Miller/Howard Investments

Strategic Investor Radio Interview with Michael Roomberg:
Energy Chain Investing with Miller/Howard

December 28, 2016  |  Michael Roomberg, CFA, Portfolio Manager/Research Analyst

Recording: Welcome to the Strategic Investor. Join us as we interview some of the world's most productive asset managers and uncover sophisticated and unique investment strategies in the markets. Here's your host, Charley Wright.

Charley Wright: Hello and welcome to Strategic Investor Radio on octalkradio.net. We bring you investment strategies you're not hearing elsewhere. Very grateful today to have Michael Roomberg with us, Portfolio Manager of Miller/Howard. Miller/Howard Investments. They are located in and he speaks to us from the very infamous town in the state of New York of Woodstock. Michael, welcome to Strategic Investor Radio.

Mike Roomberg: Thank you, Charley, and good morning to you. I bet it's quite a bit warmer there than it is here.

Charley Wright: No question about it. We're even getting a little precipitation which we definitely need. Michael, for our listeners here, Miller/Howard was founded over 30 years ago by Lowell Miller, a well-known name in the investment world. You guys originally conducted a landmark study of utilities as an asset class, which put you guys on the map. Today you guys are a family of mutual funds. Your expertise is energy and water investing. Let's begin immediately with give us a brief history of Miller/Howard itself.

Mike Roomberg: You covered it. Miller/Howard was started as a research boutique. Lowell wrote a book in the late '70s called The Momentum-Gap Method. The book was a way to identify interesting investments from technical chart patterns. Lowell got his start as a technician. Wrote the book, published it, and it was picked up and read by an actual rocket scientist who said, "I can write the code to source these types of patterns for you and identify them across the market," which was a pretty novel concept at the time. It enabled Lowell to get into the business of identifying stocks and providing technical analysis to institutional investment managers. As you correctly pointed out, the firm evolved from a research boutique that conducted ultimately a landmark study at the time of utility stock returns, which really showed how utilities can provide for a higher level of income, growth of income, inflation protection, total returns that are pretty comparable with the market overall, albeit with quite a bit less volatility. That led to an investor approaching Lowell with the idea that he put that strategy to work, and thus began our investment management business.

Our firm has evolved over the years and our focus on dividends remains. The qualities of companies that we look for have current income, recurring income, growth of income, and financial strength. Really those are the hallmark blue chip type qualities that we look for. To make a long story short, utility companies are often critically reliant upon or dependent upon or owned by legacy of their history midstream pipeline assets. We started to see what was happening with midstream pipelines beginning on the natural gas side in 2005, on the crude oil side in 2010. We had been owning these pipelines for many years through our various income-oriented portfolios.

Really, as that started to evolve and the shale revolution started to evolve, we saw how that was impacting other areas of our economy as well, areas like petrochemicals or environmental services, companies that were really breathing new life or having new life as a result of the shale revolution. We decided to start our strategy in 2011 - again, relatively early innings of the shale revolution - to really capture all the aspects of the energy revolution in one strategy.

Charley Wright: Michael, we're focusing today because our show is all about alternative investing. We're going to focus on your strategy of which you are the portfolio manager. It's called Drill Bit to Burner Tip®. Whoever came up with that name does not have to say it multiple times every day, I can tell you. I have practiced all morning to be able to say that here.

Mike Roomberg: You said it well.

Charley Wright: Tell us about this strategy and how that particular name fits here.

Mike Roomberg: Sure. As I mentioned, Drill Bit to Burner Tip® really brings together in one portfolio all of what we do in our other strategies. Collectively the firm manages about seven billion dollars in assets. We have 11 investment professionals looking at companies in this area. The Drill Bit to Burner Tip® portfolio is really that. It's the entire North American energy value chain from the drill bit in the field to the burner tip in your home. It's really premised on two beliefs. One is that shale technology is, first and foremost, a technological revolution. It's a change in the way that we provide for energy in our economy. It is one that has unlocked vast quantities of commercial resource that wasn't previously available to us.

