Our Dividend Investment Project, which we began in 2012, has benefited admirably from a pair of basic materials companies, although they differ dramatically in their business objectives. As the third quarter begins we're reviewing these holdings, wondering if we should re-position.
Followers will know that our goal is to generate high-yield dividend income and achieve growth. If we can sustain our principal, or, better yet, grow it, while producing at least 8% in dividend income, we know we're beating super-low interest bearing accounts that are less risky but only fractionally productive.
For retirees like me, this is an important objective: Produce a dependable income stream from a "nut" that doesn't depreciate -- all the better if principal grows.
The idea isn't new, of course. Some refer to the idea as the "Chowder Rule," which implies that these two, income plus growth, should add to 12% annual growth, and 8% for REITs and master limited partnerships. One can set any goal one wants; I'm a little hungrier, setting "8-plus-8" for my current-year business plan.
The two companies we have held produce high yields. Calumet Specialty Products Co. (CLMT), a refiner, has yielded 8.6% on cost and yields 7.4% on current price. SandRidge Permian Trust (PER) yields 11.5% on cost and 13.5% on current price. In the case of CLMT we appear to have purchased at a good price. In the case of PER, we evidently paid too much.
The chart below compares two companies on the basics. I've chosen to compare their prices dating back to September 2011, because that's the first full month after PER initiated its offering.
Even with its very high yield, PER has only barely over its life generated enough income to keep up with its value decrease over this time period.
Could the money be working better somewhere else? Will the price return to the level of our cost? Should we consider selling PER shares and re-deploying the money?
Another basic materials company, Cimarex Energy (XEC), has been on the watch list. I'll include it for comparison.
Here are the basics of each:
Source: Yahoo Finance
PER has the highest yield and lowest earnings per share. XEC has the highest volatility rating and the lowest yield. Price to earnings is most attractive with PER and CLMT. Analysts are not enthused about any of them at the moment.
The price of XEC on Sept. 1, 2011 was $71.05 a share; on June 30, 2013, it was at $64.99, a loss of 9%.
Let's find out more.
CLMT, a hydrocarbon refiner, is a leading, independent American producer of high-quality, specialty lubricants and fuel products. The company processes crude oil at nine facilities in Texas, Louisiana, Wisconsin, Montana and Pennsylvania. It is acquisitions minded; the company acquired three companies in 2012 alone.
Despite the low beta listed above, the stock this year has been volatile, ranging from $30-$39 a share. The week just ended saw the stock price drop below $34 a share. My cost is $31.60.
PER, a U.S Royalty Trust, produces oil and gas, and it has a lifetime that will expire in 2031. Investors must determine if they will receive an acceptable return on investment over the life of the trust, because when its resources are depleted its residual value will be minimal.
Calculating present value is an esoteric exercise based on many assumptions about the future. For a detailed look at how it is approached, please refer to the admirable work done by Seeking Alpha contributor Eliot Gue; you can read his work here. The summary point in his January 2013 article is that PER probably had present value of $17 per share, but that was back in January. One must ask what's changed in the meantime, and the obvious answer is that oil and gas prices have improved, and that helps PER.
XEC is a driller, too, but it is not organized as a trust. Instead, the company plans an long life supported by new drilling. It is a "drill-bit" growth company peopled by geo-scientists who probably know as much as there is to know about where to punch holes and how much product to expect in return.
Hedging with both
As a refiner, CLMT uses the feedstock that both PER and XEC produce. When oil and gas prices rise, PER and XEC do well, but CLMT must pay those higher costs. Of course, the company has a variety of suppliers in several regions of the country. And, as an acquisition-minded company, it can build its network with regional feedstock price vagaries in mind. For example, earlier this year the company announced that it will build a diesel fuel refinery in North Dakota, "ground zero" for the vast hydrocarbon reserves in the Bakken Formation.
CLMT can control its production, and it has impressive marketing skill with its high-quality products. But it's at the mercy of the market when it comes to cost. The company uses the benchmark "Gulf Coast 3/2/1 Crack Spread" to determine generally how its margin is tracking with the benchmark cost of refining oil. The principal reason for the company's stock price decline in recent weeks is that this spread has narrowed, and some observers argue that's the way it's going to be for quite a while.
However, some think crude oil acquisition costs will level off. Here's a chart from the U.S. Energy Information Administration:
In this view, acquisition costs for refiners will level off and then decline, a manageable situation, I believe.
If the best days are over, does it still make sense to hold a refiner such as Calumet? CLMT will report soon, so we'll have solid data on revenue growth, and, we hope, dividend. According to a report in Motley Fool, analysts predictably expect revenue growth and a profit decrease. The market seems to already have built in those expectations with recent trades below $34. A dividend decrease will certainly give income investors pause, but if the dividend holds CLMT will be a good buy at $34.
Energy sector and basic materials stocks have been quite volatile this year, because the market has reacted quickly to changes in oil and gas prices. With the upswings, PER has become more attractive, and if the $17 present value is a reasonable target, and I think it is, then sticking with PER for a while makes sense. Although I've considered cutting my losses, I've reversed myself when overlaying my business plan and additional analysis of market trends and company performance in the Permian Basin. I've actually acquired more shares when prices dipped below $14, a move which has potential to lower the average cost per share.
With CLMT, we have a well managed company, the performance of which is negatively impacted by recent higher costs. Its products are of high quality and fitted into specialty niches. It is in acquisition mode, and it has made wise decisions to expand into good markets convenient to both supply of feedstock and demand for finished products. I think the best bet is to stick with the company, with the caveat that the dividend, too, must not greatly disappoint.
With XEC, the company's low yield doesn't fit my business plan, and its volatility in the basic materials sector, without significant dividend compensation, takes it off my list. Investors interested in it should learn what they can about management and its ability to confront threats and seize opportunities, because in the near term its share price may strengthen.