Investing in quality dividend equities is an established strategy to hedge against a possible stock market decline. The Dow Jones Industrial Average and S&P 500 both hit new records on Friday but many investors are worried that the rally in equities could be running out of steam. The combination of political and economic indecisiveness is resulting in a flight to high quality US equities. It seems as if many investors are quick to forget that the US government is facing $85B of federal spending cuts this year. Most companies with high yields have strong financial positions that make them attractive to investors. Additionally, these companies usually have high cash flows from operations, one of the most important factors in a prospective investment. While some investors are buying Italian ten-year bonds yielding four percent, I suggest considering relatively safe American equities with comparable, or higher, yields.
There are eight candidates that have been analyzed below based upon SA readership criteria going ex-dividend early this week. The majority of the companies are in the energy industry and half are energy Master Limited Partnerships ("MLP"). Yields are generally clustered in the four-to-five percent bracket but there are three equities yielding over six percent. The market capitalizations are lower this week than usual and only three equities have market capitalizations over five billion dollars. I prefer that my ex-dividend candidates have market caps greater than five billion dollars but that is not a requirement, especially with smaller financial service firms and MLPs. I have focused my efforts on the ex-dividend opportunities for Monday and Tuesday due to the volume of candidates.
For details of the strategy and my screener details, please consult my methodology on the topic (last modified 4/7/2013). 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 (Relaxed for MLPs and REITs)
- Institutional Ownership ≥ 15%
- Ideally Modest YTD S&P 500 Underperformance
- Minimal European Exposure
After applying this screen, I arrived at the equities discussed below. Depending on your belief in the investment hypothesis, you may decide to hold long enough for the dividend or to hold for long-term. The information presented below should simply be a starting point for further equity research in consultation with your professional financial advisor before making an investment decision. 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.
Enbridge Energy Partners, L.P. (EEP): 7.6% Yield; Ex-Dividend 5/6
Enbridge Energy Partners, L.P. is an MLP that specializes in crude oil and liquids transportation but has been diversifying into natural gas and midstreaming operations. Two-thirds of operating income is derived from liquid pipelines with the balance coming from natural gas. The partnership is the largest pipeline transporter of crude from Western Canada into the United States and is also the largest transporter of crude from the Bakken formation. Enbridge has four publicly traded companies in its equity family (refer to diagram below) with various general and limited partnership interests.
(Source: May 2013 Investment Community Presentation)
EEP is growing slower than some of its peers (2%-5% forecasted CAGR) but offers a yield that is approximately 140 basis points higher. EEP has a lower risk profile as it relies on cost-of-service contracts and fee-based contracts for approximately 75 percent of revenue. By 2016 commodity sensitive revenue is projected to account for only 12 percent of total revenue. Distribution coverage has been declining from 1.0 since 2010 but should rebound in the upcoming years due to $8B in organic secured growth. Enbridge also has four times fewer spills than its peers, highlighting the safety of the partnership, both operationally and financially.
Alliance Resource Partners, L.P. (ARLP): 6.10% Yield; Ex-Dividend 5/6
Alliance Resource Partners ("Alliance") is an MLP that focuses on the production of coal and Alliance Holdings GP, L.P. (AHGP) is the managing general partner with a two percent interest in ARLP. Additionally, AHGP has 100 percent of incentive distribution rights and owns approximately 40 percent of ARLP's outstanding shares.
Coal is not a hot commodity due to recent clean energy initiatives but that has not stopped Alliance from reporting positive earnings. In fact, Alliance has reported 12 consecutive years of record financial results. Revenue climbed 10 percent in the last year but net income declined primarily due to higher depreciation. Earnings per share have increased by an annualized rate of ten percent, further cementing the company's reputation of outsized performance. On an EBITDA basis, performance was marginally higher in 2012 ($581M vs. $571M) but distributable cash flows declined due to higher estimated maintenance. Alliance has generated over $550M in cash flows from operations in the past two years, which is generally high enough to meet investing requirements. The first quarter of 2013 set another record in quarterly EBITDA and coal production.
The partnership's distributions continue to grow at a steady rate and have grown every quarter since 2008; this quarter's distribution grew by two percent. Since 2008 the distribution almost doubled and has been on a very strong uptrend. Consumption of coal dropped approximately 50 percent in 2012 but supply and demand are forecast to equilibrate in 2013. This should result in a less volatile year of performance and Alliance has already committed and priced 95 percent of its 2013 estimated volume. Alliance is positioned well for the future as nearly eighty percent of its reserves related to the Illinois Basin Region, which is projected to experience moderate growth through 2015.
ARLP and other coal stocks have had a challenging 2012 but I believe most of the pain has already been inflicted on the sector. I continue to take the contrarian view on coal and I am willing to collect the six percent dividend while I wait. The stock is up 16% in the past month and nearly eight percent in the past week alone which has pushed the yield down by a substantial amount. Despite the recent run, the stock is still attractive from a valuation standpoint. The return on equity is high (24%) while the forward P/E (11.4) and P/R (1.4) are both low.
