Investing in quality dividend equities is a time-tested strategy to mitigate losses, dampen volatility, and generate income in most market environments. The Dow Jones Industrial Average and S&P 500 are both near record highs but there are concerns that consumers will not be able to support the rally for much longer. The combination of political and economic indecisiveness is resulting in a flight to high quality U.S. equities. 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. The yields on junk bonds are at record lows and some are now yielding less than five percent: would you rather buy low quality bonds or high quality equities with comparable, or higher, yields?
This week there are fourteen ex-dividend candidates that have been analyzed below based upon SA readership criteria. This week is dominated by energy and financial firms including utility companies and a diverse set of financial institutions. Yields are overwhelmingly clustered in the four-to-five percent bracket but there are three equities yielding over eight percent. The market capitalizations are lower this week than usual but there are still five opportunities with market caps greater than 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 Master Limited Partnerships. Nearly half of the opportunities are trading ex-dividend today so I hope everyone had a restful Mother's Day weekend and is ready to do some research.
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 the 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.
ARMOUR Residential REIT, Inc. (ARR): 13.23% Yield; Ex-Dividend 5/13
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 quarterly report, ARR has $24.3B in agency securities opposed by $24.8B in repurchase agreements. ARR is currently levered about 9X, (debt/equity) which means its relatively low return on assets (1.28%) is magnified nine times. Both of these key metrics are moving in the wrong direction as leverage has increased from eight times and return on asset has dropped by approximately forty basis points. As I discussed in a recent mREIT article, in addition to leverage, an important metric for mREITs is book value. ARR has a calculated book value of $7.24 and a price/book ratio of 0.88. This is a sizable decrease from the $7.47 book value in the previous quarter. This indicates that ARMOUR is valued at a modest discount to its financial statement value, thus the market is generally cautious about the company. ARMOUR has two factors working against it: a declining interest rate spread and dividend concerns (discussed below). This uncertainty in the mortgage market is depressing the valuations of ARMOUR as well as peers American Capital Agency Corp. (AGNC) and Annaly Capital Management (NLY).
(Source: Extract from 3/31/2013 10Q)
In December 2012 ARMOUR cut its cut its dividend from $.09 to $.08 per month and the dividend was recently cut again to $.07 per month. 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, which represented approximately 4.6% of the company's market capitalization at the time. ARMOUR has declined 7.2% the past quarter due to dilution concerns ($435M equity offering) as well as the issues discussed above. Share offering are common for mREITs, but this is an odd decision given the recent repurchase announcement and scale of offering. These actions have fueled two large analyst downgrades from 'Buy' to 'Hold' and a stock price near the current trading level.
Earlier this year I said that ARMOUR was on thin ice due to the dilution and dividend decrease and now it looks like the company has cracked the ice. I am still bullish on quality mREITs due to the robust yields but I believe that ARMOUR is currently trading close to fair value. The stock has lagged the market by approximately fifteen percent in the past quarter alone so downside is somewhat limited but the declining return and increasing leverage are alarming signs. The yield is still enticing but investors should exercise caution. Note that ARR distributes dividends monthly.
Fifth Street Finance (FSC): 10.51% Yield; Ex-Dividend 5/13
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 solid March 2013 quarter with the following highlights:
- $9.90 book value per share, versus $9.88 in the previous quarter
- $363M of investments in 19 portfolio companies, 15 of which are new
- $161M in proceeds from debt investment sales, all for gains
- 11.40% weighted average yield on debt investments
Since September 2012 the portfolio fair values has grown approximately 36% 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 by a penny, despite the performance increase. Another yellow flag is the number of investments with losses and the overall portfolio has a fair value of $1.75B and cost of $1.74B. For example, an investment in Coll Materials has a cost of $12M and fair value of $3M. 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 minimal debt in its capital structure as evidenced by the .4 debt-to-equity ratio. The stock has been on a steady uptrend since May of last year and has risen from $8.50 to $10.85. The stock has traded in a much tighter range in 2013 and is less than two percent from its 52-week high. UBS raised its target from $11 to $11.50 in February and the stock is currently trading approximately six percent below the updated target. The monthly dividend has also been reduced in each of the past two years but management has already reaffirmed the dividend through August. One appealing benefit of owning FSC for the long-term is that the dividend reinvestment plan (DRIP) allows investors to reinvest dividends at a five percent discount, subject to terms and conditions.
