Commodity prices have risen substantially from their lows at the turn of the century. I don't believe that this secular bull market is over. However over the past 4-5 years commodity prices have gone nowhere. While investors wait for the bull market to continue, they can continue to see returns by focusing on dividend paying commodity companies. This article looks at five such companies. Each is in a different segment of the commodity complex, or uses a different strategy.
I should note that while dividends provide stability and keep companies honest, they limit growth and expansion. As an investor I try to diversify into companies with both strategies, although I will shift my focus towards dividends as I get older.
1. Each of these companies either produces commodities or benefits from the rise in commodity prices.
2. When making my selections I set a dividend yield floor at 5%, although all of these companies have dividend yields of at least 5.5%.
3. Each of the stocks I discuss has had a consistent or declining share count for at least two years. Investors have to ensure that the dividends they are being paid come from profits. There are many high yielding companies, particularly MLPs and Canadian Royalty Trusts, that are issuing debt and stock in order to maintain high payouts (i.e. Kinder Morgan Energy Partners, L.P. (NYSE:KMP), a pipeline company, and Enerplus Corp. (NYSE:ERF), an oil producer in Canada). With these companies we see debt and share count increases on a consistent basis, and I am skeptical that their dividends result from created value.
Terra Nitrogen Company, L.P.
Terra Nitrogen Company, L.P. (NYSE:TNH) produces nitrogen-based fertilizer products in the United States. CF Industries Holdings, Inc. (NYSE:CF) holds 75% of TNH. TNH has performed phenomenally well over the past decade, giving investors a 3,590% return over the past 10 years excluding dividends. Given this return I would not be surprised to see the shares correct, although such a correction would provide long term investors with an excellent buying opportunity. At current levels TNH pays a very respectable 6.7% yield, although investors should be aware that the company pays out most, if not all of its profits in dividends, and consequently a decline in profits could result in a decline in dividend payouts. TNH also does not have excess capital to grow its business meaningfully, and so investors who are looking for growth in the nitrogen sector should consider the parent company CF, which intends to invest $4 billion in expanding their manufacturing capacity over the next four years.
While TNH does not produce a limited natural resource (nitrogen fertilizers are manufactured using natural gas and nitrogen gas) the price of nitrogen fertilizers should perform well if grain prices continue to increase, as I believe they will.
Alliance Resource Partners, L.P.
Alliance Resource Partners, L.P. (NASDAQ:ARLP) is a coal producer. They pay a large dividend that currently stands at more than 7%, and they have managed to increase their payout every quarter throughout the recent bear market in coal. While coal companies have faired poorly over the past couple of years, with many seeing huge losses, Alliance Resource Partners has remained highly profitable. The third quarter of 2012 was the only quarter during the last couple of years that the company's dividend payout exceeded profits.
Alliance Resource Partners has several operations that are either producing or in development, primarily in the Illinois Basin in Illinois, Indiana and Kentucky. They also have operations in Pennsylvania, Western Virginia and Ohio. Over the next four years they plan to increase production to nearly 50 million tons, which is a 40% or so increase from current levels. This should enable them to continue to increase their dividend payout even if coal prices don't increase as much as they should.
Gold Resource Corp.
Gold Resource Corp. (NYSEMKT:GORO) produces mostly gold and silver, although they get some of their revenue from base metals. The company pays a 5.6% yield in an industry where dividends are generally small. Not only does GORO pay the largest dividend in the precious metals sector, but the company allows investors who are interested to have their dividends placed into a physical bullion account and take delivery of physical gold or silver.
Currently they only have one producing mine, the El Aguila project in Mexico (a mining friendly jurisdiction), which makes the company somewhat risky. However they have extremely low cash costs at just $150/ounce, so they will remain profitable as gold prices consolidate. They also have 5 exploration properties, all of which are in Mexico, and so they may have enormous growth potential. As of now they anticipate growing production from 100,000 oz. per year to 150,000 oz. per year by 2015.
Lukoil (OTCPK:LUKOY) is a Russian integrated oil and gas producer. Of the stocks I mention in this article this is probably the most undervalued. This is probably due to the fact that the company is Russian, and the market perceives additional political risk in Russian stocks. But these fears are overblown. The shares trade at roughly 70% of the company's stated book value and at 5.3X trailing earnings. They have consistently grown assets while paying a healthy 5.5% dividend and repurchasing their undervalued stock. While the company has limited production growth at just over 3% they claim to have the largest oil reserves of any company in the world, making this company ideal for oil bulls. Of the major commodities oil is not among my favorites, however this is probably one of the best ways to play it.
Sprott Resource Corp.
Sprott Resource Corp. (OTCPK:SCPZF) is an investment holding company that resembles a hedge fund. Like a hedge fund there is a management fee as well as a fee based upon the value created for shareholders. The company recently started paying dividends at the end of 2012, and they have an enormous payout that exceeds 10%. SRC has a unique dividend policy: they pay out 0.833% of their stated book value on a monthly basis, and the book value used to determine the dividend is updated quarterly. The company doesn't have profits in the traditional sense, but they have capital gains from investments they have made that turned out profitably. They also have a share repurchase program, under which they will buy back their stock under $4.60 Canadian Dollars/share.
SRC invests in small natural resource ventures, and so this is a great company for investors who want the incredible upside that can be attained through small commodity companies that are too speculative to be chosen by non-experts. Their largest holdings are in oil wells, however they have exposure to potash fertilizer, phosphate fertilizer, farmland and uranium. They use no leverage and have large physical gold holdings as well as a lot of cash. The company has done an excellent job creating wealth for its long-term shareholders, providing them with an annualized 29% return.
Disclosure: I am long TNH, CF, ARLP, OTCPK:SCPZF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.