Buffett Says Be A Long-Term Investor: 2 Dividends To Hold Forever (2024)

Co-produced with "Hidden Opportunities."

Do you consider yourself a long-term investor? Most of us do, but the sentiment surrounding the company and analyst coverage can rattle the cages.

It isn’t only our emotional response to coverage of a company. From time to time, even the best-run companies make very unfavorable decisions. Management envisions a strategy for the company, transforming it into something that no longer serves your needs. Or there can be significant changes in the leadership structure that can sometimes be unsettling. For most investments, you must periodically evaluate your holdings, study their performance, and make decisions based on their suitability for your needs.

The word “forever” is not to be used lightly, but it must satisfy a few critical requirements in order to be considered an investment.

• It must have a flawless record of delivering outstanding results to shareholders.

• There must be a clear indication of returns to shareholders for the foreseeable future.

• The underlying business must have the ability to maintain profitability and preserve its moat through changing times and preferences.

Our favorite investor, Mr. Warren Buffett, has insisted on buying into business models that can withstand the test of time, changing leadership, political landscape, and consumer preferences.

"You should invest in a business that even a fool can run, because someday a fool will." – Warren Buffett

Many securities have decades of solid returns but have weak forecasts for future returns due to catching up from competitors or eroded business models. Similarly, some companies present a compelling case for future growth but do not have a reliable track record of shareholder friendliness. While such companies might make a case for investment with requirements to study the performance periodically, the bar is a lot higher to be deemed a forever investment.

Today, we discuss two picks with up to 9% yields that enjoy structural protections to be cash cows for the foreseeable future. Without further ado, let's look at the picks.

Pick #1: RLJ-A, Yield 8%

Despite a looming recession, analysts and industry experts project strong travel demand (especially in the sunbelt states).

RLJ Lodging Trust (RLJ) is a hotel real estate investment trust, or REIT, that owns premium-branded, focused-service, and compact full-service hotels. The company’s hotel portfolio has well-recognized brands like Marriott (MAR), Hilton (HLT), Hyatt (H), and Wyndham (WH). RLJ operates 96 hotels with approximately 21,200 rooms in 23 states, with increased property concentration in sunbelt states (51% of the EBITDA). Source.

In 2022, RLJ-s hotels achieved 94% of 2019 Revenue per Available Room (RevPAR) driven by improved Average Daily Rates ("ADR"), which achieved 105%. The REIT’s performance was led by urban markets, which benefited from improving corporate demand trends, increased citywide attendance, continued leisure demand, and early recovery of international travel. RLJ recently raised its quarterly dividend to $0.08/share and repurchased $57.6 million of stock in 2022, demonstrating a position of comfortable cash flows.

RLJ has a comfortable debt schedule, with no maturities until 2024, and ~99% of debt is fixed or hedged to shield the REIT from rising interest rates. Source.

The REIT entered into a new $200 million term loan to address 100% of its 2023 debt maturities and proactively manage $100 million of its 2024 debt maturities. RLJ’s weighted average interest rate was 3.6% at the end of FY 2022, and 81 of its 96 hotels are unencumbered by debt.

Now let's look into RLJ’s $1.95 Series A Cumulative Convertible Preferred Shares (RLJ.PA), which have the solid characteristics of a perpetual income machine.

Investors may quickly mistake this for trading almost at par ($25) value. Let us dismiss this immediately – RLJ-A cannot be called and has no par value.

The preferred can still be converted to common shares only if a near-impossible target is reached. RLJ-A is convertible into 0.2806 common shares at the initial conversion price of $89.09 per common share. However, the company can only force this conversion if their common shares are trading at 130% of the conversion price for 20 of any 30 consecutive trading days. So for RLJ-A to be forced to convert, the common stock must trade at or above $115.82 – a whopping 900% increase from current levels.

And such a conversion would be at $32.5, a 31% upside for preferred shareholders.

RLJ-A dividends are cumulative, and a growing common dividend offers a high degree of protection to your income stream. The company spent ~$25 million towards preferred dividends and ~$93 million towards interest expenses in FY 2022. Notably, the interest expense in 2022 was $13 million lower due to favorable financing transactions. These are adequately covered by RLJ’s net cash flows from operating activities ($256 million for FY 2022). At the end of FY 2022, the company had $481.3 million in cash and cash equivalents which covers the preferred dividends for 19 years!

RLJ-A is an uncallable preferred with an almost-impossible conversion clause, making it a fixed-income investor’s dream. This perpetual cash machine offers a well-covered 8% yield for years to come.

