Vanguard Natural Resources: A Brilliant Financial Crisis Income Investment

Lately, I’ve been studying the opportunities that showed up during the 2008-2009 financial crisis to get clues about what would be the most intelligent behavior during the next time the once-in-a-generation financial crisis arrives.

Although it seems very counterintuitive, the long-term wealth maximization decision is not necessarily buying the high-quality blue chips that I frequently discuss here: Yes, they get cheap and provide a platform for 12-15% annual returns even when you are dealing with high-caliber businesses that will only be growing at 10% because you were able to lock in prices at such a cheap rate. Perhaps if you invest $40,000 over the course of a recession, blue-chips should occupy $30,000 of that investable capital.

What interests me is this: buying energy MLPs during times of crisis. I’m studying the energy MLPs that traded at over $5 billion in valuation before the crisis, and I can only find two that failed catastrophically. All the others survived and prospered substantially.

I’ll use Vanguard Natural Resources to serve as a representative example of what could have happened if you created ten $1,000 slots for energy MLP investments. Assume two go completely go completely bankrupt. The other eight go into a collection of energy MLPs that survive and prosper a la Vanguard Natural resources.

Here’s what it would have looked like: the $8,000 used to buy shares of Vanguard Natural Resources would have netted you 1,600 shares at $5 each. The company was in the midst of exhibiting its financial health, raising the quarterly payout from $0.445 to $0.50 per share. That’s about as much of clear signal as you can ask for, if you remember what 2008 was like.

The amount of distribution income those 1,600 shares of Vanguard Natural Resources would have generated is obscene. Even if you lived off every distribution provided since then, you’d still be in the interesting situation today of having 1,600 shares of VNR pump out $0.21 per share (errr, unit) monthly. That’s $336 per month, giving you a yield of 50.4% on the amount invested, or 40.3% on your total amount of invested capital when you include the two that went kablooey.

If you reinvested throughout the financial crisis—crazy things would have happened as you had very high distribution payouts mixing together with a very depressed valuation. Distributions reinvested from 2009 through 2014 would have you sitting on 2,607 shares paying out $0.21 each month, giving you $547 each month, or $6,564. It’s another year or three of reinvestments mixed with distribution growth away from crossing the hallowed “I am collecting more in cash from this investment than I put in” ground.

Speculation is at its most lucrative during times of financial crisis because blue-chip stocks get beaten by 20% or 35% while the third-tier and fourth-tier quality companies get beaten down 75-80%. Therein lies an opportunity if you are the kind of person who can survey the wreckage and think, “I’m going to place a small collection of diversified bets on this very high income sector, and we’ll see what’s standing in five years. Meanwhile, I’ll reinvest the dividends.”

Most of this post is just me thinking out loud—there’s a lot to be said about doing something like buying $10,000 worth of Coca-Cola at the split-adjusted price of $22 per share. That would have got you 441 shares then, which, if you’d been reinvesting dividends, would have grown to 515 shares now. You’d be receiving $628 in dividends from the highest-quality company in the world (although I’m open to arguments it’s tied with Nestle and Johnson & Johnson), giving you a 6.28% yield-on-cost just six years later. You won’t have to do any more thinking or maneuvering—you would just sit back and watch it grow.

I’m not done studying the financial crisis yet, and I’m sure I’ll update with more posts, but my current inclination is to think something along the lines of this: “The best approach for an income investor during a severe economic crisis is to allocate 75% of investable capital to very high-quality blue chip stocks and permit the other 25% to go towards a small collection of income-rich energy MLPs as part of a broad basket of investments.” It combines the desire to make lifetime investments with the desire to act shrewd; the current yields-on-cost for the energy MLPs that survived is mouthwatering if you like receiving $5,000 dividend checks on $10,000 investments within six years, and I’m still thinking about what to do with that knowledge.