The High Dividend Stock Investor's Collapsing Dollar Survival Guide, Part 6B

What every high yield investor must know before considering shipping stocks.

1.MARKET STATUS

Before ever considering investing in stocks, we must always first look at the overall market, since almost all stocks follow the major indices. See Part 6A, Market Update: Warning: Do Not Feed (Yourself to) the Bears.

2.THE CASE FOR AND AGAINST THE US DOLLAR

See Part 1 and Part 2 of this series.

3.WHAT MAKES A HIGH YIELD STOCK USD INFLATION RESISTANT?

See Part 3 for the full details, but here’s the summary.

Outstanding Business: Before anything, the underlying business should be robust. So as always, the first criterion is great fundamentals and reliable revenue streams that can support and grow distributions, even in recessions.

Based in Hard Assets or a Monopoly-Like Position in Vital Services:

There are a variety of such niches, but there are two basic types.

• The business owns, sells, or otherwise profits from assets with strong intrinsic demand that allows enough pricing power for revenues to keep pace with or exceed inflation. This includes firms tied to energy, vital agricultural or industrial commodities, precious metals, water, etc.
• Alternatively, a provider of critical services that for some reason dominates its market, like a major well run utility or dominant communications company.

Non-USD Denominated: Shares and/or distributions are priced in another currency, ideally a commodity based currency like Canadian or Australian dollars, but any other major currency would provide some hedge. We can include here U.S. dollar denominated and U.S. firms that get the majority of their earnings in other currencies.

In short, we’re seeking stocks of strong companies that mostly earn and distribute a high dividend in a non-USD currency and have a dominant position in a market for an essential product or service.

In this installment, we’ll continue to look at international opportunities. Since avoiding the wrong investments is at least as important as finding the right ones, in this installment I focus on warning high yield investors away from a sector that has been very good to us – shipping.

4.SHIPPING NEWS: ARE THESE STOCKS FOR HIGH DIVIDEND INVESTORS?

Perhaps the one distinct upside of a world-wide stock market collapse is that prices get so beaten down that the previously modest yields of many blue chip companies suddenly become high, as scared investors demand a higher risk premium. For the best of these, their price declines are not due to deteriorating fundamentals, but mostly due to hedge and mutual funds dumping shares to meet redemption and/or other requirements.

For the past number of years, the shipping sector has brought some wonderfully high yields and price gains to income investors. However, times change, and while the below mentioned shipping stocks will probably return one day to being great income plays, avoid them for now.

They deserve mention for their future potential for when conditions improve, so keep an eye on them for the future. Like financials, they provide a necessary service and will at some point be excellent investments when conditions discussed below improve.

All amounts quoted are in U.S. dollars (USD) unless otherwise noted. All stock symbols are New York Stock Exchange unless otherwise noted.

A.International - Continued

Because one of our criteria is that the stock price and distribution must be pegged to a non-USD currency, no surprise that most of the best USD hedge high yield stocks based outside of the U.S.

1. Shipping: A Once and Future Dividend King – Currently Dethroned.

For many years there have been good stocks with reliable high yields backed by solid businesses. Many of these businesses are still solid and will survive. Unlike other beaten down sectors, however, there is excessive risk to the dividends themselves in every company that I’ve looked at. There are simply higher yields with less risk in other sectors.

Note that while the market tends to treat the shippers as one group, dividend size and reliability can vary considerably, due to significant differences in their business models. Different conditions apply to dry bulk shippers, oil tankers, liquefied natural gas (LNG) shippers, container shippers etc. Some work mostly on long term contracts, others at spot rates, others use a mix. Different sizes of ships can command different rates under different conditions, so the fleet composition of a given company can be very important.

So what’s the problem?

The main problem is the deteriorating demand vs. supply for most kinds of shipping, and the uncertainty about how much the growing supply of ships ordered during the boom years will hurt revenues as world trade slows. In particular:

• Shipping indices like the Baltic Dry Index (for dry bulk shipping rates) are still seeking a bottom.
• Many shippers bear significant debt.
• Dramatically expanding supply: About 9000 ships under construction worldwide in the dry bulk category alone (CNN April 22 2008 in Hellenic shipping news March 22). While it’s unclear how many will ultimately be built, clearly many of those ordered during the boom years will hit the seas, so supply is expanding. Since the ships are so expensive, they can’t be parked like airliners until rates improve. Thus even slight oversupply can drive down rates significantly as owners struggle to keep ships active in order to keep up construction debt payments.
• This sector is notorious for renegotiating contracts when conditions deteriorate. Thus even firms with long term leases could become vulnerable to collection problems or deeply reduced fees if the supply of ships gets too far ahead of demand. This is a real possibility in a number of the shipping sectors.