Inergy, L.P. (NRGY): 5.28% Yield; Ex-Dividend 5/6
Inergy is an MLP with natural gas/natural gas liquids operations including transportation, storage, and supply logistics. Operations span the United States and Canada; however, natural gas storage is centered in Texas. Inergy is the general partner for, and majority shareholder in, Inergy Midstream, L.P. (NRGM), which is a pure natural gas play on North East exposure. NRGM is unique in that it has such a large presence near New York as opposed to other MLPs that are located more in the Central US.
Over 75 percent of gross profits are derived from long-term storage and transportation contracts, which provide Inergy with a stable source of distributable cash flows. Commodity risks are minimal and half of customers are utilities that have predictable demand. The dividend was slashed from $.705 quarterly to $.29 quarterly over the last year due to the divestiture of retail propane operations. In summary, Inergy should at least be able to maintain its current distributable cash flow. Gross profit and operating income have contracted slightly over the past two years. Earnings were boosted substantially in 2012 due to the gain on disposal of retail propane operations but that was a non-cash event and cash flows have been negative in the past two years. This also explains why the TTM price/earnings ratio is so low (5.3) compared to the higher forward multiple of 33.3.
Inergy has not been in the news much recently but will be reporting second quarter 2013 earnings on May 7th. The stock is up 24% thus far in 2013 and is trading at its 52-week high. Ron Hiram provides a very detailed analysis of the partnership and concludes that it is not worth owning. Overall, the negative factors outweigh the positive ones and I would avoid Inergy for ex-dividend purposes, especially at this elevated price.
Access Midstream Partners LP (ACMP): 4.46% Dividend; Ex-Dividend 5/6
Access Midstream Partners ("Access") is a midstream natural gas provider in the United States. The partnership had its initial public offering in the summer of 2010 and focuses on long-term, fixed-fee contracts. The benefit of a fixed-fee revenue model is that there is no direct commodity price exposure and distributable cash flows are more stable. Most re-contracting periods are based on 15-20 year acreage dedication with build in inflation protection.
(Source: May 2013 Investor Relations Presentation)
Nearly two billion dollars of capital expenditures are planned for 2013-2014, versus $1B in 2011-2012, which should drive future growth. A significant driver of future growth is Access' acquisition of Chesapeake Energy's (CHK) midstream assets for $2.2B. Adjusted EBITDA has exhibited 51% annual growth since late 2010 and enterprise value has climbed from $4.3B to $10.2B. Recently reported first quarter 2013 earnings attributable to Access increased by 13.7% year-over-year due to a 53% surge in revenue over the same period. The distribution per unit has grown 15% annually and could be accelerating based on the high distribution ratio. The distribution coverage ratio in the first quarter of 2013 was 1.4X versus 1.23X in the past two years.
The partnership has had its price target increased by five different institutions thus far in 2013 with RBC recently increasing its target to $47. Despite the high growth in distributions, the yield is near an all-time low because investors keep driving shares higher. The stock is already up 28% in 2013 but I believe there is more upside in this conservative company due to its stable business model and recent acquisition.
Federated Investors, Inc. (FII): 4.25% Yield; Ex-Dividend 5/6
Federated Investors, Inc. is a global asset management holding company that focuses on international equity, fixed income, alternative, and money market strategies. Half of managed assets relate to wealth management operations with broker/dealer activities accounting for thirty percent. The financial performance of Federated was in a downward trend due to the financial crisis and revenue and net income have been declining until 2012. Total revenue recovered nicely last year and almost matched the level from 2010. Net income surpassed 2010 due to fewer intangible asset expenses. The solid performance has reversed the negative trend in assets under management and AUM has risen to nearly $380B as of publication.
Aside from special cash dividends, the dividend payment has been flat for the past four years but the special dividends have been sizable. For example, the special dividend in 2012 was $1.51 per share versus annual per share dividends of $0.96. The special dividend has been distributed in even-numbered years since 2008 and essentially brings the adjusted yield closer to 7.4 percent (assuming $1.71 effective annual distributions per share). This is a very good yield; however, I do not like the unpredictability of the dividend as many dividend investors like to see their payments as quickly as possible. Federated Investors is a well-managed company on the road to recovery but is not an ideal ex-dividend candidate due to the reliance on special dividends. In summary, the four percent dividend yield received for 2013 is not enough to compensate for the risk of this company.
Entergy Corporation (ETR): 4.64% Yield; Ex-Dividend 5/7
- 2.8M Customers in Southern and Central US
You may remember Entergy as the utility company responsible for the thirty-minute blackout during the Superbowl and the company's shares have slightly underperformed the S&P 500 year-to-date. The company will be the punch line of jokes for a while but the company has other problems. Earnings were slumping last year but recovered nicely year-over-year due to write-offs in 2012. I am cautious about the company but it appears to be regaining its course.
Investors have grown confident and have driven shares 11% higher this quarter. The company received good news in April when ITC Holdings Corp. (ITC) shareholder approved the purchase of Entergy's electric transmission business. The dividend is average for the utility industry but the payout ratio has declined sharply from 83% last quarter to 51% today. A dividend capture should be relatively safe but I am not overly bullish on Entergy and believe the stock is slightly overvalued.
The information presented has been summarized below. I make no guarantees regarding the information in the chart as industry classifications and yield calculations are frequently imperfect. Orange and green represent "avoid" and "consider" classifications, respectively.
Additional disclosure: Please refer to profile page for disclaimers.