Keeping a Long-Term View of the Real Economy

In v e s tm en t Pr o duc t s: Ar e n ot Fd I c Insur ed • m Ay Lose vALue • Ar e n ot BAn k GuAr An t eed

Keeping a Long-Term View of the Real Economy

Quarterly report 1Q 2020

March 30, 2020

In LasT quaRTER’s REpoRT wE offEREd IdEas abouT how to make clear and rational decisions in the midst of the herd activity that surrounds the market. One of the key points we mentioned for avoiding herd emotion and herd action is to maintain a long-term view during times of stress. Today, we believe investors should be focusing not on the daily tally of “coronavirus case counts,” but on how the real economy will most likely look in 3 to 5 years. From that perspective, many may find current market conditions enticing.

recent crises at a Glance

Since the founding of our firm in 1984, there has been an im-portant crisis in the markets every 8–12 years (our founding coincided with the end of the oil-shortage crisis and the end of sharply rising interest rates in response to what had been out-of-control inflation). In 1987 there was a sharp crash that was mainly the result of secular market dynamics and not the real economy (portfolio “insurance” and program trading backfired as exit possibilities could not accommodate the magnitude of fleeing positions). Indeed, the real economy continued to do reasonably well, and markets slowly recov-ered as investors regained confidence that the system had been repaired. Perhaps that technical crash was also a pre-cognition of the disasters for banks in 1990–91, when rising rates exposed the corruption in savings and loans banks and upended the mortgage market. But that was an economic hiccup, not really crisis.

After relatively smooth sailing during the Clinton-era 1990s, in 2000 the tech bubble of elevated “new economy” valuations collapsed. This was devastating to the portfolios of investors who were even partly invested in technology, but what was plain in real time became even plainer in retrospect. That is, the valuations of that sector bore no relation to sensible busi-ness valuations; they were pure emotion. Investment accounts were harmed, but so-called value, or “old economy,” stocks began to rise as investors remembered what investing really is. Again, a crisis for investors and the trading marketplace, but not truly a crisis for the real economy. Not long after each of

these “crises” the equity markets recovered and went on to make new highs within a reasonable investment time frame.

The year 2008 was a true crisis felt in the markets but also in the society at large. We can recall wondering if our economic system could survive. Banks were hurt worst, but the overall economy ground to a halt and unemployment soared. Would everything be different in the future? It turned out to be a slog, a long slow process that never really became robust. But that wasn’t bad at all for investors, for new money at least. A famous investment firm coined the term “new normal,” suggesting a poor economy and low future returns, dem-onstrating that even the most sophisticated investors and analysts can’t always know what lies ahead. The “new normal” proclamation came almost to the day of bottoming for the market and the economy, in March of 2009.

the crisis right NowIs this 2008 all over again? 2020 is a time of extremes, and it is uncertain. It isn’t 2008 because the financial system has remained intact, and that’s what’s needed for economic re-covery. But it isn’t a trivial moment, to be sure.

Volatility is extreme by any measure. One has to go back to the 1930s to find analogs. Volume is equally extreme. Sentiment measures are extreme. Debt levels are extreme, and that’s not a good thing in a time of reduced cash flows. But like 2008, the government has gone into action to protect the economy. Observers were skeptical then, but we were skeptical of the skeptics, and expressed a longer-term optimism because the government was “on the case.” Yes, it was an anxious time, and we feared for banks as the linchpin of the financial system, but slowly the various financial and fiscal programs gained traction, leading to one of the most durable bull markets of the modern era.

Some positive pointsThere is much we don’t know, including the duration of the pandemic (as we write at the end of March it shows no signs of abatement in the US or Europe). However, we have faith in our

Continued on page 2.

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Quarterly report 1Q 2020


1 US Bureau of Labor Statistics.

medical industries to eventually solve this problem—after all, hepatitis C, a virus, has been cured, and HIV, also a virus, has been effectively suppressed. The relevant scientists suggest that either cure or vaccine or both will be available within about a year or less.

The medical crisis will pass. The question is how much damage will it do to the economy during its period of acute infection? That is not something anyone can know at this point, but we suspect its reach will be broader and perhaps deeper than 2008. That doesn’t mean it will be worse for investors, since stocks tend to discount a recovery long in advance of reality. And banks, the aforementioned linchpin of the economy, are profoundly sounder than they were in 2008. The tools to restart stability and growth are there.

