It has not been easy for savers to generate a return on their investment recently. Interest rates are at historic lows and show no signs of improving. The Federal Reserve recently hinted that it plans to keep interest rates at near zero even if unemployment returns to a normal rate. England and Australia are also fearful of dipping into a recession so maintained their low interest rates. Rather than settling for a negative return after inflation I suggest high-yielding equity securities.
I utilize the dividend screen discussed below to identify potential ex-dividend opportunities. This week there are 14 candidates, 11 of which have been analyzed below based upon SA readership criteria. The equities are overwhelmingly utilities with the majority being traditional electrical utility providers. This week half of the yields are on the low-end of the range but there are three equities offering over ten percent. Pitney Bowes (PBI) is the unusual stock this week as the sleepy office equipment company is yielding nearly 11%. Nearly 75% of the market capitalizations this week are below five billion but there are two large companies this week. ConocoPhilips (COP) is the heavyweight this week with a market capitalization of $70B. Most of the opportunities go ex-dividend on Wednesday but many are going ex-dividend today as well.
For details of the strategy and my screener details, please consult my methodology on the topic (last modified 1/21/2013). In brief, the screen focuses on relative stable equities with a concentration on liquid companies at affordable valuations. This is summarized below:
- Dividend Yield ≥ 4.0%
- Ex-Dividend Date = Next Week
- Market Capitalization ≥ $1B
- P/E Ratio: 0-20
- Institutional Ownership ≥ 15%
- Ideally Modest YTD 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, (i.e. less than three month holding period), you still need to exercise caution. Depending on your belief in the investment hypothesis, you may decide to just hold long enough for the dividend or to make the stock a longer-term holding. The information presented below should simply be a starting point for further research in consultation with your professional financial advisor before making an investment decisions. My goal is to present new companies to you and provide a brief overview of their recent developments; this should not be considered a substitute for your own due diligence.
ARMOUR Residential REIT, Inc. (ARR): 13.52% Yield; Ex-Dividend 2/13
ARMOUR Residential REIT is a company that invests in various agency mortgage backed securities ("MBS") which are issued or guaranteed by U.S. government affiliated agencies. As of the most recent quarter, ARR has $22.1B in agency securities opposed by $19.9B in repurchase agreements. ARR is currently levered about 10X (liabilities/equity) which means its relatively low net return (<2%) is magnified ten times. This explains how these agency REITs can sustain double-digit yields despite such low relative returns on assets. Portfolio Management 101 has an excellent overview of ARR and its risks. As I discussed in a recent mREIT article, in addition to leverage, an important metric for mREITs is book value. ARR has a book value of $7.90 and price/book ratio of 0.89. This indicates that ARMOUR is valued at a modest discount to its financial statement value thus the market is generally cautious. I suspect general uncertainty in the mortgage market is depressing the stock's price. Additionally, concerns regarding the sustainability of the dividend (discussed below) have been weighing on the stock. This discount is generally comparable with peers American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).
As a REIT, ARR must distribute at least 90% of its taxable income to shareholders. Currently, ARR distributes 100% of taxable income and may be facing cash flow issues. The company has $193M in cash from operations in the first three quarters of 2012 while it paid out $187M in dividends to common and preferred shareholders. Such a tight spread is not uncommon for mREITs. ARMOUR simultaneously issued $1.5B in stock which was the financing source that caused cash to increase over the period. With this in mind, the liquidity issue has not been problematic in the last few years as this hot sector of the market has had minimal trouble raising capital due to strong returns. The economic climate could get increasingly more challenging so this is a risk worth noting. The risk is mitigated by bullish insider activity and I believe you should follow management's lead.
December 2012 was a very active month for ARMOUR. The dividend was cut from $.09 to $.08 per month, an 11% decline. This should not be a total surprise as the dividend has declined at least once per year every year since 2010. This dividend decrease was partially offset by the authorization of a $100M stock repurchase plan. This represents approximately 4.6% of the company's current market capitalization which is a meaningful repurchase from a shareholder perspective. Saibus Research concludes that "on a pure price/book ratio, ARMOUR is quite undervalued as its share price is at a 17% discount to its book price [the discount has subsequently declined]. However, we believe that investors are displeased that the company's dividend payment schedule has been 'death by a thousand cuts'". With this information in mind, I believe ARMOUR is reasonably priced at 6.6 P/E and has a high enough yield to compensate investors for the risk assumed. Note that ARR distributes dividends monthly.