Thus I present the following merely as stocks to watch for when shipping rates improve, but to avoid for now.

Diana Shipping (DSX): Like other dry bulk shippers, (DryShips (DRYS), Eagle Bulk Shipping (EGLE)), Diana has suspended dividends until further notice in order to survive. Thus no longer an income stock.

Nordic American Tanker (NAT): Buy under 26, Strong Buy under 22. Yield over 20% suggests investors are pricing in a dividend cut, though no indications at this time. An oil shipper. No debt, considering acquisitions, and Q4 profits up over nine (yes, nine) times over Q4 of 2008. P/E of about 9x. As good a bet as any for the oil tankers. A spot shipper, so its fortunes are subject to increase in supply of tanker ships. I was not able to find reliable info on this. Suggestions?

If there were one oil shipper to choose, this would be my choice.

Paragon Shipping (PRGN): If you insist on exposure to this sector for diversification, then it rates a Buy under 4, Strong Buy under 3. Yield over 6% at current price of $3.27. Like all other bulk shippers, it's cut its dividend. Unlike many, it still has one, and it appears sustainable for the coming year at least. Its fleet is fully booked for 2009 at good rates. Half of 2010 is booked, which could become good news if rates firm. Fourth quarter results were good. It earned about $10 million, or 37 cents per share, up from $7.7 million or 29 cents per share in Q4 of 2007. Excluding a one-time charge, they would have earned 52 cents per share for the quarter. Revenues for the quarter rose 47% to $44.7million.

Currently the best of the bulk shippers for income investors, though again, there are better, safer yields available.

Seaspan Corp. (SSW): Watch but avoid for now. While it’s among the best container shippers, and the company that will very likely survive current conditions, avoid until further clarification of dividend. If management signals long term commitment to the dividend, then in the current market it’s a Buy under 10, Strong Buy under 8.

The current yield of over 20% suggests investors are pricing in a dividend cut, and there are plenty of signs suggesting that or complete suspension. These include:

• At some time in the next couple of years the firm will need about another $400 million to complete their building program. Cutting out the dividend for about 3 years would provide the funds without needing to add debt or issue shares, if in fact those options are open to them (?).
• In a recent Reuter’s interview, senior management stated: "But capital is very precious today, so it's much better to hunker down and stay healthy," he said. "Unless we have some good sense of where the capital markets will be, we will be very cautious to use the capital we have."
• I emailed their investor relations department regarding my concerns about the dividend. I received the following response. "Decisions on dividend payments are based on market conditions at the time.” Hardly reassuring.

Unlike much of the shipping industry, all of SSW’s ships are leased on long term usually 10-12 years) contracts, thus revenues and expenses are very steady and predictable. The firm is on schedule to almost double in size through 2011, because it has contracts to build and deliver another 32 ships with long-term charters in place to their current fleet of 35 ships. Improving financials, steadily rising dividend combined with beaten price combines for a dividend around 20%, but as noted above, there is a real chance of that disappearing.

At some point in the future, SSW may well again be a great income play on improving prospects for China and shipping to/from China, which is actually still seeing solidly positive GDP growth

For now, the dividend’s fate is unclear.

This sector will again be worthwhile for high dividend investors, and there may be some stocks I’ve missed. For now, however avoid the sector unless you really do your homework on a given stock.

B. Oh Canada

If you could only invest in one country’s stocks for combined high dividends and USD hedge, Canada would be the clear choice.

Due to the abundance of stocks with solid fundamentals, low tax structures, and their CAD denominated prices and very high yields I give “my Canadians” their own category. In addition to great fundamentals and dividends, these stocks and their yields are in Canadian dollars. The CAD is a prime commodity based currency backed by one of the healthier banking systems. In addition to their share prices being down with the overall market, these carry an extra discount due to the CAD’s recent decline against the USD. Prices quoted are in USD.

Except for the energy producers (their revenues and dividends rise and fall with energy prices), the companies we’ll be discussing are prospering and offer some of the very best risk/reward combinations anywhere.

In part 7 we’ll begin to look at these in depth.

Disclosure: I have positions in most of the above mentioned investments.

Comments

[elizabeth C...:]

Great stuff, I have read all your articles and am following a number of the positions - I have been watching energy and the Canroys for a while after going to cash earlier; hoping today to buy some of the energy stocks on a pullback.
Would you consider putting all your recommendations into a downloadable table with your (up-to-date) recommendations, and yields at those levels, as well as any comments? I am writing out a kind of table and see that your recommended levels have changed in some cases over the course of the article. Links to live charts would be great too.
Also, this is very many positions - do you have top choices from each category? These could be starred in a table.
Sorry if this is too much work, I appreciate very much what you have done already!

