Yes, You Can Retire On Dividends, 2 Fat Yields +8%

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Co-authored with Hidden Opportunities

In a recent interview, Mr. Steve Eisman, the senior portfolio manager at Neuberger Berman, popularly known as The Big Short investor, outlined his rationale behind infrastructure being a winning sector for the years ahead, making it an excellent fit for a long-term investor.

“For the first time since I can remember, this whole group now has a real secular story. Not that they’re not cyclical. They are cyclical, but they have secular tailwinds that they’ve never really had before,” he said. “And those tailwinds are gonna last quite a long time.” – Steve Eisman

Now, Infrastructure is a very broad category with many sub-sectors. Energy infrastructure includes power plants, storage facilities, gathering, processing, and transporting infrastructure. The transportation sector includes bridges, toll roads, airports, marine ports, railroads, and much more. Utilities include electric and gas utilities, renewable energy, and water. Communication infrastructure comprises satellites, cellular towers, and the fiber network. Storage centers, distribution, and logistics also form an essential component of the world of infrastructure. Everything mentioned above needs to be improved at scale to cater to a modern economy with a growing population.

There are four solid themes that offer strong tailwinds to the companies in this sector.

1. Everyone talks about Artificial Intelligence and how it is going to transform the world we live in. This is all that Wall Street has talked about lately, and every major corporation is investing significantly in this to avoid K-Mart’s fate for failing to adopt technology. AI capabilities can mean different things for different businesses, and its implementation and adoption can be in many flavors and levels. But the common denominator for this story is the industrial implications. According to JPMorgan, these new microchips that empower AI capabilities consume three times more electricity than a CPU, and the investment bank projects a tenfold growth in power demand by 2026. Additionally, these new GPUs run much hotter than traditional hardware, increasing the requirement for high-end cooling systems for data centers. Altogether, we see a significant boost in electric grid improvements and spending.

2. Supply-chain disruption and tightness during the global pandemic served as a lesson for U.S. companies to reshore their manufacturing capabilities. The federal government is heavily supporting this revitalization, mainly through its significant piece of legislation, the CHIPS and Science Act, which was enacted in August 2022. New factories are just beginning to crop up, and we see a decade-long development ahead.

3. The path taken by G7 nations towards greenification of the infrastructure towards renewable standards will continue to be a tailwind for the sector for the foreseeable future.

4. In recent years, the U.S. has consistently scored very poorly in the reports published by the American Society of Civil Engineers. The country did not have a significant industrial policy for over seventy years. But now, we have the Inflation Reduction Act and the Infrastructure Investment and Jobs Act, which will add $1.2 trillion to this sector over ten years.

With multiple catalysts at play, let us examine ways to improve our retirement income from this vital sector.

Pick #1: UTF – Yield 8%

It isn’t easy to cherry-pick individual winners from all these tailwinds. So for those interested in drawing income from the entire sector, we have a CEF (Closed-End Fund) for you to consider.

Cohen & Steers Infrastructure Fund (UTF) operates with over $3.2 billion in managed assets and 242 holdings. The fund’s top holdings represent ~30% of the assets and comprise some of the largest electric utility, gas distribution, energy pipeline, and toll road companies in the country. Source

UTF is well-diversified across other sectors, such as airports, cell towers, and freight rails, with modest allocations to fixed income. 69% of the CEF’s assets represent U.S. and Canadian companies.

UTF has a strong track record of regular distributions since its inception in 2004. The CEF makes monthly payments of $0.155/share, calculating an 8% annualized yield. YTD 2024, UTF’s distributions are estimated as 51% NII (qualified dividends) and 49% long-term capital gains.

UTF employs a 30% leverage in its investment strategy, with 85% carrying rates fixed at 1.6% with a weighted average term of 2.26 years. The CEF’s weighted average cost of all financing stands at a modest 2.3%, positioning the fund well to deliver accelerated returns from a sector experiencing massive tailwinds in the near term.