Pitney Bowes Inc.: 10.81% Yield; Ex-Dividend 2/13
Pitney Bowes provides mail processing equipment and integrated mail solutions to diverse businesses worldwide. In general, if a company has any issues with its mail, Pitney likely has the solution. You might know the company from the automated metered stamping machine that is ubiquitous in offices across the country. This type of product is the company's core service but the company has attempted to diversify. Once a company has a Pitney Bowes offering they often work with the company to provide more services. For example, enterprise business solutions and management services have been bright spots for the firm.
As you can tell this is a mature, sleepy business that has only average growth prospects (if any) but is a cash cow. At this point in its life cycle the company can generally forego investing in the future and simply collect income on its legacy operations. PBI has been a serial underperformer but the stock has rocketed up 30% in 2013. The negative performance in 2012 was mainly due to fears about congressional changes to USPS and the continued shift away from physical mail but even in this digital age, business mail is not going to disappear anytime soon. The USPS shift to five day mailing will likely not impact Pitney substantially. The company reported fourth quarter earnings that showed a declining rate of revenue contraction, and even growth in areas. The company continues to generate substantial free cash flow ($770M in 2012) so Pitney should be able to maintain the dividend despite the high payout ratio of 71%.
I have been on the fence with PBI due to its poor performance but always kept it on my watch list. This company entails above average risk due to its industry but I believe it is at least worth further research due to the combination of high yield and low P/E. The Seeking Alpha crowd is relatively mixed regarding their faith in the company. For every investor who believes the stock is attractively priced, there is seemingly another investor who believes the yield is in danger. The stock certainly appeared oversold below $11 but I am uncomfortable owning the stock as it approaches $14. I would wait for a pullback below $13 before considering a dividend strategy.
Fifth Street Finance (FSC): 10.71% Yield; Ex-Dividend 2/12
Fifth Street Finance is a financial services firm that specializes in middle-market buyouts and other related financing services. The company makes strategic, generally non-controlling, investments in diverse companies and profits from the related fees. The company recently reported a record December quarter with $422M of investments closed. Two-thirds of income are derived from cash interest income with fee income compromise the bulk of other revenue. Over the past year investments have grown approximately 25% and the company has been a solid performer; however, there has been significant share dilution. Weighted average common shares outstanding have risen by over thirty percent in the past year so net investment income per share actually declined. Another red flag are the number of investments with losses and the overall portfolio has a fair value of $1.58B and cost of $1.57B. For example an investment in Coll Materials has a cost of $12M and fair value of $1M. Fifth Street profits primarily from income/service revenue so this is not overly concerning but is a situation that requires monitoring.
FSC is cheap with a 9.4 forward P/E and has no long-term debt in its capital structure. The stock has been on a steady uptrend since May of last year and stock has risen from $8.50 to $10.85. The stock has traded in a much tighter range in 2013 but is mere pennies from its 52-week high. The monthly dividend has also been reduced in each of the past two years so another decrease is possible as early as June if the trend holds. I would avoid FSC for dividend capturing due to the red flags mentioned above.
KKR Financial Holdings (KFN): 7.59% Yield; Ex-Dividend 2/12
KKR is a specialty finance company that operates primarily in the private equity and specialized investment categories. As with many of the companies that appear in my dividend screens, it appears that KKR is depressed because it is a financial services company and now has a P/E below six. Private equity firms have been in the news since Mitt Romney ran for president and the carried interest tax debate continues to rage on. This is a dark cloud hanging over the entire industry.
