The market has moved ahead rather convincingly. (Against all logic, but convincingly, nonetheless!) As I search for quality dividend income for our firm’s clients, I have been drawn to a few companies that have been overlooked as investors embrace risk and abandon slow, steady firms that have not yet enjoyed the catalyst that will drive them higher.
The first two of these are in the oil and gas business. Oil and gas, both the commodity and the stocks, fell precipitously from mid-2008 into early 2009. Oil has since recovered about 30% of that decline, while natural gas remains depressed.
I see a rough winter ahead, with warnings from both The National Oceanic and Atmospheric Administration and, more importantly, the squirrels, bears, coyotes, blue jays, raccoons and other denizens of my extended mountaintop back yard. That means more use of heating oil and natural gas. With gas prices this low, it also most likely means both winter and continuing changeover from other electricity-generating fuels to natural gas. I believe a combination of these two factors, plus the increasing scarcity of dependable dividend-paying stocks, may provide the catalyst for greater demand for these firms. Of course, any shock to the oil-producing regions or the oil transport business would mean an even greater possibility of growth for more secure, closer to home providers.
One such provider is Pengrowth Energy Trust (PGH) a Canadian royalty trust that has 100% of its holdings in Canadian oil and natural gas properties. The company currently pays a 7 cent dividend every month, or 84 cents a year. On a stock currently selling at 9.22, that comes to a yield of 8.07%. Back in January, PGH was selling for 9.14.
The company has a $2.4 billion market cap, sells at 14 times trailing twelve months (TTM) earnings, has an easily manageable 30% debt-to-assets ratio, and a net profit margin of 22%.
There are two factors beyond PGH – and every other Canadian Royalty Trust’s – control: the price of the underlying commodity, and the tax changes invoked by the provisional and national governments.
Short term, I couldn’t tell you on a bet which direction the price of oil and gas are headed. There are plenty of newsletter junk-mail senders who will tell you they can, and my hat would be off to them if they really could. At this point, my hat remains solidly in place...
But long term? To me, that’s a no-brainer. Is there any question that India, China and the other emerging nations will use more gas, oil, coal, uranium, timber, etc. in the future than they do today? If they are walking today, they covet a bicycle. If they have a bike, they dream of a scooter. If they have a scooter, they covet the mobility and independence that comes with owning their own car. There will be cyclical downturns of course, but the secular trend goes only one way: demand up, supply struggling to keep up. While this trend is beyond PGH’s control, it certainly bodes well for its future.
As for the tax changes coming in 2011, those are beyond PGH’s control, too. And they will make the yield less attractive -- if it were happening today. Who knows if the factor within their control (below) will allow them to increase their dividends even though the taxes will be higher?
That “within their control” factor is: just how fast is the company replacing assets -- faster than it is depleting them, or is it depleting them faster than it is replacing them? The benefit here goes to the nimble and the better-capitalized. Those with a relatively low debt-to-equity ratio, like PGH, should be able to both raise equity and borrow from lending institutions to snatch up competitors who are not so thrifty and to acquire properties at a good price. Many Canadian royalty companies have chosen to lower their payout ratios and conserve cash. This doesn’t make some individual shareholders happy, but it should: a low payout ratio and a long reserve life mean a steady stream of dividends!
Another Canadian royalty trust I’ve been buying for some clients, that is selling for the same price it sold for in January, is Enerplus Resources Fund (ERF). Enerplus sells at just 6 times earnings, has a market capitalization of just under $4 billion, and pays an 18 cent-a-month dividend, resulting in a yield of 9%. Its debt-to-equity ratio is just 17% and, while its short term net profit margin is nil as it digests some recent acquisitions, its gross margins are 60%.
The last company selling at the same price it sold for in January is Atlantic Power (OTC:ATLIF). Based in Canada, Atlantic owns interests in a diversified portfolio of 14 power generation projects and one 500 kV 84 mile electric transmission line -- all located in major U.S. markets! Well-known U.S. utilities like Progress Energy, Georgia Power and Tampa Electric are some of the utilities which ATLIF supplies with electricity under long-term Power Purchase Agreements. Since ATLIF just this month converted from a form of corporate ownership known as an Income Participating Security to the more traditional common stock, U.S. charts will only show the company as having a week or so worth of history. Look it up under the Toronto Stock Exchange symbol, ATP, however, and you’ll find plenty of data.
The company’s website (here) is a font of information. Just one example:
Answering the question, “How does ATP's business model mitigate investor risk?”
ATP’s projects have a diverse base of electricity and steam customers, technologies and fuel types, and operate in multiple regulatory jurisdictions and regional power pools. This diversity reinforces ATP's stability of cash flows by limiting investor exposure to an individual electricity or steam off-taker or to market, regulatory, or environmental conditions in any one region. In addition, all of ATP's electric capacity is being sold to customers with investment-grade credit ratings. Also, its power purchase agreements generally pass through changing fuel prices to the offtakers. [JS: “Offtakers” refers to the buyers like Tampa Electric…]
Makes sense to me.
ATLIF sells at 8 times earnings, has a market cap of $600 million, pays just under 9 cents a month, or right around 10%, has net margins of 36% and, like all capital-intensive electricity providers, however, has a whopping 411% (4.11:1) debt-to-equity ratio.
I’ve searched long and hard to find what I believe are quality high-yield firms that we can buy for the same price we would have paid in January but whose prospects since then are considerably brighter. I believe these three qualify.
Author's Disclosure: We and/or clients for whom it is appropriate are long ERF, PGH and ATLIF.
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Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but will not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
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