Just like the Gold Rush of the 1800s, if one were to only look at the individual miners that went out there, you'd be missing the broader picture of all these various industries that sprung up or benefited, as we call it, from the emergence of this industry and this trend. Companies like Levi Strauss that were distributing dry goods to miners or Wells Fargo that was transporting gold back to money-centered banks. These are the type of companies that, in the end, are among the largest wealth beneficiaries of what's taking place here. The portfolio is built to have that breadth. A traditional energy strategy is really just a proxy bet on the price of the commodity. Whereas with this portfolio we're focused on the consumers of the commodity, companies that benefit from the abundance of North American energy, which we think will continue to be enhanced over the next several decades.

It's also mainly focused on natural gas. We believe that natural gas is a bridge fuel between an economy today that's mainly powered by coal to a lesser extent and oil to a future that's powered by renewables. Between here and there we'll have a major transitional shift in our economy. It will cost significant amounts of dollars. Natural gas will continue to serve as the bridge fuel that will lower our environmental footprint. I can go into detail about the environmental qualities of natural gas, but, to put it very simply, many of your listeners, Charley, will go home tonight. They will boil a pot of water on a gas-burning stove with the windows closed with no problem. They wouldn't do the same thing with a charcoal grill in the middle of their dining room. It's quite that simple on an industrial scale in terms of the pollution effects of natural gas. We're very bullish on the future growth of natural gas for that reason.

Charley Wright: We all hope that you're accurate here, because that would be a real boon, not only the economy but for the environment, et cetera. Let's drill down a little bit here and talk about the specifics. We looked at it from the 10,000 foot level. Specifically, are you invested in four, five different specific industries? Do you just look at particular companies? What are you invested in, in this strategy?

Mike Roomberg: We divide the portfolio universe into four buckets. The first is the upstream. These are the independent oil and gas producers that own the right to produce oil and gas. They do so at the lowest price possible and they are price takers. These are companies that really directly benefit from rising commodity prices. The second area is the midstream producers.

Charley Wright: These companies are what kind of companies? Give me some examples.

Mike Roomberg: Oil producers or gas producers. An example in our portfolio in that bucket, if you will, Charley, would be a company called Cabot Oil & Gas*. They own the rights to develop thousands of acres in the northeast Marcellus Shale. They drill down several thousand feet and they are able to unlock vast quantities of gas at a very low cost. This is one of the leading companies in our portfolio. They're located about 95 miles to New York City, which is the largest gas-consuming market in the United States. They have the perpetuity right to produce that gas on that acreage for what will amount to several decades of drilling inventory.

Charley Wright: You're looking at companies who are well-positioned for these kinds of opportunities. Then I presume you are looking at their fundamental indicators to make sure that they're profitable, sales are up, they have free cash flow that is strong, et cetera, et cetera.

Mike Roomberg: Absolutely. We are bottom-up stock pickers. We are constantly screening a universe of stocks that are style fit for this theme that I've just discussed. We are constantly looking for companies that possess not just the right qualities that make them good companies, but ones that are mispriced in the market, because it's not enough to have a good company. It also has to be one that's not receiving all of the full amount of love that it should from investors.

Charley Wright: Okay. What's the second category?

Mike Roomberg: The second category's called the midstream. This is the area of what many people are familiar with, MLPs. These are volume-sensitive businesses. They're mainly oriented like toll roads, so the more cars, the more traffic, and the more fees they're able to generate on their pipelines. It's a very volume-sensitive business. Rarely has the actual underlying earnings of these companies been impacted by the commodity. But you do see a correlation, if you will, with the price of oil and gas at times when really investors begin to expect changes in the volume of flows, which can be brought about by a significant rise in prices, which will foster more drilling activity and more production and more shipments. The same can be said when oil prices collapse, as they did a couple years ago. It's a very attractive business model.