Private equity companies are attractive dividend producers because they often either turnaround or improve existing companies and are able to return excess cash quickly. These can be volatile companies since their ventures can fail but once they have successful investments, they can pay above-average dividends. The dividend was suspended in 2008 when the market crashed, but was reinstated in late 2009 and has been steadily rising ever since. As a limited partnership, there are special tax implications for this investment that also need to be considered on an individual basis with your tax consultant.
KKR is similar to Prospect Capital Corp. (PSEC), which I covered recently; however, KKR focuses more on European opportunities and macroeconomic interest trends. PSEC specializes in finding companies with robust cash flows and making strategic investments. Having said that, KKR's 7.6% yield and low P/E ratio still makes it a compelling investment opportunity. The company recently reported fourth quarter earnings that pushed the book value to $10.31, indicating that shares are trading at an eight percent premium to financial statement value. With the stock trading near book value I am not overly concerned about the shares declining significant in the near-term. It should be noted that last quarter the shares were trading at a three percent discount around the dividend date so there are signs of overheating. The stock has been in a nearly unbroken positive channel since June and the stock has risen in 25% in the past year. The stock is near the low-end of it channel so there should be technical support that makes a dividend capture even more attractive. The distribution was raised to $.21 per quarter in 2012 and a special $.05 dividend was declared but that is not relating to this week's ownership of record.
Exelon Corporation (EXC): 6.69% Yield; Ex- Dividend 2/14
- 5.4M Customers in Illinois and Pennsylvania
Exelon has been under pressure recently and dropped significantly in November when it announced its plans to reduce its dividend payment. The stock promptly fell from $36 to $29 on fears that the payment would be reduced. Exelon took the unusual step of slashing its forward dividend by 40%. Management discussed the dividend at length in its recent earnings call:
"In response to the lower forward prices and weaker financial expectations, we took several steps during 2012 to maintain our $2.10 dividend and strengthen our credit metrics. Most significantly we reduced our growth investment plans by $2.3 billion during the year by delaying or canceling nuclear upgrade projects and removing other investment targets …
We believe that our dividend should be sized to reflect our business model and keep our balance sheet strong. We also think that the dividend might be sized to allow us capacity and flexibility to pursue growth that will enhance the company's long-term value. While we remain confident that there is $3 to $6 of megawatt hour of fundamental upside in the market, it is increasingly clear that we will not see the upside as soon as we had expected.
Without near-term market recovery and a strong desire to resolve the uncertainty of our dividend, our Board and I have determined now it's time to act. This was a tough decision for all of us. We recognize the value of the dividend to our investors. We analyzed several scenarios and determined that this action will provide the investor with a stable, sustainable dividend and capacity for growth and long-term values.
We have an opportunity to invest in growth. We cannot do that efficiently if we're leaning on a balance sheet to maintain an 80% to 90% payout level. We are acting now to right-size our dividend to be more aligned with the commodity sensitive nature of our business. After assuring that we have had a strong balance sheet and credit metrics, we'll renew our focus on investing in future growth to enhance long-term shareholder value."
Many analysts believe that this will be a positive move for the stock as it simultaneous improves the financial position while positioning the company for future growth. The dividend yield of 6.7% was one of the highest in the traditional utility business and it will be much closer to 4% after the cut. This is still a very respectable dividend and if the growth prospects materialize, the stock could return to the mid-$30s. I would proceed cautiously for now but take advantage of the dividend while it lasts.
TECO Energy, Inc. (TE): 5.17% Yield; Ex-Dividend 2/13
- 1M customers in Florida; Coal operations in Kentucky, Virginia, and Guatemala
TECO is unique in that its operations are very diverse. The Florida regulated utility services approximately one million customers while Kentucky and Virginia interests focus on coal mining. 75% of revenue is derived from regulated activity with the remaining quarter from unregulated operations. Recently reported revenue lagged and management reported unimpressive forward earning guidance. The dividend was maintained and appears safe with a 75% payout ratio but there is little to get excited about here if you are looking for dividend growth. After Exelon's dividend decrease, TECO is one of the highest yielding utilities left but I would much rather prefer selecting either a traditional utility or a coal company rather than this hybrid. The stock is fairly priced with a 14.6 P/E so it is an adequate ex-dividend candidate.