The President was right that our economy is “not built” to shut down. Americans want to be out there working, pro-ducing, and striving. That’s all true, but our understanding is that the US economy is “not built” to withstand periods of zero revenue. That will deal a body blow to retail-facing industries such as the stores and restaurants that are closed as we write, and all who supply and service them, as well as the debt financers who enable the whole chain of commerce.

A glass-half-empty view posits that the economy has suffered a disruptive body blow, the microbial equivalent of a hurricane that flattens a town. However, a glass-half-full view asserts that the town has been flattened before, and it has rebuilt before, with better and new buildings that are hurricane proof. Over 250 years the system and the people within it have shown resilience, tenacity, determination, and imagination—and have always come back. We don’t see why this will be any different, though the human toll in terms of mortality as well as economic disruption will be great.

the Short-term FalloutLike many things, however, the doing will be harder than the envisioning. There will be personal tragedies and business tragedies. The government will be poorer and deeper in debt, and taxes will eventually have to rise. Interest rates may not be as benign as they were after 2008—recall that the vast consensus of observers then predicted higher interest rates, though that was wrong because so much liquidity over-whelmed the demand for money. And there will be changes in society as well as the economy as a result of the pandemic.

On the downside, we think the universe of retailers and restaurants will substantially shrink, as will the population of workers in those industries (roughly 20 million before

COVID-19 hit—about 100 times the average new claims for unemployment for 20191). Landlords will share the pain, both for commercial tenants and individual renters. Companies with substantial debt will find themselves unable to cover their monthly payments. In a restrained economy there is less need for resources, including energy and minerals, and for the tools and equipment of extraction and processing.

the upside for Investors, as We See It

On the upside, life in the cloud has proven itself. Work from home will gain new traction, and 5G services will meet acceler-ated and increased acceptance. Everything cloud acquires new urgency. Much will go on as before, especially for the healthcare industries serving an aging population. Technology was a kind of savior after 2008, and its efficiency and produc-tivity mean it will continue to play that role. And of course you have to turn on the lights, and run that technology, so utilities need to remain an important factor in an investor’s landscape.

Secular market factors are very positive, and if not for the uncertainties of the pandemic they would suggest the best opportunity to invest in equities in at least a generation. Volume has not been so high since 2008, and high volume typically marks the end of a decline. Prices have declined sharply. Enough to discount the harder road ahead? That’s un-known, but the further prices decline, the more they discount negative prospects. Sentiment has swung from an extreme of bullishness (which is bearish) to an extreme of bearish-ness (which is bullish). Stocks are oversold by quantitative measures, a reasonably expectable bounce at the end March notwithstanding. Rates remain low and will likely stay that way for years, at least at the short end.

The Fed is ready to do “whatever it takes,” and the previous episode of this posture worked out well for equity investors—there will be no shortage of money, which may overcome inevitable low velocity. Because bonds rose this year and equi-ties declined sharply, large institutions (including pension funds and sovereign wealth funds) around the world with an equity/bond mix will need to rebalance in favor of equities, and that is a huge source of funds for the equity market. A record-breaking flow of funds into money markets and short-dated credit will want a new home before too long, as returns of less than 1% get tiresome when you have a mid-single-digit or higher return assumption for your funds. Private equity is loaded with cash to purchase whole companies.

1 US Bureau of Labor Statistics.

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During the Global Financial crisis, the S&p 500 dividends were down less than 10% and recovered to prior levels by the end of 2010. Financials still have not reached 2007 levels, though the sector is much stronger now as a result of regulatory controls. We would expect the hardest-hit sectors, such as restaurant, travel, nonessential retail, and in-person entertainment, to experience a forward path similar to financials in 2008. The eventual recovery could be more robust, as the companies may not be prevented from restarting dividends, as banks were. Source: Bloomberg.

S&p 500 Index Dividends 2007–2019

Will the two themes—economic damage and uncertainty as to duration versus a classic setup laying the groundwork for a new bull market—balance out? No one can know without more data and information, but the environment is not all one-sided.

a Future for Dividends

Importantly for us, we are well aware that dividends are not guaranteed. Companies whose cash flow has disappeared are not going to have the funds to pay dividends (which should always be an evidence of prosperity in any event), and we will see many reductions and cuts in the broad market, just like 2008–09 (1 out of 3 S&P 500 companies cut in 2008–9, though aggregate levels were restored by about 3 years out). Some companies will take action out of a feeling of prudence due to uncertainty, even if they can in fact afford to keep paying.