Charley Wright: Here we have the MLPs. We have the exploration, upstream. Here we have midstream. What's the third?

Mike Roomberg: The third is downstream. This is mainly areas of regulated natural gas utilities. Utilities are regulated in each individual state. In California you have the CPUC that regulates how much natural gas utilities are allowed to earn. Mainly they don't earn any money on the gas. If gas prices are high, many people think that utility is gouging them, but really they don't earn any of their money on the actual gas itself. Instead, they're incentivized to invest in the infrastructure itself, all the delivery systems that they maintain. They're allowed to earn a profit on that. The regulators want to keep their profits in check, but more importantly they want to keep the overall bills in check for retirees and low-income participants, et cetera. When gas prices remain low, as we think they will because of this abundance of North American natural gas, these companies generally make more and higher returning capital investments without impacting customers' bills to the same degree. These are companies, an example of a company that wouldn't really be correlated positively to the price of gas, in fact that have benefited when gas prices are lower. That's, again, something that speaks to really the differentiation aspects of this portfolio.

Charley Wright: What's the fourth?

Mike Roomberg: The fourth is an area that‘s very differentiated. This is the enablers and beneficiaries. For instance, we might be invested in a regional financial bank, a savings and loan bank, in an area that has a very high overlap from a branch standpoint with a shale-producing area. My home state of Pennsylvania, where I was born and raised, there's 50,000 royalty recipients that are getting checks from natural gas drilling companies every month. They don't have the benefit of a large money-centered type bank, and so they go to their regional savings and loan. That bank in turn has a higher level of deposit growth. There's more seasonal activity, more migrant workers, more economic activity in hotels. C&I loan activity, commercial and industrial loan activity, from that bank benefits to a greater degree from the activity that's taking place in that area. These companies will generally generate benefits not just from higher prices, but greater levels of activity. Again, in that area of our portfolio there's very low correlation, generally speaking, to the price of the commodity.

Charley Wright: You're in these four areas. You select stocks in those. You have about how many positions at any given time in the portfolio?

Mike Roomberg: The portfolio generally has between 35 and 40 stocks in it, Charley. It gives us the ability to be diversified while at the same time leveraging the fruits of our labor in really identifying mispriced stocks. We are absolutely not closet indexers. We like to really get deep in the weeds on individual companies and find where the market we think may be missing the opportunity. We call it a lack of imagination when, as investors that are looking to the future, maybe two or three horizons beyond what's visible today. We talk about our location here, in Upstate New York. It really gives us an ability to sit here and evaluate the landscape as it may exist beyond the hustle and bustle of what's just in front of us.

Charley Wright: Do you try to have an equal distribution among the four different categories?

Mike Roomberg: We want to provide a better risk-adjusted return for investors. But we also want to provide this diversified exposure to this long-term theme. Energy will always be cyclical. A lot of folks forgot when shale took off in 2010 that this was going to go up into the right forever. But then they forgot that energy again will always be cyclical. While we always try to be exposed to the broad area of the entire investing universe, we can tactically allocate and under-allocate each of those individual buckets that I just described. Given how they all act differently, given their different areas of the value chain with respect to commodity prices, interest rates, expectations for economic growth and valuations, we can tactically overweight and underweight each of those buckets, really we can sidestep some of the carnage, if you will, when inevitably markets turn. In fact, we have a large group of companies in our investment universe that could benefit from lower prices, as I mentioned.

Charley Wright: Michael, we need to take a short break here. We're well beyond the time. This is very interesting stuff about certainly a very important sector of the economy. Again, we're talking with Michael Roomberg, Portfolio Manager for Miller/Howard Investments, for their strategy Drill Bit to Burner Tip® fund. You're listening to Strategic Investor Radio on octalkradio.net. I'm Charley Wright. We'll be right back.

