The looming fiscal cliff has caused extreme market volatility and has forced investors to seek safer stocks. With the economic and political climates becoming more tumultuous, I have been concentrating on high yield opportunities. Stocks with high yields tend to be "safer" because the yield provides a cushion against capital depreciation and inherently implies that the underlying equity has sufficient cash reserves (although not always the case). Dividend stocks tend to have a strong financial position but it is always critical to check the liquidity and solvency ratios before considering an investment. Blue-chip dividend companies are well-known but there are attractive equities with high yields going ex-dividend every week. This strategy can work in one of two ways: either you buy before the ex-date to receive the dividend or buy after if the stock declines far below the after-tax amount of the dividend. Regardless of your short-term strategies, these equities can be attractive longer-term investments depending on your individual circumstances.
Buying the stock to receive the dividend is intuitive but many have contacted me requesting further details on the second strategy. Investopedia has a great example of how this works. To explain this, I will use AT&T (T) as an example. AT&T declared a $0.45 dividend to shareholders of record on January 10, 2013. On the ex-dividend date the stock price should decline by the after-tax dividend amount, with an assumed tax rate of 15% because many dividends qualify for a preferential tax rate. It is true that you can personally avoid immediate taxation by owning the security in an account with beneficial tax treatment but this serves as a benchmark.
As a result, an investor would expect the stock price to decline by $0.38 = [$0.45 * (1-.15)]. If AT&T declined by more than $0.38 in the absence of negative news you might have an attractive opportunity. For conservatism you may ignore the tax aspects and only trade if the stock price declines by the full dividend amount. Executing this strategy can generate returns over short periods of times but should only be performed on companies that you would be comfortable owning.
To focus on these opportunities I ran a screen with a focus on relative safety for the investments as the objective is to concentrate on liquid companies that are affordably priced. I began with a specification of a dividend yield greater than four percent and an ex-dividend date within the next week. To provide some layer of safety I narrowed down the environment by looking at companies with market capitalizations greater than $1B, PEs between zero and 20, and institutional holding percentage in excess of fifteen percent (except ADRs).
While not a precise requirement, I prefer companies that have underperformed the S&P 500 year-to-date as it indicates reduced downside relative to peers. For example, if negative macro news breaks, the stock that has declined more in the past year should ideally perform better than a similar stock with year-to-date gains. With the impending European crisis I now avoid companies with significant European exposure. This is summarized below:
- Dividend Yield ≥ 4.0%
- Ex-Dividend Date = Next Week
- Market Capitalization ≥ $1B
- PE Ratio: 0-20
- Institutional Ownership ≥ 15%
- Ideally Modest S&P 500 Underperformance
- Minimal European Exposure
After applying this screen I arrived at the equities discussed below. Although I envision these as short-term trading ideas, you still need to exercise caution. The information presented below should simply be a starting point for further research in consultation with your professional financial advisor before you make any investment decisions. My goal is to present new companies to you and provide a brief overview of their recent developments and this should not be considered a substitute for your own due diligence.
Prospect Capital Corporation (PSEC): 11.46% Yield; Ex-Dividend 11/28
Prospect Capital is a specialty finance company that operates primarily in the private equity and specialized investment categories with a focus on secured lending. PSEC trades at a relatively low 6.7 P/E, consistent with the depressed multiples of other financial services companies. Many private equity firms have been trading at P/Es in the single digits, which is remarkably low given the recent success of the industry.
Private equity companies are attractive dividend producers because they frequently revitalize or improve existing businesses and are able to return excess cash quickly. These can be volatile firms because their ventures often do fail but once they have successful investments, they can pay above-average dividends. Prospect's well-established history supports my belief in management's ability to continue the past success.
The firm prefers to make small investments ($5-$50M) in small-to-mid-size North American companies. Prospect has been very active in financing activities, and has been successful in finding demand for its revolving credit facility. In June 2010, Prospect began distributing dividends monthly rather than quarterly, which accounts for the large perceived dividend decrease from $0.40 to $0.10. The dividend has held steady around $0.10 per share since then, but growth is not a requirement when the current yield is already so high.
Early this year, Prospect agreed to acquire a specialty finance company, First Tower Corp., in a cash/stock deal valued at approximately $233 million. First Tower specializes in offering installment loans to consumers for mid-sized consumer purchases. Based upon TTM earnings, the deal would offer a current yield of 21%; therefore, should be an accretive acquisition. This is another case of the rich getting richer, and shareholders should take advantage. Prospect reported another strong quarter of earnings earlier this month and net investment income increased 166% year-over-year. The current portfolio yield sits around 13.3% revealing that the dividend is quite safe. Private equity investments are complex due to the scale and diversity of their operations so I strongly recommend that you read the earnings release for further details of investment activities. The company has been very active recently and entered into seventeen deals in the first September quarter, exceeding my expectations slightly. Prospect has completed six new investments since the last quarter, further indicating strength and growth in earnings.