All of our strategies have high dividend yields—typically in excess of four times the yield on government bonds—and we want to keep it that way. We’ve focused for decades on companies with reliable cash flows and strong balance sheets that can ride out a period of softness, and these special times alert us to increase our vigilance even further. Of note, the many dividend-oriented “products” or “indexes” that have

arisen in recent years are driven by formulas relating to past dividends, but pay little heed to balance sheet strength or cur-rent conditions that may impact the dividend. In other words, those portfolios are carrying lots of securities that met the criteria in 2019, as of the last index rebalance, but may enter the ranks of nonpayers in 2020. Our efforts are dedicated to distinguishing our portfolio from those passive approaches and keeping the income high.

It is our philosophy that long-term investment success depends on reliable income, and for us, nothing has changed. We will always adapt to current circumstances when necessary, but our foundation remains the same. Now more than ever, a long-term view gives us comfort in the resilience of the real economy.

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ThE woRLd was shocKEd by how RapIdLy ThE noVEL coronavirus spread during the first quarter of 2020. China reported its first cases to the World Health Organization on December 31, 2019, and their first death, on January 11. The US did not report its first death until February 29. As of the end of the quarter, the US had over 180,000 confirmed cases and over 3,600 deaths. By quarter end, US companies were only beginning to make sense of the new reality.

Financial markets didn’t wait for clarity, and moved quickly away from risk assets. The yield on 10-year Treasuries swooned to below 1%, as the yield on corporate bonds widened. Equity markets were down; while defensive sectors did better than cyclicals, all sectors were down. Energy stocks did the worst, as the coronavirus depressed energy demand while Saudi Arabia and Russia both threatened to raise supply in their battle for market share. Dividend stocks in general, as well as in our Income-Equity Strategies, traded down more than both the S&P 500 and the Russell 1000 Value indexes. Both versions of the Income-Equity Strategies are currently yielding more than 5%, reflecting market nervousness. A number of stocks not held in Income-Equity have already announced dividend cuts. In general, companies announcing dividend cuts to date have been heavily indebted, confirming our long-held belief that dividends from overly levered companies are not reliable.

Income-Equity strategies


Source: Bloomberg, EDGAR, Miller/Howard Research & Analysis.

Dividend increases. Our Income-Equity Strategy had 10 declared dividend increases this quarter; the No-MLP version had 9. Declared dividend increases averaged 6–7% during the quarter.

portfolio income. On a year-over-year basis, based on representative accounts, income from both versions of Income-Equity rose 3–4%.

avoiding dividend cuts. We exited three positions—sabre (sabR), occidental petroleum (oXy), and delta air Lines (daL)—before they announced the discontinuance of their dividends.

reducing energy exposure. Oil prices dropped precipitously in March. After briefly adding to oXy in January, we completely exited in February. We also sold Total sa (ToT) and trimmed Enterprise products (Epd).

Buys. Early in the quarter, our buys focused as always on companies with high yields, growth of yield, and balance sheet strength. We initiated positions in Eastman chemical (EMn) and Keycorp (KEy). As the coronavirus panic began to grip the market, we were able to enter Merck (MRK), cardinal health (cah), and williams-sonoma (wsM) at what may prove to be attractive initial prices.

Portfolio Highlights

quarterly Report 1q 2020

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Coronavirus/COVID-19 referencesSource: Bloomberg, EDGAR, Miller/Howard Research & AnalysisAs of 3/30/2020

More than 70% of dow members have referenced coronavirus in sEc filings since the beginning of the year.

coronavirus/coVID-19 references

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industries are always girded for major changes. Dividends should prove reliable.

We expect banks to report high loan growth associated with borrowers’ drawing down credit lines. It will be prudent for banks to provision for higher credit losses, so earnings reports will be choppy. Our banks, however, did well in the Fed’s most recent stress test, and the extraordinary support from both the Fed and the US government will help. We expect a halt to stock buybacks but a continuation of dividends.

