the motor vehicle and parts space, which declined 2.4 percent month over month, though sales were still up 9.8 percent from a year ago. In May, wholesale trade in the automotive space surged 9.8 percent, so it was due for a retrenchment in June. When excluding this subsector, which still accounted for about 17.1 percent of June's tally, wholesale sales rose 1.2 percent. Among the numerous individual industries that are categorized into the seven subsectors, the single biggest contributor to the rise in wholesale trade by dollar amount was agricultural supplies. Wholesale trade in this industry jumped by CAD95 million, or 4.9 percent, to CAD2.04 billion. On a year-over-year basis, growth in wholesale sales of agricultural supplies is slightly more moderate, at 4.1 percent. Given the strong real estate market in Canada and the resurgent housing market in the US, the building material and supply subsector also enjoyed strong sales in June, up 2.2 percent, to CAD7.6 billion. StatCan notes that this was the sixth consecutive gain for this subsector and the highest level on record. In particular, the lumber industry rose 3.7 percent, to CAD3.6 billion. On a year-over-year basis, sales in this industry have risen by 14.6 percent, ranking it fourth for growth in wholesale sales among Canada's industries during this period. In addition to overall wholesale trade, we're also monitoring sales of machinery and equipment to gauge the extent to which Canada's businesses are investing for future growth. Bank of Canada Governor Stephen Poloz is keen for the country's economy to transition from its dependence on debt-burdened consumers to being driven by rising export activity, particularly among manufacturers. The central bank chief believes higher exports will spur business investment, thus begetting a virtuous economic cycle of greater hiring, spending and subsequent production. In the wholesale arena, spending on machinery and equipment is encouraging. Sales of machinery and equipment rose 0.4 percent, to CAD11.03 billion, which was also 6.5 percent higher than a year ago. The subsector's single strongest industry supplies equipment to the construction, forestry, mining, and industrial industries, with wholesale sales up 9.8 percent year over year, to CAD3.84 billion. Wholesale trade in this area hit an all-time high of CAD11.13 billion last November, but June's sales were the second-highest on record. In fact, sales in this area have risen now for three consecutive months following their first-quarter swoon. Economists project that Canada's economy expanded by 2.6 percent during the second quarter. For full-year 2014, GDP is forecast to grow by 2.2 percent, outpacing the US economy by two-tenths of a percentage point. Although Canada's economy is not yet operating at full capacity, that hasn't stopped the country's stock market from outperforming its developed-world peers so far this year. The S&P/TSX Composite Index is up nearly 14 percent year to date in local currency terms, almost double the gain of the S&P 500. This article originally appeared in the Maple Leaf Memo column. Never miss an issue. Sign up to receive Maple Leaf Memo by email. Drivers That NEVER Strike Earlier this summer, a strike at the port of Los Angeles threatened to stall shipments out of main gateway of imports from Asia. Whether you agree with their cause or not, you can't argue that driver strikes are a reality in just about any industry… except for one. There's a group of companies in Australia using robot-driven trucks with stunning results. They're so effective, one of the companies is sitting on $2 billion in cash. I don't have to tell you what that will do for dividend payouts and share prices! Click here to discover how to bank gains of up to 737% by getting in on "the next big thing." You are receiving this email at benjamart.ss.stock@blogger.com as part of your subscription to Investing Daily's Stocks To Watch, published by Investing Daily. To ensure delivery directly to your inbox, please add postoffice@investingdaily.com to your address book today. Email Preferences | About Us | Premium Services | Contact Us | Privacy Policy Copyright 2014 Investing Daily. All rights reserved. Investing Daily, a division of Capitol Information Group, Inc. 7600A Leesburg Pike West Building, Suite 300 Falls Church, VA 22043-2004 U.S.A.