By Serkan Unal
JANA Partners, a hedge fund established and managed by Barry Rosenstein, currently has some $3.5 billion in assets under management. The hedge fund is a value-oriented entity specializing in event-driven investing. It primarily invests in U.S. equities, applying a combination of risk arbitrage, activist, market neutral and long/short equity strategies. The fund invests in undervalued companies with below-industry P/Es, high free cash flow and attractive dividend yields.
JANA Partners has just revealed its 13-F for the fourth quarter 2012. Interestingly, in the quarter, the hedge fund completely sold out of its high-profile technology positions, including Apple Inc. (AAPL), Google Inc. (GOOG) and Motorola Solutions, Inc. (MSI). Instead, the fund established large new positions in an online vehicle auctions and remarketing company Copart Inc. (CPRT), an internet infrastructure services firm VeriSign Inc. (VRSN), and The ADT Corporation (ADT), a provider of electronic security, interactive home and business automation services. JANA Partners also initiated a few new positions in dividend-paying stocks. Below is a closer look at four such dividend payers that have yields above 2.0% and that appear undervalued.
Waste Management Inc. (WM) is North America's leading provider of integrated waste management solutions and the biggest recycler. It has a dividend yield of 3.9%, payout ratio of 68% of the current-year EPS estimate, and five-year annualized dividend growth of about 8.0%. JANA Partners purchased 1.29 million shares of WM in the fourth quarter of 2012. The company is one of the largest holdings in The Bill and Melinda Gates Foundation Trust (check out its top holdings). WM stands to benefit from favorable long-term trends in population and economic growth. Still, the company recently reported EPS below analyst estimates, despite a beat on the top line with a 0.8% revenue growth. In 2013, the company projects a modest growth in adjusted EPS of between 3% and 6%, with adjusted EPS guidance of $2.15-$2.20, falling below the consensus EPS estimate of $2.30. However, EPS growth is forecast to accelerate to between 8% and 12% in 2014, once the adverse effect of the compensation headwinds from accruals is removed. Despite the modest EPS growth, WM expects to grow its free cash flow by between 33% and 45% this year, which provides room for a planned dividend hike by 2.8% to $1.46 per share and a $500 million share buyback authorization. WM is trading at 16.4x forward earnings, below its industry's multiple of 17.9x.
Iron Mountain Inc. (IRM) is a records management, data protection, destruction and recovery services company. It has a dividend yield of 3.1% and a payout ratio of 88% of the current-year EPS estimate. Its dividend grew by 8.0% over the past year. The company also paid a special dividend of $4.07, equivalent to some $700 million, as a required part of its planned conversion into a REIT. The conversion into a REIT will take place by January 1, 2014. The lion's share of Iron Mountain's income is from renting storage space to customers in its 64 million square feet of real estate around the world. The company reports 23 consecutive years of storage rental growth. It expects revenue growth of between 1% and 3% annually through 2016. Based on pro forma REIT metrics, excluding the $140 million cash portion of the 2012 E&P distribution, the company expects adjusted FFO in 2013 of $3.63 per share, which is a 1.4% increase from the year earlier. As a percentage of adjusted FFO, the dividend payout ratio could be at most 70% in 2013. Its pro forma current dividend yield will be 6.7%. In terms of valuation metrics, the newly formed REIT would be undervalued relative to its competitors. Its price-to-pro-forma-adjusted-FFO of only 9.0x is lower than the multiples of its industry peers. In the fourth quarter of 2012, JANA Partners purchased nearly 1.4 million shares of IRM.
Spectra Energy Corp. (SE), an owner and operator of natural gas-related energy assets, has a dividend yield of 4.1%, payout ratio of 81% of the current-year EPS estimate, and five-year annualized dividend growth of 5.6%. In November 2012, the company boosted its dividend by an above-average 9.0%. The company has been heavily investing in natural gas infrastructure, including pipelines and storage, to take advantage of the record natural gas output flows. The company reported a drop in fourth-quarter profit of 27% year-over-year, mainly due to lower commodity prices. However, its U.S. transmission business saw profits rise. Despite the lower overall profit, the company still beat FactSet analyst expectations by a penny. Spectra Energy recently agreed to buy the Express-Platte Pipeline System, running from Canada to Illinois, for $1.49 billion, which will mark the company's entry into crude oil transportation business. Its large infrastructure investments, estimated at some $25 billion by the end of the decade, are weighing on free cash flow in the near term. However, these investments will expand the company's long-term transmission and storage capacity, bolstering profitability and cash flows in the future. The stock is trading at 20.2x forward earnings versus 21.6x for the pipelines industry. JANA Partners acquired 450,000 shares of SE in the fourth quarter of 2012.
KAR Auction Services, Inc. (KAR), another vehicle auction services company, has a dividend yield of 3.5% and a payout ratio of 64% of the current-year EPS estimate. The company initiated a dividend in the December-2012 quarter. KAR has a high free cash flow yield of 8.7%. Its free cash flow conversion ratio of more than 3.0 is excellent. The company's long-term annualized EPS CAGR is 10.8%, a slowdown compared to a CAGR of 24% achieved over the past five years. The market outlook is improving. According to Manheim's 2013 Used Car Market Report, used vehicle sales totaled 40.5 million in 2013, with dealer retail sales rising 5% from the year earlier. Wholesale auction volumes, which remained stable in 2012 (at between 7.5 million and 7.7 million units sold), are expected to rise 5% in 2013. By 2015, wholesale auction volumes will top 8.6 million units (see page 7 of the presentation). Manheim's "Used Vehicle Value Index indicates that while wholesale prices softened last year for the first time in three years, they remain historically high." Interestingly, KAR Auction Services was exploring a leveraged buyout last year but decided to suspend the sale after talks failed. The company is trading at 19.3x forward earnings, compared to 20.8x for Copart Inc.