The stock has been largely immune to poor equity performance in 2012 and has risen from $9.50 to $12 but has recently fallen below $11. The stock has dropped 7.5% in the past three months due to dilution concerns relating to the company's $384M net stock issuance ($11.10 per share before fees). Dilution is never good for a company but Prospect has a history of raising capital to fulfill investing requirements. I am confident that the $300M in capital will be put to good use and investors would be wise to take advantage of the drop in the share price. The P/E is still below seven and the yield is in excess of eleven; therefore, I am bullish on Prospect Capital's future. Many companies with yields in excess of ten percent can be yield traps, but Prospect has withstood the test of time and also offers capital gains opportunities. None of the loans originated in the past four years have gone on "non-accrual" status, highlighting management's ability to select attractive investment opportunities. Jeffrey Gall recently performed a detailed analysis of Prospect's holdings and came to the conclusion that "Outside of a few minor portfolio holdings, PSEC's portfolio is very healthy … Given its current portfolio coupled with the fact that PSEC is trading below book value makes PSEC a stock worth owning." If you needed even more of a reason to buy PSEC there was recently a "cluster insider buy" in which the COO, Director, and CFO all purchased shares within a five-day period.
Baytex Energy Corp. (BTE): 5.84% Yield; Ex-Dividend 11/28
Baytex Energy is an oil and gas company that engages in the acquisition, development, and production of oil and natural gas in Western Canadian and is expanding its presence in the United States. As a Canadian publicly listed corporation there may be special tax considerations for United States shareholders depending on their unique situations. Despite its natural gas interests, more than 75% of revenue is derived from heavy oil with light oil accounting for nearly twenty percent. Todd Johnson has a very comprehensive overview of Baytex in which he concludes "I believe Baytex is a long term winner in the Canadian monthly dividend oil sector. I prefer the company's focus upon internal funding and monthly dividends."
Baytex recently announced an acquisition of 46 sections of undeveloped oil sands leases in the Cold Lake area of northeast Alberta for approximately $120M. This acquisition is consistent with Baytex's focus on heavy oils. Note that Baytex pays dividends monthly and that payment has remained constant at $.22 per month throughout 2012. Overall Baytex appears to be a solid dividend opportunity but there may be storm clouds looming on the horizon. Demand for pipeline capacity is outstripping supply and those companies without refining capabilities, such as Baytex, may suffer. Earnings are estimated to drop almost thirty percent going forward if the demand stays at this level. This is a critical situation to monitor if you are considering a long position in the company.
Integrys Energy Group, Inc. (TEG): 5.17% Yield; Ex-Dividend 11/28
I wrote a detailed explanation of how I analyze utility companies earlier this month and in brief I focus on the number of customers and geographic locations. Larger companies enjoy scale benefits and are able to profit more from smaller rate increases. While geographical differences exist for regional utilities, the underlying business is essentially the same: a stable, cash-cow business that returns most profits to investors via dividends and share repurchases.
Integrys services one million customers in the Midwest U.S. Integrys primarily operates in the regulated utilities markets but has one non-regulated subsidiary. TEG does not have the most solid financial position as its current ratio and debt-to-equity ratio are both less than one. Unlike many of its peers TEG is actually growing revenues thanks to higher rates while simultaneously lower costs. Even before Sandy it was rare to find a utility that was revising earnings estimates upwards but Integrys did exactly that after reporting third quarter earnings. Further enhancing performance is the planned acquisition of Fox Energy for $440M. The Fox Energy Center is intended to operate primarily on natural gas which should lower the cost component mix for Integrys. The deal is expected to close in April 2013 and be financed with debt (initially short-term, then long-term). The tenuous financial position introduces additional risk with this utility but the 5.2% dividend yield compensates for the risk assumed.
Lorillard Inc. (LO): 5.11% Yield; Ex-Dividend 11/28
Lorillard is one of the "big tobacco" companies with brands including Newport, Kent, and True. I have invested in both Altria (MO) and Philip Morris (PM) with tremendous capital gains and dividends over the years. Lorillard lacks the industry leading brands but it is a similar investment hypothesis. U.S. cigarette volume is declining, but tobacco is still a strong worldwide seller. Furthermore, declines in cigarettes are being partially offset by demand for smokeless tobacco and other products. Tobacco companies are both mature and safe, which presents the opportunity to return money to shareholders via dividends and share repurchases. Lorillard recently announced a $500M buyback plan, which is approximately three percent of the shares outstanding. Lorillard also recently declared a 3-for-1 stock split for investors of record on December 14. For these reasons, I hold PM in my "Great Recession II" portfolio. Lorillard is currently notably cheaper than both Altria and Philip Morris, thus I would consider this as one of the better potential investments in the industry.
Lockheed Martin Corporation (LMT): 5.08% Yield; Ex-Dividend 11/29
Lockheed Martin is an advanced technology manufacturing company that specializes in defense and other related fields. Lockheed is the company behind the F22 fighter plane, as well as anti-missile defense systems. The company has the distinction of being the largest provider of IT services and training to the United States government.