Our remaining holdings all have reasonably strong balance sheets, so should be able to weather the pandemic. We be-lieve the entire portfolio should be well positioned as the coronavirus recedes. Once investors get a green light, demand for income will return. In addition, value investing historically has done best coming out of a recession, so Income-Equity’s historically low valuation should set it up for a strong recovery, in our view.

See Income-Equity Strategies yield tables on page 11.

Income-equity Strategy yield Minus 10-year treasury Interest rate Since Inception November 30, 1997–March 31, 2020

Source: Bloomberg; Miller/Howard Research & Analysis.

Our goal is to avoid dividend cuts and situations where the dividend is impaired for the long term. However, we antici-pate that some management teams could temporarily cut or suspend the dividend just to be “prudent” despite having strong balance sheets and in order to position for a recovery. We’ll analyze each situation as it arises. Portfolios that are diversified across many sectors are best positioned to navi-gate turbulent waters. We expect our portfolios to generate healthy incomes despite the risks.

looking ahead While we are in highly uncertain times, our Income-Equity holdings have strong balance sheets, which should help protect dividends. Clearly risks have increased, but so have rewards. As the chart above shows, the spread between Income-Equity’s yield and the interest rate on the 10-year Treasury has never been so high. Certainty has a high price.

In terms of specific sectors, our technology and pharma-ceutical holdings have low leverage, as companies in these

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ThE poTEnTIaL IMpacTs of ThE coRonaVIRus on dEMand and ThE disagreement between OPEC+ members combined to send the energy space into a freefall. The dispute between Saudi Arabia and Russia sent oil prices down more than 30% and started a brutal price war. At the beginning of trading in Asia, Brent futures suf-fered the second-largest decline on record, trailing only the sell-off during the Gulf War in 1991. The WTI Front Month contract is still down $40/barrel from its January highs.

The International Energy Agency (IEA) in its March 2020 “Oil Markets Report” said it expects global oil demand to fall in 2020—the first full-year decline in more than a decade—because of the deep contraction in China, which accounted for more than 80% of global oil demand growth in 2019, and major disruptions to travel and trade. The IEA estimated that global oil demand in the first quarter could decline by 2.5 MMbbls/d (2.5 million barrels a day) year-over-year.

looking aheadIn the current environment, we continue to stress-test the names in our midstream portfolios. We are examining contracts, debt maturities, balance sheets, and cash flow in order to identify and evaluate the durability of our holdings. The most pertinent ques-tions for midstream companies are: What if oil stays below $30/barrel for several years? Would the midstream industry take this opportunity to forgo distribution increases? Or would it potentially cut distributions in order to lower debt so that once things return to a more normalized state leverage would be lower?

It is worth pointing out that Enterprise products partners (Epd), our largest position, announced its 1Q20 distribution early, in March instead of April, and kept its payout flat quarter-over-quarter.

For investment-grade companies (all credit-rated holdings in the MLP Strategy are currently IG rated, and one name does not have a rating), we believe cutting capital spending will continue to be the first step in defending investment-grade credit rat-ings. We believe asset sales could follow, although in this market that might be tough. Lastly, we would not rule out distribution cuts, although that is likely to be the last thing management teams would want to do.

One development is that midstream companies have started to provide rate relief to some of their producer clients in exchange for contract extensions. We believe this is a win-win for producers and midstream companies.

In the long run, these are essential assets. Once economic activity rebounds, volumes should increase. We believe those midstream companies with healthy balance sheets and diversified operations will be the best positioned to benefit from the rebound.

MLp strategy

Distributions increases. This quarter 10 of our 14 holdings announced dividend increases. The average increase was 6% year-over-year.

portfolio holdings. We sold Tallgrass Energy (TGE) as the company is being taken private and announced it would not pay a dividend going forward. We also sold western Midstream partners (wEs) because the current high yield points to a probable and deep distribution cut, and the company’s leverage has continued to tick up. We used the proceeds to increase our weights in williams (wMb), Enbridge (Enb), pembina (pba), and Tc Energy (TRp) as these C-corps have large and diversified asset bases.

Mlps vs. c-corps. MLPs generally lagged C-corp peers, and we suspect this was driven by forced selling due to margin calls in leveraged products.


Source: Bloomberg.


