Don’t Run! Capitalize On Bank Fears With These “Buys”

Banking sector problems keep grabbing headlines. But rather than run for the hills, savvy investors can use that volatility to add “Buys” ELSEWHERE. These three MoneyShow contributors name their favorite names.

Doug Gerlach, Investor Advisory Service

The bill has seemingly come due for the Federal Reserve’s mistaken belief inflation was “transitory.” A late start in tightening policy to combat inflation led to the fastest rate hikes in forty years, and it should come as no huge surprise the stress from such a move might break something. But stocks like Air Lease

AL
Corp. (AL) still look attractive.

The collapse of Silicon Valley Bank (“SVB
VB
”), the 16th largest bank in the U.S., was the headline casualty. But Signature Bank was also shut down by regulators and the impact was evident across the sector, notably regional banks where share prices declined sharply.

The banking turmoil has substantially changed expectations for the Federal Reserve’s path forward. Fed policy works with long and variable lags. The SVB situation demonstrates the impact of rapid rate increases is starting to bite.

The Fed may be facing a situation where inflation remains a problem but if it continues to raise rates, it also increases the risks to financial stability. That is not where the Fed wanted to end up, and it may be able to thread a needle, but increasingly it appears the Fed may have some difficult choices ahead.

As for AL, it had a mixed quarter, but the outlook continues to brighten dramatically. Revenue increased less than 1%. EPS fell 20% excluding a gain on the recovery of one of the 21 seized planes. Looking at trends over the past few years, results in Q4 2021 are the outlier.

Results in the year-ago quarter were aided by the receipt of deferred rental payments and an elevated level of “end of lease revenue,” both highly profitable. Subsequent quarters have been negatively impacted by the absence of revenue from planes confiscated by Russia.

Looking ahead, Air Lease expects to take delivery of 70-80 planes this year, a significant increase from 2022. The actual number of scheduled deliveries is 88, but Airbus and Boeing
BA
are running three months behind schedule. Air Lease is also looking to sell more planes from its fleet than in recent years, capturing gains on sales while also helping to offset the capital outlay on new planes.

Demand for aircraft is robust, and orders placed with manufacturers won’t be delivered until 2028; airlines needing planes sooner will have to negotiate with holders of an earlier delivery slot, and Air Lease has 398 scheduled for delivery from 2023-2028.

Jim Pearce, Investing Daily’s Personal Finance

Higher interest rates leave less margin for error for markets. But once the Fed is done raising rates, I expect bond yields to come down gradually and the share price of companies like American Electric

AEP
Power (AEP) to start rising.

The opportunity for financial arbitrage is greater when artificially low interest rates allow businesses to borrow money at very low cost. But the risk increases significantly when borrowing costs triple in less than a year.

That is one reason why AEP announced in February that it has agreed to sell its interest in a partnership that owns a portfolio of unregulated renewable assets. The deal should close during the first half of this year, at which time AEP expects to receive $1.2 billion of net proceeds.

According to Julie Sloat, AEP’s president and CEO, “The proceeds from the sale will be directed to the significant pipeline of opportunities we have to enhance service for customers across our footprint and advance our clean energy transition.” The company reiterated its “plans to invest approximately $40 billion over the next five years in its regulated wires and generation business.”

The appeal of regulated assets during a rising interest rate environment is that the utility can factor higher borrowing costs into the rates that it charges customers. However, the rates charged for its unregulated businesses are set by the market.

Presumably, AEP has determined that the ROI (return on investment) for its regulated assets will be greater in a higher interest rate environment. Since the Fed started raising interest rates a year ago, AEP’s share price has fallen from above $105 last August to below $90 by the end of February.

Despite its recent pullback, there is nothing wrong with AEP. Its fiscal 2022 Q4 results released in February came in as expected, and its guidance for full year 2023 results includes a 4% to 7% increase in operating EPS compared to last year.

The disposition of its unregulated business should make it easier for the company to achieve that guidance. The question for investors is how much they are willing to pay to receive AEP’s quarterly dividend of 83 cents per share.

At a share price of $90, that works out to a forward annual dividend yield of 3.7%.

Elliott Gue, Energy and Income Advisor

Energy stocks have generally trended lower, with the S&P Energy Index recently underwater by around 10% year-to-date. But that means several energy stocks now trade below their “Dream Buy” levels, including one I really like, Kinder Morgan

KMI
Inc. (KMI).

The selling of energy stocks has become largely indiscriminate. That’s normal when the overall stock market starts to roll over. And the turmoil in the banking sector has provided a good reason for investors to trim their holdings of stocks, including industries that are firmly in long-term up cycles like oil and gas. So long as that’s the case, we’re going to play things cautiously.

But what’s behind the long-term energy cycle is years of under-investment in new supplies and infrastructure. The Federal Reserve’s rate hikes, combined with falling oil and gas prices, have if anything made that situation a good deal worse by further discouraging investment in supply.

That means when demand does return there will be an even worse supply gap, which will push up energy prices and energy stocks to new heights. Energy markets are still in the very early innings of the up cycle.

As for KMI, “Dream Buy” prices represent levels of valuation where our stocks in the past have traded only under extreme circumstances. An example would be the pandemic market crash in 2020. Buying them at these levels has never failed to produce windfall profits for patient investors.

All of Kinder’s ongoing midstream projects are reportedly on time and on budget. The company also no longer has the exposure to variable rate debt that it did last year, which should ensure it meets management’s flat guidance for 2023 distributable cash flow and EBITDA.

Kinder does face an uncertain outcome in a federal court challenge to a Federal Energy Regulatory Commission permit for its East 300 natural gas pipeline. If the court rejects the permit and forces additional filings, it could add considerably to the final cost.

But most observers rate Kinder’s odds of victory as very good. Even if it’s defeated, guidance would be unlikely to change much, with the company easily generating free cash flow in excess of dividends to keep whittling away at its debt.

Recommended Action: Buy KMI up to $22.