Recording: According to the consulting firm Strategic Capital Allocation Group, every decade since 1900 has experienced at least one bear market, and several have experienced as many as three. How do we protect our principle from these declines without missing the gains when prices rise? At Strategic Investor Radio, we interview asset managers with unique strategies, designed to grow your investments. Investing is not rocket science. It's rocket fuel, if you know how to harness it. For podcasts of our interviews, please visit us at strategicinvestorradio.com.

Paul: Now back to Charley and his guest.

Charley Wright: Thank you, Paul. Again, we're talking with Michael Roomberg, Portfolio Manager for Miller/Howard Investments, of their fund Drill Bit to Burner Tip®. Michael, you've told us about the four categories, all focused on either energy or beneficiaries of the energy, primarily liquid natural gas industry. Tell us, do you hedge on these positions at all, other than through diversification?

Mike Roomberg: No. We do not, Charley. In fact, we generally have a policy of being fully invested long-only. We don't bet against the price of the commodity or individual stocks, and we don't really manage cash. We like to provide a service. Our fund, which you've referenced, Drill Bit to Burner Tip® fund, provides daily liquidity for investors. To the extent that investors want to manage their own cash, we let them do that. They can buy the fund and sell the fund at their discretion. As long as they're invested in the fund, we like to be invested in the theme on their behalf. We don't actually bet against any companies who use all US-traded equities.

Charley Wright: You deal in North America, so you deal in Canada as well.

Mike Roomberg: Correct. We have a number of companies that are traded on the New York Stock Exchange but are headquartered or have a significant amount of operations in Canada. There's about 11 reasons, which I won't go through in their entirety, that make the shale revolution distinctly a North American revolution. We think that the US, and Canada to a lesser extent, will maintain their first mover advantage for decades to come. This is a product of, again, many different factors that make shale development here so attractive.

I'll give you one great data point that I love to point out. The Chinese have always been historically done things that we've done in the past, ultimately bigger, better, faster, cheaper. With respect to shale, China has a target of developing their own shale resources by 2020. The amount that they'd like to produce by 2020 is what we produce today in a week from shale. The US and Canada are very far ahead in this, and we think that that is really a structural advantage that we'd like to capture in this portfolio. Of course, the friendly Canadians and the US, it's free of the conflicts that many times bedevil investing in energy, which is obviously a globally-focused industry.

Charley Wright: You mentioned earlier, Michael, that the price of oil and natural gas and other energy products is cyclical. Cyclical returns are not popular with investors. I presume you guys focus on the longer term and not what has happened in the past six months, a year, even two years.

Mike Roomberg: We have remained very active through the cycle, Charley. We've noticed the inflections points, the various ... We live and breathe the commodity markets, and so we're always trying to position the portfolio to really mitigate some of the volatility and not have that come at the expense of benefiting from rising markets when they are rising. We remain very active and tactical in that regard. We do have a longer term vision and we like the sandbox, if you will, that we're playing in. We think it will yield a lot of high returning opportunities over time. But we are also focused on the short term, because, as we've seen, really my colleagues will say that we've experienced several lifetimes of energy investing in the last two and a half years. I think that's apt. The nimbleness and the diversity of this portfolio is really seen by investors that we work with as a way to dip your toe into energy without making a pure proxy bet on price.

Charley Wright: Tell us, what are the typical kinds ... I realize you're not on the sales end of things. You're not talking every day to advisors and investors and the like. But what are the typical kinds of objections that your firm is running into on this fund?

Mike Roomberg: That's a great question. In fact, I try to talk as much as I can with folks that are in the market, whether it's our clients or investors. But the bottom line is you're right. Most of our time is spent pretty monk-like, just pouring over financial statements and documents and filings and research reports. To answer your question, I think that the biggest question is people wonder, is shale real? Does it have this multi-decade future ahead of it? Is it environmentally safe? You mentioned at the top of the show that I do have a background in water and energy, and water topics are ones that people focus on. As an environmentalist myself, I recognize that if companies cut corners, they do things improperly, and there's not good regulation, then mistakes can happen.