I would avoid FSC for dividend capturing due to the issues mentioned above. Even if you are optimistic about FSC's prospects, it appears that the upside is limited at this level. JPMorgan rated FSC a buy in late March with a bullish report; however, the price target of $11 implies only one percent upside for the stock. The report focuses on the fact that FSC has $1.5B in assets (which has since increased as mentioned above) and business development companies typically achieve scale benefits at that level. JPMorgan mentions that the dividend is "increasingly secure," which would lessen one large risk for shareholders. Prospective investors should read Fifth Street Finance's latest newsletter for additional insight into future performance of the company. Note that FSC distributes dividends monthly.
PennyMac Mortgage Investment Trust (PMT): 8.89% Yield; Ex-Dividend 5/14
PennyMac is a REIT that invests in US residential mortgage loans and other mortgage assets. PennyMac profits from direct investment in loans and correspondent lending, which involves pooling and selling or securitizing new prime mortgage loans. Unlike other mREITs, PennyMac actually holds the underlying loans at times, rather than just owning securitized products. The investment process is to purchase nonperforming loans and seek profitable loan modifications. Interestingly, most nonperforming loans were purchased from Citigroup (C).
(Source: 14th Annual Credit Suisse Financial Services Forum Presentation)
This investment strategy has been working very well and 2012 income more than doubled to $138M while diluted EPS rose 30%. The fourth quarter was especially strong due to a perfect storm of higher home prices, greater paydowns, and lower delinquencies. This trend continued in the first quarter of 2013 as net investment income rose by 150%. This is a risky sector of the market but there are high potential rewards. Additionally, management has some inventive ways to pursue further growth (see above). This is not my favorite mREIT because of its non-performing/non-agency focus but it is hard to argue with the returns: investors have been handsomely rewarded with 46% gains the past year. Despite the strong performance, PennyMac actually is lagging the S&P500 by approximately 12% thus far in 2013. The dividend yield is not as high as other leading mREITs but nine percent is very respectable and there is the potential for dividend growth as well. PennyMac requires further research due to its complex operations but is worth considering for dividend purposes.
Buckeye Partners, L.P. (BPL): 6.27% Yield; Ex-Dividend 5/14
Buckeye Partners is a master limited partnership ("MLP") that provides midstream, terminaling, storage, and other energy logistics services. Buckeye's pipelines and operations are generally concentrated in Central and Northeastern United States in addition to operations in east Texas. Domestic pipelines & terminals account for nearly 75% of 2012 EBITDA while international pipelines & terminals generate the majority of the EBITDA balance. Most international operations are concentrated in the Bahamas and Puerto Rico.
(Source: 2013 Morgan Stanley MLP Corp Access Event - March 6, 2013)
In 2011 and 2012 Buckeye spent approximately $265M on organic growth capital expenditures, a sharp increase from the $47M spent in 2010. In 2013 Buckeye has forecasted $330M, highlighting its dedication to growth. Overall, Buckeye has invested over four billion dollars to grow its operations since 2008 and it has paid-off well. Adjusted EBITDA has grown every year since 2008 and jumped from $488M to $560M from 2011 to 2012 alone. A similar trend has held with distributable cash flows that have increased from $212M in 2008 to $392M in 2012. Ron Hiram has a very detailed article that discussed Buckeye's distributable cash flows in the first quarter of 2013.
Buckeye Partners is one of the best performing stocks in 2013 and has surged over fifty percent in less than half a year. The stock was stuck in a tight range between $45 and $50 from August 2012 to January 2013 but has soared recently. Deutsche Bank and Barclays both increased their price targets last week but the stock is already trading above Barclay's target of $64. P/E ratios are not ideal metrics for MLPs but the forward P/E just barely met my screener criteria. Buckeye appears slightly overvalued at this level but it still is a solid dividend opportunity to consider given the strong growth in distributable cash flows.