Pick #2: CEQP- Preferred Shares, Yield 9.3%

Crestwood Equity Partners LP (CEQP) owns and operates midstream assets in the Williston Basin, Delaware Basin, and Powder River Basin. The master limited partnership's operations are divided into Gathering & Processing and Storage & Logistics. Source.

Notes:

• CEQP is a master limited partnership that issues a Schedule K-1 to common and preferred stock investors for tax purposes.

• CEQP preferred stock has multiple ticker symbols depending on your broker. We will be referring to this security as CEQP– (with a dash). Please refer to this linked document for additional details, including the caution about holding CEQP– in a retirement account.

As a midstream company, CEQP is effectively shielded from volatile energy commodity prices, with 85% of the revenues contractually set as fixed-fee or take-or-pay. According to the company's revenue guidance for 2023, its operations are 59% aligned to Natural Gas, 30% to Crude Oil and Water, and 11% to Natural Gas Liquids.

For FY 2022, CEQP reported adj. EBITDA of $762 million and distributable cash flow ("DCF") of $467 million. For 2023, the company estimates adj. EBITDA to be in the range of $780-$860 million, and DCF to be $430-$510 million. This reflects a YoY ~8% EBITDA and 0.6% DCF growth, respectively (at the midpoint of the guidance). While common shareholders enjoyed a 5% hike in 2022 distributions, management did not indicate a distribution increase in 2023. Instead, they have provided guidance of ~$50 million in DCF after distributions for the year which they intend to use towards debt reduction.

CEQP maintains modest debt levels and guides a 3.9x leverage ratio at the end of 2023 (at the midpoint of the guidance). The MLP has no near-term maturities until 2025, providing some flexibility with capex, which the company expects to be between $135-155 million for FY 2023.

CEQP's current distribution will enjoy 1.6-1.8x coverage based on 2023 guidance. We will now turn our focus to the company's 9.25% Cumulative Non-Redeemable Preferred (CEQP.P), which enjoys some rare benefits in the fixed-income space.

• A preferred that cannot be called with an "impossible" conversion clause: We have seen perpetual preferred trading post-call date. CEQP– cannot be redeemed but can be converted. However, CEQP cannot force conversion unless the Volume-Weighted Average Price of the common exceeds $92 for 20 out of 30 days (CEQP ended the trading day at $24.8 on February 24, 2023).

• A preferred with voting rights: It is rare for preferred shareholders to have voting rights on corporate matters. CEQP– preferred shareholders get to vote on all matters as common shareholders. This is important as it helps ensure that if CEQP gets acquired, the terms are favorable for preferred shareholders.

• Penalties for missed distributions: While cumulative preferreds offer protection against missed payments. CEQP– takes this to the next level by imposing a penalty. A single missed distribution automatically raises the quarterly payment by 22% to $0.2567/quarter. Additionally, any accrued and unpaid distributions will be increased by 2.8125% each quarter. This structure of penalties incentivizes management to stay current with preferred distributions.

Annually, CEQP spends $60 million for preferred distributions, a sum that is covered 7.2x at the low end of the estimated FY 2023 DCF. As such, CEQP– enjoys substantial distribution coverage and presents a solid opportunity at this time. This preferred sports an attractive 9.3% yield today.

CEQP's guidance for 2023 may sound weak for a common shareholder, but as an investor in its preferreds, I am encouraged to see adequate distribution coverage. CEQP– is a true Sleep Well At Night preferred for long-term income investors, and current 9.3% yield levels present attractive opportunities to initiate or add to one's position.

Conclusion

Our emotions can drive decisions, which can easily lead us to deviate from our goals. Before we act based on the news, we must evaluate the fundamentals of our portfolio positions. Their continued match for our investment requirements must inform the decision-making.

During his investing career, Mr. Buffett has exited positions in numerous companies due to failure to suit Berkshire Hathaway’s (BRK.A, BRK.B) requirements. But Coca-Cola (KO), American Express (AXP), and Wells Fargo (WFC) are a few names the Oracle of Omaha has been holding for almost three decades and continues to draw attractive returns from the seeds sown a long time ago.

As income investors, ensuring the consistency of dividend income is the most important measure. Management makes quarterly (or annual) decisions on dividend payments, and it has the potential to impact us positively or negatively. As such, periodic monitoring of company performance and management priorities is essential, making most securities less suitable to buy and hold forever. At 'High Dividend Opportunities', our aim is to buy high-dividend stocks for our Model Portfolio, which currently is composed of 45 such stocks for diversification purposes.

In this article, from all those quality dividend payers, we share two promising candidates you can lean on for big income for the foreseeable future. Up to ~9% yields are up for grabs to regain your focus on your longer-term objectives.