Investors searching for yield in the current market have to be nimble and creative to meet their income objectives. Ultra-low risk options like Government bonds and certificates of deposit pay less than the likely inflation rate over the next few years. Junk bond spreads have narrowed to historical lows over triple AAA rated securities, and I would be wary that their rally is unlikely to continue. Utilities do not yield what they did just a few years ago, are selling at higher than average historical valuations versus the overall market, face low growth prospects as well as an increasingly constraining regulatory environment. Other traditional high yielding sectors like Pharmaceuticals have had nice runs but Pharma giants like Pfizer (PFE) and Merck (MRK) yield only 3.5% to 4%, have minimal growth prospects and have not had too many successes within their drug pipelines (versus patent expirations) over the last few years. Finally, Telecom is much pricier than it was two years ago. For example, AT&T (T) yielded 6% in February 2011 and now yields just over 5%. In addition, the shares are trading near the top of their five year valuation range based on P/E, P/CF and P/B.
So where does a yield investor look for ideas to provide income and growth within their dividend portfolios as we start 2013? I have the vast majority of my income holdings in two areas, Energy Master & Limited Partnerships and "Special Situations".
Energy Master Limited Partnerships -
This is one of the least covered stories of the last decade. The sector has benefited greatly from the huge expansion of domestic oil & gas production over the last ten years. The sector has provided better performance than the S&P every year since 1999 until last year where it underperformed the overall market by some 12%. Some of this was caused by concern that tax treatment would change as part of the fiscal cliff talks. As that came and went with no changes, the sector is off to a strong start in 2013. I also believe the sector is well positioned to thrive in a period of stagflation that I see coming down the pipeline as the result of our current fiscal and monetary policies. Credit Suisse came out with a report the other day calling for the sector to again outperform the overall market in 2013 and it profiled a myriad of entities it likes at current prices. One of these is Enterprise Product Partners (EPD) which I have in my own portfolio.
Enterprise Products Partners provides midstream energy services to producers and consumers of natural gas, natural gas liquids, crude oil, refined products, and petrochemicals in the United States and internationally.
4 reasons EPD is a good addition to an income portfolio at $55 a share:
- EPD yields 4.7% and has doubled distribution payouts over the last decade.
- The company has beat earnings estimates for the last six quarters and consensus earnings estimates for both FY2013 and FY2014 have ticked up over the last month.
- Revenue growth is projected to come in at over 13% in FY2013 and the stock has a low beta (.61).
- S&P has its highest rating "Strong Buy" on EPD citing its strong balance sheet, diverse cash flows and strategically placed assets.
Special Situations -
Special Situations is what I call my income selections in stocks and/or sectors that are not traditionally thought of as yield plays. Two of my favorites in my portfolio within this area are below.
Friedman Industries (FRD) engages in steel processing, pipe manufacturing and processing, and steel and pipe distribution activities in the United States.
4 reasons FRD is a good value and income pick at $11 a share:
- The stock yields 4.8% and the company treats its shareholders well. It issued an additional 50 cent special dividend in 2012.
- The stock is cheap at less than 6.5x forward earnings and just 16% above book value.
- Earnings are on a nice uptrend. The company made $1.20 a share in FY2012 but is on track to make more than $1.50 a share in FY2013 and analysts projected better than $1.75 a share in FY2014.
- Given the small market capitalization (approximately $75mm), product niche and the age of the management team; I have this near the top of my possible buyout candidate list.
Microsoft (MSFT) -
If someone told an investor that Microsoft would be one of the better dividend payers in the S&P a decade ago, he probably would have been met with a chuckle. However, over the last few years, the company has funneled a good portion of its cash flow to increasing dividends. I look at Microsoft sort of like a utility stock with a slightly lower dividend yield but much better revenue and dividend payout growth than the utility sector.
4 reasons Microsoft is a solid yield pick up at under $28 a share:
- The stock yields 3.3% and the company has more than doubled its dividend payout over the last five and a half years.
- The company is one of four in the S&P with a triple AAA credit rating and has over $50B in cash and marketable securities on its balance sheet.
- The stock trades at less than 9x forward earnings (closer to 7x if you subtract net cash), a discount to its five year average (11.6).
- Analysts expect approximately 8% revenue growth for both FY2013 and FY2014. The stock sports a very reasonable five year projected PEG (1.18) for a three percent plus yielder.