Mar 24 11:01 AM

[Alan Young:]

On shippers: NAT is unique in that it carries little or no debt on its books. Instead, it has been issuing new stock when it needs to raise cash. Obviously, that makes the share value subject to dilution.

It occurs to me that container ships will probably not become profitable until after bulk and tankers have rallied, since finished goods require raw materials and energy as inputs.
I appreciate reading other opinions on all these ideas.
I'm holding DHT, ESEA, FREE, GSL, and PRGN.

On "one country" for dividends etc.: Canada rises and falls with oil prices. Why not Australia, which is more diversified? (Of course, the first question is, why only one country?)

Mar 24 01:16 PM

[J. Stack:]

I think NAT is the leader in the field. During the downturn, it consistently paid its dividend. And, the chairman, Mr. Hansson, has been transparent with his shareholders. Looks like it is managed in the "old-fashioned way." Little or no debt. J. Stack, Sequim, WA

Mar 24 01:36 PM

[Cliff Wachtel:]

Thanks for your kind words. Lots of good ideas, don't think I'll have time in the near future, but you're right about summarizing and prioritizing into a table. Maybe as summary article. The coming parts will deal with a lot of great stuff from Canada, so stay tuned! Cliff


On Mar 24 11:01 AM elizabeth Cecelski wrote:

> Great stuff, I have read all your articles and am following a number
> of the positions - I have been watching energy and the Canroys for
> a while after going to cash earlier; hoping today to buy some of
> the energy stocks on a pullback.
> Would you consider putting all your recommendations into a downloadable
> table with your (up-to-date) recommendations, and yields at those
> levels, as well as any comments? I am writing out a kind of table
> and see that your recommended levels have changed in some cases over
> the course of the article. Links to live charts would be great too.
>
> Also, this is very many positions - do you have top choices from
> each category? These could be starred in a table.
> Sorry if this is too much work, I appreciate very much what you have
> done already!

Mar 24 05:48 PM

[Cliff Wachtel:]

Insightful point about the containers shippers lagging the others, though I'd want to study it more. Intuitively what you're saying makes sense. Cliff


On Mar 24 01:16 PM Aalan wrote:

> On shippers: NAT is unique in that it carries little or no debt on
> its books. Instead, it has been issuing new stock when it needs to
> raise cash. Obviously, that makes the share value subject to dilution.
>
>
> It occurs to me that container ships will probably not become profitable
> until after bulk and tankers have rallied, since finished goods require
> raw materials and energy as inputs.
> I appreciate reading other opinions on all these ideas.
> I'm holding DHT, ESEA, FREE, GSL, and PRGN.
>
> On "one country" for dividends etc.: Canada rises and falls with
> oil prices. Why not Australia, which is more diversified? (Of course,
> the first question is, why only one country?)

Mar 24 05:51 PM

[change is t...:]

Cliff as you know high (yield) dividends can be risky, which is why they yield what they do. Do you have an opinion on whether there is an underlying income/asset percentage (or even more important...... strategy) you would recommend now? (Reinvest Canroy's dividend into shipping stocks for example).

This is a unique time. I think everyone agrees dividends are critical, however asset appreciation matters too. On the one hand if dividends' that have been cut are gone for good, then never is too soon to buy the cutting companies. On the other if those companies are in temporary suspension, then reinvestment choices do not mean just reinvest in the ones that paid the dividend. So, at some point in the future could you suggest which companies in your opinion, that have undergone cutbacks are just being conservative, and which ones have true underlying demand or finance constraints that make the dividend just.....gone baby gone.

Thanks for your article here.

Mar 25 05:55 AM

[texalope:]

We all know the stock market is a discounting mechanism that is likely to rise long before improving conditions are apparent. How do you propose to time the entry into these stocks?

If you buy today when prices have discounted awful outcomes and hold for 5 years it is not impossible to expect to achieve a double. This means a 15% annual return. Perfectly acceptable to me as an investor.

Mar 25 07:05 AM

[oilsands:]

Cliff, thanks for another fine article. I believe it is significant when the comments following an article are insigtful; indicative of good work by the author. I am really looking forward to your next one; couldn't be more timely.

"change is the only constant," love your nickname. Your comments here are outstanding.

"texalope," agree, but replacing vanished dividens is more of a necessity for some of us.