2-year Debt Maturities as % of total Debt MLP Strategy Holdings as of March 31, 2020

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2Y Debt Maturities as % of Total Debt

Source Bloombergas of March 31, 2020

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Source: Vox.com.Data shown: January 1, 2020–March 22, 2020

how uS Internet traffic has Grown as people Spend More time online Due to coronavirus


as GoVERnMEnTs LooK Ed To sLow ThE spRE ad of coVId -19, global markets reeled from the financial repercussions. Unsurprisingly, our four major sectors were pressured during the quarter. Within the context of weak equity performance, dispersion was elevated.

The best performing asset class was communication services, led by the data-conveying towers companies that generated positive returns during the quarter. Industrials was second, buoyed by new additions waste Management (wM) and forward air (fwRd), and resiliency from united parcel service (ups) and fedEx (fdX), as ecommerce became even more ingrained in consumer behavior. Utilities was our third best performing sector, trading in line with the broader market before pulling ahead the final week of the quarter. We view utility performance as detached from fundamentals, and took the opportunity to increase our exposure on the dislocation. Midstream was a material laggard amid a perfect storm of demand destruction from COVID-19 and a decision by OPEC+ to pursue market share over price stabilization. Within the sector, performance varied materially based on volumetric and direct commodity-price exposure.

looking ahead We feel the portfolio is well positioned to weather a daunting near-term outlook. Regulated utilities should continue to provide a haven for investors, and any headwinds from usage or bad debt appear surmountable. Communication services should continue to benefit from data-demand trends, which have spiked higher in many areas emphasizing social distancing. Within industrials, transportation and logistics companies are expected to benefit as manufacturing comes back online and companies replenish strained inventories. Midstream is admittedly challenged in the current commodity-price environment, but our preference toward integrated systems, contract quality, and financial strength favors exposure to the most durable business models.

The case for essential service providers with high barriers to entry has never been so tangible. The necessity of these assets won’t be destroyed by a pandemic or even by rising joblessness, and our holdings have the financial wherewithal to manage through crisis.

Infrastructure

chaos as ladder. We used the recent sell-offs to initiate positions in nextEra Energy (nEE) and wM. We had previously been monitoring these industry leaders but were uncomfortable with their premium valuations.

other new additions. We also initiated positions in nisource (nI) and fwRd. As nI puts the Merrimack Valley accident behind it, we expect its discount to narrow. We expect fwRd to benefit as supply chain managers look to expedited delivery to relieve strained inventories.

tactical allocations. We trimmed aEs corp. (aEs), Veolia Environnement (VEoEy), Essential utilities (wTRG), and fortis (fTs) following periods of relative outperformance. We had previously increased our positions in these names in 2019.


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utilities plus

MaRKET VoLaTILITy REachEd hIsToRIc LEVELs In ThE quaRTER as ThE World Health Organization (WHO) declared a global emergency a mere month after the detection of the first COVID-19 cases, and countries around the globe shut down nonessential services to stem the spread of the virus. To help mitigate the economic fallout, the Federal Reserve cut the federal funds rate to zero and Congress passed a $2 trillion stimulus package.

During the quarter, the strategy declined 15%, trading in line with the broader market for much of the quarter before powering ahead during the final week. Utilities’ relative performance through March 23 was counterintuitive given the backdrop of economic stress, volatility, and declining interest rates. However, a confluence of forced selling by levered investors, elevated valuations, and fears that usage will decline and customers will struggle to pay their bills kept utilities in the path of the storm.

looking ahead

Industrial and commercial power demand is expected to decline, although this could be partially offset by higher residential demand as consumers hunker down at home. To date, US power demand has been resilient, but some power markets are beginning to report declines amid milder weather and different usage patterns more closely resembling weekends. While these declines create a near-term headwind, they certainly don’t compromise the regulated business model. Many utilities have provisions that decouple volume fluctuations from allowed profit. For others, regula-tors tend to true up allowed billing rates to adjust for changes in demand. The risk of bad debt should also be low given the plan for large federal grants and loans to lower-income consumers.

Even in these difficult times, industry fundamentals remain attractive. Utilities have extensive opportunities to deploy capital, driven in large part by a switch from coal to natural gas and renewables. This transition is reinforced by public opinion and regulatory support. Utilities have long been a haven for investors, and we don’t see anything in the current environment that would alter that dynamic.

New additions. We added Exelon (EXc), an integrated utility with merchant generation. The company provides ~12% of the clean energy generated in the US.