The stock has essentially remained in a tight range between the high 60s and low 80s since the first quarter of 2009, but has been on a roller-coaster ride recently. In April, LMT set a new 52-week high of $92 before tumbling back into low $80s two months later only to set a new high. I wrote in August that Lockheed would have difficult pushing above its 52-week high of $95 but would have support in the low $90s due to its P/E of ten and high yield. I am still not completely sold on Lockheed due to the looming fiscal cliff but the five percent yield should provide some cushion from further declines. With the super committee's failure to make a decision, defense spending is facing $600B in cuts, which could spur further downward pressure so I am not comfortable owning this stock deep into December.
Due to the nature of operations, Lockheed is highly leveraged to government spending and Goldman estimated that the company has 97% exposure to "government agencies". Despite the potential decline in government spending, investors can collect a respectable dividend that has been exhibiting respectable growth in the past decade. Not only does Lockheed has a strong yield, the company is dedicated to repurchasing shares and repurchased over $400M shares so far this year. The stock has been under pressure due to the president's resignation over ethics violations but investors have far more to be worried about at this time.
Avista Corp. (AVA): 4.99% Yield; Ex-Dividend 11/27
Avista is a utility company that produces energy for fewer than one million customers in the Western United States. Avista announced second quarter 2012 earnings that declined primarily due to weak revenue. Management was very bearish when describing the quarter and it should give potential investors cause for concern.
Avista's earnings for the second quarter and first half of 2012 were below our expectations largely because retail loads were lower than we anticipated. The continued weak economy and operational challenges at certain industrial customers resulted in lower retail sales volumes [emphasis added]. Based on results for the first half of the year and a reduction in our forecasted loads for the remainder of 2012, we expect our consolidated and utility earnings to be at the lower end of our guidance range for the year. -- Avista Chairman, President and Chief Executive Officer Scott L. Morris
Fortunately utility resources costs have declined but "other operating costs", depreciation, and all other costs increased year-over-year. The company's financial position is not in jeopardy but I do not foresee any catalyst that will reverse the company's fortunes. Things were not any better in the third quarter as revenues declined approximately one percent and EPS of $.10 missed estimates by a staggering $.34. Management is forecasting double-digit organic growth next year but I have to see it to believe it given its past performance.
I cannot recommend Avista, because it has a small customer base, unfavorable geographic region, and has faced economic pressure that has forced it to guide lower. The yield is merely average for the industry and there is no compelling reason to pick Avista given the risks assumed.
Waste Management (WM): 4.42% Yield; Ex-Dividend 11/26
Waste Management specializes in a business that few others want to deal with: waste and garbage. WM offers collection, transfer, recycling, and disposal services for both residential and commercial customers. The business is not just simply picking up garbage and depositing it in landfills anymore. Now there are high-tech recycling and related operations that are integral to the business and offer WM a competitive advantage over smaller rivals. Aside from Waste Management's massive fraud in the 1990s, this company has been a steady performer that capitalizes on an unpopular business. The stock has lagged the S&P this year as its earnings continue to be a mixed bag, with the company missing top-line estimates and barely surpassing EPS targets. Revenues have been relatively flat, but earnings were soft as a result of higher costs for fuel. A decline in recycling commodity prices further shows that the company just cannot catch a break. The company plans to cut 700 jobs in an attempt to rein in costs, but I think the weakness will continue in the absence of an external catalyst. The economy continues to challenge municipalities, so Waste Management has necessarily begun exploring alternative revenue sources. The company announced plans to partner with Renmatix to investigate the feasibility of converting consumer garbage into manufacturing sugar. These are the sort of deals that Waste Management will be forced to pursue if it wants to return to its growth days.
The dividend is on the lower end considering its P/E, but this quality company is still worth considering due to its 'safe haven' reputation. The image is starting to deteriorate as Barron's has logically questioned the safety of the dividend - "dividends this year will consume more than 57% of projected free cash flow, and about two-thirds of expected earnings of $2.14 a share." I believe you can find better dividend and capital appreciation opportunities elsewhere.
Note that WM went ex-dividend yesterday and appreciated $.07, or less than one percent. The ex-dividend strategy predicted that Waste Management would decline by approximately $.30. If you were considering initiating a long position in Waste Management the anticipated 'buy' signal did not materialize so I would delay any potential purchase.
Great Plains Energy Incorporated (GXP): 4.37% Yield; Ex-Dividend 11/27
Great Plains Energy Incorporated is the holding company of Kansas City Power & Light Company and KCP&L Greater Missouri Operations Company. In those two regions Great Plains services approximately 820,000 customers. Great Plains appears to be a compelling pick because it is currently trading below book value; however, the yield is on the low side given its P/E versus the industry. The poor liquidity situation makes GXP even less attractive with .43 and .61 quick and current ratios, respectively. As low as those ratios are, they are actually a remarkable improvement over earlier this year. The stock dropped from over $22.50 to $20 in early November after reporting another quarter of declining revenue and missing earnings targets. GXP has some value but it needs to improve its financial position before it can be considered for dividend capturing.
The information presented has been summarized below. Yellow and red represent "avoid" and "consider" classifications, respectively.
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