We are very much proponents of good regulation. To the extent that regulations are enforced and companies are doing the right thing, this is a safe industry. It's one that, especially on the natural gas side, is working to reduce our carbon footprint, our sulfur dioxide footprint, and our imprint with respect to coal and all of the things that come along with that. I would say that would be one aspect. Then the rest are probably what you see with every investment. Has the market run too far or am I getting in too late? Things of that nature.

Charley Wright: I don't think anybody's wondering if they're getting in too late at this point. They're wondering how long it will be before it was worth it, probably. These kinds of things we'll just have to see here.

Mike Roomberg: I would concur with you. We wouldn't be talking about it if we didn't think that way.

Charley Wright: Michael, a question we like to ask all of our guests: what keeps you awake at night?

Mike Roomberg: Other than my three-year-old and my six-year-old who occasionally wander into the bedroom, not much. This is a bipartisan fuel. It's politically supported on both sides. It's a technology that's proven and improving. Really, it boils down to the macro side. Everyone has focused on the OPEC cut, for instance, on the oil side, but a couple hundred basis points of extra economic growth would be equivalent in terms of the benefits of the tightening of the market from that standpoint. To the extent that there's more economic activity, there's more demand for energy, that's really what our north star is. To the extent that there's risks to that, as there were in '08 and '09, that's really the only thing that worries me, because I know that this is something that's very well supported. The science backs it. Energy is a critically important component of modern life. There is nothing around us that's possible without good, reliable sources of energy.

Charley Wright: No question about it. It just hit me, Michael, I remember back in 2008 when the price of oil went from 150 to 30, or whatever it was, in a very short period of time. All I heard on the media was how wonderful this was, because it was going to put all this money back into the consumers' pocket and they were going to spend it and it was like a tax cut and it was wonderful. This time around I heard that originally when the price started dropping. But then, when people recognize that there is so much of the economy that is dependent upon the energy industry and that the dropping price was actually hurting the economy, people really woke up and said, "Hey, wait a minute. We really do depend on energy not just as a product but as a method of fueling our economy."

Mike Roomberg: There's no question about it. If I look at the spending side, for every dollar increase in the price of crude oil that's another $3.65 billion of capital investments that are being spent each year in the United States. Obviously the money multiplier effects of economic growth, that is very apt for this area. The energy industry is an important part of our economy, and one because of shale that's becoming even bigger in terms of our economy. You did have consumers that benefited. Certainly people had a couple extra dollars in their pocket. That is part of the shale revolution, is the benefit of low prices. If we didn't have shale today, your heating bills would be two to three times more what they are today. Filling up your gasoline-powered car would be two to three times higher. You'd still have all those crazy fuel surcharges on the airplanes.

Energy does cost people. When the prices come down that's good, but it also comes at the expense of a huge amount of capital investment, which is only growing in importance in our economy as we are on track now. We actually are in position, as of this year, to be exporters of natural gas. That is an export of the United States. Everybody says, "We don't make anything here anymore." Well, petrochemicals, plastics. We are now one of the lowest cost places in the world to manufacture plastics because of the cost of the energy is so cheap here. It's cheaper than China and Japan, Southeast Asia, Europe. We are a leader in that. This is an increasingly important part of our economy, not just from a drag on consumer spending when prices rise but the benefits that flow from that in terms of increased activity.

Charley Wright: Michael, remind us, was there a recent restriction from the federal government on the exporting of natural gas?

Mike Roomberg: Not on natural gas. On oil there had been a longstanding restriction. Really what that did, without getting too technical, is just inhibited increased production activity that would benefit consumers. The type of oil that comes out of shale is a certain quality. It's pretty high quality, believe it or not. The US refineries, pre-shale, were built to import what is generally pretty low quality oil. We had this overabundance of high-quality oil that, no matter how much our refineries wanted to use that as their feed stock to make things like gasoline and jet fuel, they weren't able to. If we could exchange our high-quality oil for low-quality oil, we could not only increase drilling activity in the United States, but offset that mismatch and make an abundance or more available the imports and offset the drag on GDP that is inherent in having a larger trade deficit. It's a win-win. It was just a matter of getting the policy correct and accepted by politicians. Ultimately that happened.