Welcome back. The dislocation in the market provided an opportunity to reestablish a position in onE Gas (oGs) after selling the name last year on valuation concerns. The company benefits from one of the strongest balance sheets in the sector.

tactical allocations. We trimmed Essential utilities (wTRG) and Eversource Energy (Es) after periods of relative outperformance, and increased Mdu Resources (Mdu) and sempra Energy (sRE) after periods of relative underperformance.



Source: US Energy Information Administration (EIA); Miller/Howard Research & Analysis.

uS power Demand 1Q 2020 As of March 25, 2020

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US Power Demand - Q1

2020 3-year Average (includes 2017, 2018, 2019)

As of 3/25/2020Source: MHI, EIA

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drill bit to burner Tip®

ThE yEaR bEGan wITh Much hopE. ThE End of 2019 offEREd one of the strongest energy quarters in years, OPEC and Russia agreed to deepen their production cut agreement, and energy demand accelerated alongside healthy global economies. Most important, US shale produc-ers had finally grown up, eschewing deflationary drilling for aggressive dividend increases and stock buybacks.

Then 2020 occurred, with a “once-a-century” pandemic that, for energy investors, is now further complicated by the fiercest oil price war in several decades. As evidence mounted that the forced shutdowns in China would spread to other major economies, we took swift action here, eliminating all oil producers carrying material debt, reducing exposure to volume-sensitive pipelines, while increasing previously avoided, beaten-down natural gas producers and highly contracted pipelines that offer havens. Though cold comfort for sure, it was indeed a victory for active management. Though the sector has been very difficult, we’re confident that this approach produces the most ways to win.

looking aheadBarring an unexpected détente in the Saudi-Russian price war, the energy world is entering a complicated period that will carry long-term ramifica-tions that we believe ultimately favor US shale. At current prices, while American production volumes begin to fall rapidly, we estimate that many key countries supplying 25% of the world’s oil will be insolvent within 2–3 years. Many smaller or overly indebted American producers, not owned in this portfolio, could also disappear. Those American shale companies with little or no debt, and with decades of inventory of low-cost acreage, are primed to become the leaders in whatever future follows the current moment, in which the world’s major petrostates decimate each other in a circular firing squad. For patient long-term investors, we think this will afford a very rewarding entry point.


energy and income. Needless to say, the short-term outlook for energy dividends is shaky. But for a moment prior to the coronavirus crisis, investors received a glimpse of “normalized” income potential in this space. One-third of our companies raised their dividends in January and February. The indicated yield on this strategy is now 7% (5.1% in the No K-1 version). Depending upon the duration of the shutdown, some holdings face temporary suspension of dividends. We’re optimistic that the return to normal life will spell a resumption of potent equity income and growth here too.

along the energy value chain. We made several changes in advance of the rout in oil stocks, particularly increasing our natural gas exposure. As opposed to oil, which is used for transportation, gas is used for heating, cooking, and electricity—all uses that will remain in demand. Too, falling oil production will mean less cheap associated natural gas, providing a potential opportunity in heavily discounted gassy E&Ps and pipelines.


Source: US Energy Information Administration (EIA), Annual Energy Outlook 2020.

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our positioning in the 2020 pandemic

The spanish Influenza. chart showing mortality from the 1918 influenza pandemic in the us and Europe.Image: courtesy of the National Museum of Health and Medicine. This work is in the US public domain as it was published

or registered with the US Copyright Office before January 1, 1925.

whEn dIscussInG EXTREME wEaThER EVEnTs, you’ll frequently hear people joke that 100-year events, say floods or hurricanes, are coming every five or ten years. But in the case of pandemics, extreme outbreaks are truly rare.

One hundred years ago a vicious strain of influenza engulfed the world. Estimates of the death toll vary widely, ranging from 20 to 100 million in a much less populated world. We have better medicine today, but human nature hasn’t changed much. Skepticism among politicians and businessmen was rampant: Why shut everything down? What’s a little flu? Looking back, it’s easy to second-guess those who wanted life to go on as normal. Few events in our experience can unfold as fast as a pandemic.

However, the pandemic will end in a time frame that is short for a long-term investor, and the ultimate value of our investments will be largely unaffected, in our view. This may sound like a throw-away comment, but it’s actually very important. If we were investing in sports franchises, this conclusion would not hold. Suppose a basketball team loses its star center. That would put a perma nent dent in the value of the franchise. For a large corporation, there is no equivalent. It would be sad if the CEO of one of our holdings was unable to work because of the virus, but a competent CEO should have a succession plan and business should run as usual.