Pick #2: SCE Preferreds – Up To 8.5% Yields

Southern California Edison, popularly known as SCE, is one of the largest electric utilities in the United States. The company provides services to over 15 million people across 50,000 sq. miles of Central, Coastal, and Southern California. SCE is a wholly-owned subsidiary of Edison International (EIX), which has been providing electric utility services in the region for over 136 years.

In addition to California having among the highest number of data centers in the country, EIX has significantly de-risked its grid against losses due to wildfires by 85-88%. We believe the market underestimates how significant of a wildfire risk reduction (and as a result, cost savings) EIX has achieved, leading the industry’s response to climate change through covered conductor wiring, trims and removals in forest areas, inspections, and weather station and HD camera deployments. Source

EIX’ core EPS for Q1 2024 was $1.13, placing its quarterly ($0.78/share) dividend at a modest 69% payout ratio. The company expects a 5-7% Core EPS CAGR for 2025-2028, with the firm’s financing plan showing minimal equity needs. Both EIX and SCE maintain investment-grade balance sheets with well-staggered maturities in the coming years. The company plans to issue $500 million parent debt to refinance $500 million maturity. SCE’s strong cash flow generation and incremental debt to finance accretive growth address nearly all its cash needs through 2028.

EIX has been an excellent dividend steward with 20 years of annual payment raises. For FY 2024, EIX has guided core EPS of $4.75-5.05, placing the $0.78/share quarterly dividend at a modest 63% payout ratio.

For Q1 2024, EIX spent $22 million on its preference stock dividends (down from $26 million in Q1 2023) and $41 million on SCE’s preference stock dividends (up from $29 million in Q1 2023). The company paid $295 million on common stock dividends. These payments enjoyed adequate coverage from the company’s TTM net income of $1.09 billion. EIX reported $1.2 billion million in cash and cash equivalents at the end of the first quarter.

SCE recently raised $350 million by issuing its newest preferred, SCE-N. This makes it the seventh public preferred we can choose from to satisfy our fixed-income needs. This security was rated BB+ at the time of issuance. All SCE preferreds pay qualified dividends, and several types are available to suit varying requirements.

• SCE Trust II, 5.10% Cumulative Trust Preference (SCE.PR.G) – Yield 6.4%

• SCE Trust III, 5.75% Cumulative Fixed-to-Floating Rate Trust Preference (SCE.PR.H) – Current floating rate 8.5%

• SCE Trust IV, 5.375% Cumulative Fixed-to-Floating Rate Trust Preference (SCE.PR.J) – Yield 5.6%

• SCE Trust V, 5.45% Cumulative Fixed-to-Floating Rate Trust Preference (SCE.PR.K) – Yield 5.5%

• SCE Trust VI, 5.00% Cumulative Trust Preference (SCE.PR.L) – Yield 6.4%

• SCE Trust VII, 7.50% Cumulative Trust Preference (SCE.PR.M) – Yield 7.1%

• SCE Trust VIII, 6.95% Cumulative Trust Preference (SCE.PR.N) – Yield 6.8%

SCE-G and SCE-L are both trading post their call dates, offering yields of 6.4%, and ~25% upside to par.

SCE-M and SCE-N are both trading above par, but present 7.1% and 6.8% yields that investors can lock into for at least the next four years.

SCE-H currently trades post its call date and its floating rate yields 8.5%. Investors must note that the coupon resets every quarter and is subject to change based on the 3-month Term SOFR rates.

Conclusion

In most industries, you get better deals when you buy more, like family bundles in telecom or bulk licenses for software. But utilities are different. They charge you significantly more as your consumption increases.

Utilities are a terrific business. They invest heavily in modernizing and expanding the grid, then pass almost all these costs onto customers through rate hikes. Look at your utility bill, and you’ll see charges even if you use nothing because there are charges for the connections to your home. And the best part is that we will continue to be consumers, no matter how the economy fares.

We are growing income from strong businesses that stay profitable during economic pressures and deliver reliable dividends. This ensures our retirement lifestyle remains stable, recession or no recession. This is the beauty of the Income Method and the flexibility provided by income investing.