Natural gas exports, on the other hand, there's been local permitting issues and they have to be permitted at the federal level as well.

Charley Wright: Michael, you make some compelling points here. Unfortunately we've got to move on, but this is very interesting stuff. Second question we like to ask all of our guests: what book on investing would you recommend for our listeners?

Mike Roomberg: That's a great question. What book would I recommend? Well, here I got to represent the home team and point your listeners to The Single Best Investment, which is among the most definitive books on dividend investing that readers can have access to today. The book was written by our firm's founder, Lowell Miller, who was, again, my CIO today in 1999. Charley, I'm not sure the age demographic of your average listener.

Charley Wright: We're all young and vibrant here. No question about it, Michael.

Mike Roomberg: In that case, many will probably not recall in 1999 when the book was published. That was a pretty unfashionable time to be talking about dividend stocks.

Charley Wright: It was. That was the height of the tech boom right there.

Mike Roomberg: That's it. The hot thought was the companies that hardly had any earnings, let alone sales or customers, and certainly didn't pay dividends. It's emblematic of what we do. We're independent thinkers. After that bubble burst, obviously it didn't take long for folks to remember the eternal appeal of a solid, modestly growing, high quality, dividend paying portfolio.

Charley Wright: The author is Lowell Miller and the title, again?

Mike Roomberg: The Single Best Investment.

Charley Wright: The Single Best Investment. Great. Give us your website. We didn't talk about it, your fund is a mutual fund, correct?

Mike Roomberg: Correct. The portfolio is available through a mutual fund. The ticker symbol is DBBDX. The website for our fund is MHI, that's Miller/Howard Investments, mhifunds.com. Folks can obtain more information from our main office, which is, telephone number is 845-679-9166. Again, the fund is called Drill Bit to Burner Tip®. It's a bit of a Rorschach test, if you will. Some folks love it and some folks don't like it. It really does describe what we do for clients, which is gain them exposure to what we think is one of the most appealing secular growth stories in our otherwise fairly slow-growing economy.

Charley Wright: We've got to congratulate you, Michael. You guys are looking at something that is very important to our nation's economy, is a great opportunity for the future. We've taken a dip here, but, like you say, everything is cyclical, not just energy but everything. We've had a dip here. This is a great thing, as I can see, that you guys are doing, is raising money to encourage and to participate in the energy opportunities, natural gas, oil, et cetera. Michael, final words for our listeners here?

Mike Roomberg: Absolutely. North American energy independence is what we are focused upon. As you mentioned, most of the things around the market today have risen and are trading near all-time highs. Energy is a category that's still well below where it was in the past several years ago. We think that the future is very bright for the portfolio.

Charley Wright: Michael, thank you very much. We really appreciate you coming on today. Again, this has been very, very interesting in more than one way.

Mike Roomberg: Thanks, Charley. I appreciate it and enjoyed the conversation.

Charley Wright: Again, we've been talking with Michael Roomberg, Portfolio Manager at Miller/Howard Investments, and manager of the Drill Bit to Burner Tip® Fund. You've been listening to Strategic Investor Radio on octalkradio.net. We'd love you to contact us at info@strategicinvestorradio.com and you can go to our website to hear podcasts of all of our interviews and shows, strategicinvestorradio.com. I'm Charley Wright, wishing you an enjoyable week and productive investing.

Recording: You've been listening to The Strategic Investor, your source for compelling investment strategies from some of the most productive asset managers in the industry. For unique investment strategies, visit us at strategicinvestorradio.com. Investing is not rocket science.

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