The pandemic will permanently impact some businesses. The most obvious are idiosyncratic—for example, consum-ers may shy away from cruise ships for years. Most of the long-term economic damage, however, will be associated with problems faced by overly leveraged companies. Getting from the current state of emergency to the other side will involve challenges, including lower revenue, disrupted supply chains, difficulty collecting on debts, and the like. Companies with variable cost structures will likely contract and then expand again with little permanent damage. Highly indebted companies could have trouble, both paying their interest cost as well as finding a willing lender if they need more capital to get through the valley.

In contrast, firms with healthy balance sheets should have the flexibility to survive the crisis and thrive on the other side. Through our process of intensive due diligence and continuous monitoring, we’re confident that these qualities predominate in our portfolios relative to their respective categories.

For example, we continue to focus on high current yield, prospects for dividend growth, financial strength, and earnings stability in our Income-Equity strategies. As the tables on the page 11 show, we believe the companies in our Income-Equity strategies are well-positioned to weather this downturn and poised to return to dividend growth when economic conditions improve.


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yield, Growth, strength, stability

Source: Bloomberg; S&P 500; Miller/Howard Research & Analysis. The data above is based on representative accounts in our Income-Equity Strategies both with and without MLPs and is subject to change.* Projected Dividend Growth—Miller/Howard Portfolio Team’s 3-year annualized projected dividend growth based on data from various sources, adjusted to reflect our view of future economic and market conditions. There is no assurance projections will be realized.** Bloomberg Dividend per Share 3-year forward estimates.*** Excludes financials.

Income-equity Strategy (with Mlps)2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1Q 2020

Income-Equity Yield 5.1 5.1 4.8 4.4 4.2 4.7 4.0 3.7 4.3 3.7 5.4

S&P 500 Yield 1.9 2.1 2.2 1.9 2.0 2.2 2.1 1.9 2.2 1.9 2.3

Ratio 2.7x 2.4x 2.1x 2.3x 2.1x 2.2x 1.9x 2.0x 2.0x 2.0x 2.3x

Income-Equity Projected Dividend Growth* 6.2 6.8 7.5 7.5 7.5 5.8 5.0 6.3 7.8 7.3 – †

S&P 500 Projected Dividend Growth** 5.8 5.9 5.1 5.9 4.7 4.2 4.0 4.2 5.2 4.2 – †

Ratio 1.1x 1.1x 1.5x 1.3x 1.6x 1.4x 1.2x 1.5x 1.5x 1.7x – †

Income-Equity Dividend Coverage Ratio 1.3x 1.4x 1.5x 1.3x 1.3x 1.3x 1.3x 1.5x 1.9x 2.3x 2.1x

Income-Equity Net Debt/EBITDA*** 2.2x 2.4x 2.5x 2.6x 4.2x 2.8x 2.0x 1.9x 1.4x 1.9x 2.0x

Income-Equity P/E Ratio Trailing 13.4 13.3 14.1 13.4 16.4 14.2 17.2 17.7 12.6 12.8 9.5

S&P 500 P/E Trailing 15.4 13.4 14.4 17.4 18.4 18.8 20.5 21.7 16.5 21.6 23.2

Premium/Discount -13% -1% -2% -23% -10% -24% -16% -18% -23% -41% -59%

Income-equity Strategy (No Mlps)2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1Q 2020

Income-Equity (No MLPs) Yield 4.9 5.0 4.7 4.1 4.0 4.6 3.9 3.7 4.2 3.6 5.3

S&P 500 Yield 1.9 2.1 2.2 1.9 2.0 2.2 2.1 1.9 2.2 1.9 2.3

Ratio 2.6x 2.4x 2.1x 2.2x 2.1x 2.1x 1.9x 2.0x 2.0x 2.0x 2.3x

Income-Equity (No MLPs) Projected Dividend Growth* 6.3 7.0 7.6 8.2 7.7 5.9 5.0 6.4 7.9 7.5 – †

