Seeking Alpha
Long-term horizon, dividend investing
Profile| Send Message|
( followers)  

Summary

  • AGL Resourced held its dividend steady at $1.08 per share in 1998, at a time when it did not generate profits to support the payout.
  • Since AGL kept its dividend payment throughout its turbulent times, the company suffered a much lower earnings growth rate because the dividend consumed so much of the company's profits.
  • Going forward, AGL is a much more attractive investment opportunity because revenues are growing by 7.5% and the dividend only accounts for half of the company's profits.

If you study the history of AGL Resources (NYSE:GAS), a utility company with 5 million customers that operates subsidiaries like Chattanooga Gas, Atlanta Gas Light, Virginia Natural Gas, Elkton Gas, Florida City Gas, and Elizathbethtown Gas, you will see that AGL does not have a particularly robust record in the growth of dividend department.

Two troublesome statistics immediately stick out:

Over the past five years, AGL has only grown its dividend at a rate of around 3%.

And secondly, this is due to the broader trend of AGL to only grow its profits by 2% over the past decade.

When someone studies why AGL has had such difficulties increasing cash flow, it's most telling to take a broad perspective and turn back the clock to 1998 to see when those difficulties arose.

At the time, the AGL Board decided to pay a dividend of $1.08 per share, in line with its past. This is understandable - owners of utility companies like to see regular dividends arrive, and it's seen as a significant blow when a utility cuts its dividend.

The problem? AGL no longer had the operating performance to support the dividend. In 1998, AGL brought in $1.08 per share while only making $0.91 per share. Even though profits increased a bit in the following years, the decision to keep the dividend payout stable made it difficult for AGL to deliver future growth - you had a situation where the dividend payout was above what was appropriate, and AGL's decision to hold the dividend steady at $1.08 through 2002 made growth much more difficult to come by.

In the past several years, however, AGL has finally banished the ghost of its cumbersome dividend by keeping the rate of dividend growth slow (after paying out $1.68 to shareholders in 2008, the company is only on pace to pay out $1.96 this year). By keeping the dividend growth rate low, the company has been able to grow earnings at a faster clip and reach a place where its dividend payout is much more sensible and reasonable (this year, AGL is expected to generate $4.10 per share in profits while making $1.96 in dividend payments to shareholders, which works out to a dividend payout ratio of only 47.8%).

AGL is one of those situations where judging the company's forward prospects by its past results is not appropriate because the company is on much better footing today compared to years ago. Back in 1998, the company was paying 15% more as a cash dividend than it was bringing in. That made it difficult for AGL to achieve substantial forward earnings growth. Now, we have an entirely different situation looking forward: The dividend only accounts for half of the company's current profits, offering new investors a much better deal going forward compared to someone contemplating an investment in AGL back in 1998.

Going forward, there is reason for optimism on the dividend growth front. AGL doesn't do much by way of buybacks - it has historically used $100 million here and there to buy back a few shares - but the bulk of increasing profits tend to reach shareholders in the form of a growing dividend payment. Given that the company is growing revenues by 7.5%, recently fueled by service contract expansion in Georgia and Illinois, and given that the payout ratio is now only half of dividends, there is now a sound rationale for dividend growth going forward in the range of 7% compared to the 3% that has been the recent historical norm.

I don't write this article to suggest that AGL Resources is the best dividend investment you can make today. Instead, I write this to suggest that its future will be better than its past dating back to 1998, and this is a good example of "past performance is no guarantee of future returns." The terms offered by a current investment - that is, 7.5% revenue growth plus a dividend payout ratio in the 45-50% range, makes the investment far more intriguing than we've seen from AGL Resources in the past decade.

Source: AGL Resources: The 1998 Dividend Has Been A Haunting Ghost