Entergy Corporation (ETR): 5.11% Yield; Ex-Dividend 2/12
- 2.8M Customers in Southern and Central US
Entergy had one of the highest profile blunders in utility company history as it was responsible for a thirty minute blackout during the Superbowl. The company will be the punch-line of jokes for a while but the company has other problems. Earnings have been slumping and management recently stated that reported earnings will likely be in the lower half of its 2013 earnings guidance range. The dividend is above average for the utility industry but the payout ratio is also on the high end at 83%. A dividend capture should be relatively safe with less than five percent above its 52-week low but I am not overly bullish on Entergy and believe the stock is slightly overvalued.
ConocoPhilips: 4.58% Yield; Ex-Dividend 2/14
ConocoPhillips is one of the largest independent exploration and production companies with a clear concentration in natural gas. ConocoPhillips' production is concentrated in North America with the remaining approximate forty percent in Europe, Asia, and the Middle East. ConocoPhillips completed the spinoff of Philips 66 (PSX) in the summer of 2012 to separate the downstream operations. Warren Buffett famously announced that Berkshire (BRK.A) was buying PSX at the expense of COP and even apologized to investors for his poor original choice of COP.
ConocoPhilips has been in a positive channel since June as the stock has risen ten points to $62 but recently has fallen to $58. With a forward P/E of 9.5 and a 4.6% yield I believe it still makes for a solid ex-dividend opportunity. I would be more enthusiastic if the stock was trading at $55 but a forward P/E lower than ten is difficult to argue against.
Consolidated Edison (ED): 4.31% Yield; Ex-Dividend 2/11
- 3M customers in the Northeast
[Note that Consolidated Edison went ex-dividend yesterday and declined by only $.03 despite issuing a $.615 pershare dividend. One would expect the stock to decline by at least $.40 if considering taxes thus Con Ed did not decline eough to make a post-dividend buy profitable. Please refer to the below for details of the stock.]
I have been long Consolidated Edison ("Con Ed") for years as it is a stable utility company with a wide customer base in a preferable geographic region. I own Con Ed in my Great Recession II portfolio and was starting to worry that the stock was overbought in the summer as the yield dipped down towards four percent. For reference, I originally purchased Con Ed with the yield around five percent.
(Source: Yahoo! Finance edited by Paul Zimbardo)
Since August the stock is down about 10% compared to a 7% decline for the S&P 500. The underperformance became pronounced after Hurricane Sandy at the end of October. I waited for the dust to settle after the storm and wrote an in-depth article in late November recommending the stock. As you can see from the chart below Con Ed bottomed around the date of the article and has slowly returned about five percent, although that still lags the S&P 500 somewhat. Con Ed is no longer my favorite utility due to the low relative yield for the sector but it is affordably priced and should have limited downside going forward.
Corus Entertainment (CJREF.PK): 4.11% Yield - Ex-Dividend 2/12
Shaw Communications (SJR): 4.11% Yield - Ex-Dividend 2/12
Shaw Communications spun-off Corus Entertainment in September 1999 and both companies engage in diversified entertainment offerings but focus primarily on Canadian cable television. Cable companies have traditionally been able to distribute sufficient cash flows to investors but the tides are shifting with the rapidly rising cost of content. Sports programming is a double-edged sword because it is one of the biggest advantages over Internet streaming; however, it is the most expensive for cable companies to offer. This is still a 'cash cow' industry but it is changing too quickly for me to fully support investing in it.
Factor in the popularity of Internet connected televisions and other devices and I am not extremely bullish on the traditional entertainment content business model. I do not believe that investors are being adequately compensated for the level of risk assumed and the other companies mentioned offer comparable (or higher) yields for less risk. Five percent seems to be that magic yield number for this type of utility companies that draws interest and that could occur again with Shaw if it declines in the future. Note that Shaw pays dividends on a monthly basis.
The information presented has been summarized below. I make no warranties regarding the information in the chart as industry classifications are frequently imperfect. Yellow and red represent "avoid" and "consider" classifications, respectively.
Please refer to profile page for disclaimers.