S&P 500 Projected Dividend Growth** 5.8 5.9 5.1 5.9 4.7 4.2 4.0 4.2 5.2 4.2 – †

Ratio 1.1x 1.2x 1.5x 1.4x 1.6x 1.4x 1.2x 1.5x 1.5x 1.8x – †

Income-Equity (No MLPs) Dividend Coverage Ratio 1.6x 1.4x 1.4x 1.3x 1.3x 1.3x 1.3x 1.5x 1.9x 2.3x 2.1x

Income-Equity (No MLPs) Net Debt/EBITDA*** 2.1x 2.4x 2.5x 2.7x 2.6x 2.6x 2.2x 2.1x 1.4x 1.9x 2.0x

Income-Equity (No MLPs) P/E Ratio Trailing 13.2 13.5 14.5 14.6 17.2 16.5 18.2 18.0 12.9 13.5 9.5

S&P 500 P/E Trailing 15.4 13.4 14.4 17.4 18.4 18.8 20.5 21.7 16.5 21.6 23.2

Premium/Discount -14% 0% 1% -16% -6% -12% -12% -17% -22% -38% -59%

■ Our Income-Equity Strategies each offer a high dividend yield that is 2.3x the yield on the S&P 500 Index, and have ample dividend coverage and reasonable leverage levels (net debt/EBITDA).

■ Both portfolios trade at a significant discount to the broad market on price-to-earnings as well. Value investing historically has done best coming out of a recession, so the historically low valuations should set the Income-Equity Strategies up for a strong recovery, in our view.

■ The near-term picture is cloudy for projected dividend growth. However, we believe the portfolios are well-positioned to weather this downturn and poised to return to dividend growth when economic conditions improve.

† 1Q 2020 projected dividend growth has been removed due to the unreliability of current projections within the current environment. The 1Q 2020 earnings season should provide clarity regarding projections.Dividend yields shown for Miller/Howard portfolios exclude cash. All data is as of year-end, unless otherwise noted.common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time. Dividend yield is one component of performance and should not be the only consideration for investment. See definitions and full disclosure on page 12.

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QTR 2020Q1 3002 PUB RIA | UBS U20Q1_3002 4/21

M I L L E R / H O W A R D I N V E S T M E N T S | 1 0 D I x O N A V E W O O D S T O C K N Y 1 2 4 9 8 | ( 8 4 5 ) 6 7 9 - 9 1 6 6 | M H I N V E S T . C O M

Notification to clients: Contact your Advisor with any material changes to your financial profile that would impact your suitability for investment.

DeFINItIoNSearnings Before Interest, taxes, Depreciation, and amortization (eBItDa)—A non-GAAP measure used to provide an approximation of a company’s profit-ability. This measure excludes the potential distortion that accounting and financing rules may have on a company’s earnings; therefore, EBITDA is a useful tool when comparing companies that incur large amounts of depreciation expense because it excludes these noncash items, which could understate the company’s true performance.Net Debt to eBItDa—A measure that computes the company’s ability to pay off its debt by utilizing the earnings before interest, taxes, depreciation, and amor-tization (EBITDA). price-earnings ratio (p/e)—The ratio of a company’s share price to its earnings per share. The ratio is used as a valuation tool and can help determine whether a company is overvalued or undervalued.

This report represents Miller/Howard Investments’ views. The statistics and projections cited in this report have been provided by sources generally considered to be reliable, but are not guaranteed. Opinions and estimates offered constitute Miller/Howard Investments’ judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is solely informational. The information and analyses contained herein are not intended as tax, legal, or investment advice and may not be suitable for your specific circumstances; accordingly, you should consult your own tax, legal, investment, or other advisors, at both the outset of any transaction and on an ongoing basis, to determine such suitability. The material may also contain forward-looking statements that involve risk and uncertainty, and there is no guarantee they will come to pass. any investment returns—past, hypothetical, or otherwise—are not indicative of future performance. The information provided should not be considered a recommendation to buy or sell any security, and should not be considered investment, legal, or tax advice. Securities mentioned are being shown for informational purposes only. Buy and sell rationales are the express opinions of MHI’s investment team. These securi-ties should not be considered a recommendation to buy, sell, or hold any of the securities and are not intended to imply that any one security listed above, or the portfolio as a whole, is suitable for a particular client. There is no assurance that the securities purchased have remained or will remain in the portfolio or that securities sold have not been or will not be repurchased. common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time. Dividend yield is one component of performance and should not be the only consideration for investment.

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