Main Street Capital (MAIN): 6.26% Yield; Ex-Dividend 5/17
Main Street Capital is a $1.0B business development company that specializes in equity, equity related, and debt investments in companies with revenue between $10M and $100M. The majority of investments are non-controlling/non-affiliate; however, approximately 25% of the portfolio is in controlling investments.
The stock was upgraded by Robert W. Baird from 'Neutral' to 'Outperform' in March but has slumped more than five percent in the past quarter. The major news the past month was the filing of the first quarter 2013 10Q. Over the past quarter, NAV per share has increased two percent (excluding the special dividend payment). Despite the appreciation in NAV per share, the stock still trades at a very high premium to book value (1.61 price-to-book ratio). Net investment income and distributable net investment income have both jumped by over 30% in the past year. Despite this strong performance, dividends per share have only increased by 11%. Note that the dividend is paid monthly.
Despite the recent increase, the dividend payment has exhibited only slight growth throughout the years. Cash flows from operations have been volatile but have generally been on an uptrend. I scanned Main Street Capital's schedule of investments and I admire the fact that the company has hit numerous home runs and grand slams. For example, one investment in CBT Nuggets, LLC., has appreciated to $8.37M from a cost of $1.30M. Based upon my review, these impressive investments appear to outnumber the poor investments by a healthy margin.
I covered Main Street in detail earlier this year and concluded that it was worth considering for dividend capturing but I would be cautious given the high premium to book value. This is a company with a track record of success but I am leery about buying a business development company with a price-to-book ratio of 1.61. Fortunately for prospective investors, MAIN has tumbled from its high of $34 and interested investors can now buy shares under $30.
Duke Energy Corporation (DUK): 4.25% Yield; Ex-Dividend 5/15
Duke Energy is the largest electrical power utility company in the United States with a $50B+ market capitalization and over seven million customers in the Southeast and Midwest. Utilities have been a hot sector recently and Duke has risen from $60 to over $70 in the past six months.
In the first quarter of 2013 adjusted diluted EPS slid from $1.13 to $1.02 year-over-year and the main cause was the increase in the number of shares outstanding following the $13.7B acquisition of Progress Energy. The incremental increase in shares caused EPS to decrease by $.41, a staggering impact given the low EPS base. Management is forecasting EPS to strengthen in the second half of 2013 due to merger synergies and positive rate case regulatory outcomes. The acquisition will result in a reduction in headcount as well as consolidation of systems, procurement contracts, operating models, and supply chain aspects - all of which should reduce costs going forward. Duke is target EPS growth of 4-6% from 2013 to 2015 so ideally performance will improve quickly.
(Source: Q1 2013 Earnings Release Presentation)
One of Duke's stated goals is to continuing growing the dividend while maintaining a 65-70% payout ratio. From 2009 through 2013 (estimated full year), there has been only a two percent CAGR for the distribution; therefore, Duke's dividend is only tracking inflation. The forward P/E of 15.7 is in-line with the industry given the dividend and scale of operations. If you are looking for a large, relatively safe dividend company, Duke fits the description well but do not count on it continuing its streak of capital appreciation.
Consolidated Edison (ED): 4.00% Yield; Ex-Dividend 5/13
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. Con Ed provides service to approximately 4.7 million customers in New York, New Jersey and Pennsylvania. The largest customer base is in New York where Con Ed has a regulated monopoly in areas for electric and gas service. 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 touched four percent. For reference, I originally purchased Con Ed with the yield in excess of five percent.
(Source: Yahoo! Finance)
Since August 2012 the stock has been underperforming the S&P 500 and now has lagged the market by approximately 17% in the past year. 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 returned about twelve percent since then but has been unable to close the 'Sandy gap'. Con Ed is no longer my favorite utility due to the low relative yield for the sector but is affordably priced and should have limited downside going forward.
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.
Please refer to profile page for disclaimers.