Mar 25 12:23 PM

[dsrtwriter:]

I parked a lot of cash in the Canadian dollar ETF when it was just above par with the US dollar and commodities were high.Didn't enjoy the decline against the US dollar, but I have held on, since I know that the US dollar is ultimately headed down as the printing presses heat up, and if this and the world economy does recover, the first demand will be for input resources. That should bode well for Canada, if they can resist further socialization and Islamization.

Mar 25 02:31 PM

[Cliff Wachtel:]

You're right, high dividends usually indicate that the market believes there is higher risk and demands compensation.

However, the market is not always correct. My goal is to find those cases (or in the case of this article, confirm that the companies or sector is to be avoided.

Watch for parts 7A and B, which deal with Canadian oil and gas trusts. The sector has been pounded, not without some justification given the collapse of energy prices. However, the selctions I present offer reward greater than the risk, though there is definitely near term risk if energy drops again.

In part 8, the rewards get even more out of proportion to the relatively low risk when this series proceeds into more stable sectors like energy infrastructure and power funds, whose cash flows are more stable yet still have dividends north of 8%, sometimes much more (and that's without considering that the Canadian dollar is oversold compared to the USD).

thanks for your worthwhile comments. Cliff


On Mar 25 05:55 AM change is the only constant wrote:

> Cliff as you know high (yield) dividends can be risky, which is why
> they yield what they do. Do you have an opinion on whether there
> is an underlying income/asset percentage (or even more important......
> strategy) you would recommend now? (Reinvest Canroy's dividend into
> shipping stocks for example).
>
> This is a unique time. I think everyone agrees dividends are critical,
> however asset appreciation matters too. On the one hand if dividends'
> that have been cut are gone for good, then never is too soon to buy
> the cutting companies. On the other if those companies are in temporary
> suspension, then reinvestment choices do not mean just reinvest in
> the ones that paid the dividend. So, at some point in the future
> could you suggest which companies in your opinion, that have undergone
> cutbacks are just being conservative, and which ones have true underlying
> demand or finance constraints that make the dividend just.....gone
> baby gone.
>
> Thanks for your article here.

Mar 25 03:27 PM

[Pessimistic...:]

Mr. Hansson spoke on MM the other night and was delighful to listen to. He was very excited for the future of not only NAT but its shareholders. The have a very clean balance sheet with an asset to dept ratio of close to 7 to 1. The dividend is at $.87 cut back from $1.61 as a precaution after the last years end and it has a yield north of 16.5% . Future projections at 20% . The stock trades at around $30.00 right now and looks to profit greatly as they bring in oil which is stored in vessels. Mr. Hansson mentioned it will all be based on timing the oil prices.This is not his first rodeo and will not be his last with the vessel oil storage and I believe he will profit emmensley from this move. I see a slow steady ascent which will also re-instate a higher dividend.

Mar 25 08:12 PM

[change is t...:]

Thanks Cliff, I will look out for you and your future posts. I agree, the market is not always right, however, the market...... like my dad used to..... gets the last word.

Mar 25 08:28 PM

[SoCal Scott:]

I have read virtually nothing that comes even close to understanding NAT's business model. NAT carries no debt and returns virtually all of its profit to shareholders via dividends. The dividend does not "get cut" or "restored;" it's based on company earnings for the quarter. As shipping rates go up, profits rise (the company needs rates above ~$10K to be profitable) and so does the dividend. Shipping rates are cyclical, thus so is the dividend. I've owned NAT for years and it's blown the socks off of any other investment I own. Do some research for heaven's sake.

Mar 26 03:05 AM

[docmike:]

Cliff, since you live in Israel, perhaps you can offer some suggestions about investing in Israeli stocks. I liked your pitch of CEL; let's hear more.

Mar 28 09:45 PM

[Slunder:]

Although NAT pays out a nice dividend the stock tends to go in the same direction as Suezmax rates. Currently the spot rates are at $20k/day, with a forward curve indicating sub $25k/day for the rest of the year. (coming from $65k/day 1 year average). Good company, but say goodbye to current yield. Suezmax forward curve indicates cash earnings of $2.25 pr. share or EPS of approx 75c/share in 2009. (EPS consensus = 1.14). I think NAT is a fantastic stock to own but at these levels its way too expensive. Buy it at $20.

Apr 01 02:17 AM

[nmelendez:]

I am surprised you did not include Brazil and Argentina. PZE has a beautiful yield at 5.5%, owns 75% PBR and has a great distribution for oil and derivatives in Brazil and Argentina. China is now trading with Argentina in their local currency. CRESUD is another i like but lower yield, 4%. However they are still a bit expensive. Waiting for 7 to buy.

Apr 18 07:01 PM