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Basic materials are hot right now. With oil prices rising past $110 a barrel, copper setting all time highs, and steel close to its 2008 peaks, many investors are scouring the markets for good investment opportunities. Some investors look at basic materials as good dividend stocks - strong consistent dividends; however, it can often result in simply chasing the highest yield.

One can always ask the questions, 'is this a high dividend yield because it has strong earnings and good prospects or is it a high yield because the price is in decline due to fundamental questions about the company'. Finding a 5% dividend yield only to have the stock drop 10% in price is not very useful. When looking at investment opportunities it is important to dig a little deeper to understand the company's growth prospects and risk profile. However, for those interested in simply chasing yields here are the current top dividend yielding stocks in basic materials with at least $250 million in market capitalization.

Top Yielding Stocks
TickerNameYield (%)Market Cap ($ Millions)Industry
SCCOSouthern Peru Copper Corporation6.3*31,459Copper mining
SDRLSeadrill Limited5.415,516Oil & Gas Drilling
RDS.BRoyal Dutch Shell4.3245,007Integrated Oil & Gas Firm
SSLSasol Ltd.4.034,055Integrated Oil & Gas Firm
TRPTranscananda Pipelines, Ltd.4.029,693Production and Pipelines
BTEBaytex Energy Corp3.97,048Oil Exploration and Production
TOTTotalFinaElf, S.A.3.9149,907Integrated Oil & Gas Firm
SIDNational Steel Corporation3.722,963Steel Production
NLNL Industries, Inc.3.6669Specialty chemicals
SESpectra Energy Corp3.618,697Oil and Gas Pipelines

Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011. *SCCO yield is 6.3% by both Zacks and Yahoo!Finance which represents an annual yield based on the most recent dividend of $0.58. Using the trailing twelve months dividends would give around 4.9% yield which would place it in 2nd place. This distortion will appear for any stock with irregular dividends.

As noted by the presence of oil companies above, I've included oil and gas companies as well as the traditional coal, steel, and paper companies. This list does exclude partnerships and trusts. The second list below reflects the highest yields in this category:

Partnership and Trust - Top Yields
TickerNameYield (%)Market Cap ($ Millions)Industry
CQPCheniere Energy Partners, LP9.3485Production and Pipelines
BPTBP Prudhoe Bay Royalty Trust8.22,487Oil & Gas Royalty Trust
CLMTCalumet Specialty Products Partners, L.P.8.2808Refining and Marketing
ENPEncore Energy Partners LP8.11,123E&P MLP
MVOMV Oil Trust7.9476Oil & Gas Royalty Trust
FGPFerrellgas Partners, L.P.7.61,974Refining and Marketing
BBEPBreitBurn Energy Partners, L.P.7.61,284Exploration and Production
SBRSabine Royalty Trust7.61,007Oil & Gas Royalty Trust
GLPGlobal Partners L.P.7.2602Refining and Marketing
NRTNorth European Oil Royality Trust7.0288Oil & Gas Royalty Trust
NRGYInergy, L.P.6.94,468Refining and Marketing
OXFOxford Resource Partners, LP6.9262Coal

Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011.

The above two lists provide good starting points for looking for the highest yields, but the focus will be to find stocks with strong yields when also adjusted for risk and growth.

Balancing Dividends with Growth and Risk
Simply chasing yields fails to consider growth and risk with respect to the selection. The key growth is in dividend growth, but sales and EPS growth may also provide some indication of potential dividend growth. While the ability to convert sales into cash flow and dividends may vary, the large range of differences clearly impacts potential dividend yields going forward. One way to balance growth and risk with dividend yield is to look at the dividend formula:
Current Price = Forward Dividend / (Required Equity Return – LT Growth)

So looking at this equation to maximize the Price, one wants to maximize the Forward Dividend, minimize the Required Equity Return and maximize the LT Growth or some combination of these levers. Some rearranging shows that the goal is to maximize the following:
DRG Index = Forward Dividend Yield + LT Growth – Required Equity Return

The Required Equity Return can be calculated using the Capital Asset Pricing Model. The Risk Free Rate is most typically associated with the U.S. Treasury bond with the most appropriate time frame to match that of stocks. I would use the 10-year bond, which is currently yielding 3.296% and 6% for the equity risk premium. The Forward Dividend Yield which can be calculated based upon the Current Dividend Yield and some estimate of 1 year of Dividend growth.

This method does face a couple of challenges since growth estimates can seem to be unrealistic at times for forward projects and historical rates can be misleading. For example, a company that has just started paying dividends might show significant growth that would be expected to slow. I created a couple of arbitrary steps and capped dividend growth at 20% for computing the one year forward dividend yield. I then capped the long term growth rate using the minimum of the historical dividend growth, the long term consensus EPS growth and 15%.
While these caps are somewhat arbitrary, the goal of any screening type of analysis is to create a useful list. The previous two lists already show the top yielding stocks. The second aspect was that I decided to exclude the partnerships and trusts from consideration since they do not operate under the same going concern considerations that the other companies due. Also, the quick review of the top performing partnerships and trusts mirrored the list of highest yielding partnerships and trusts.

The analysis focuses on the following companies that showed the greatest excess growth and dividend yield relative to calculated hurdle rate (a.k.a. required equity return). The first recognition is that the basic materials group included several agricultural and other types of companies (Monsanto) that might not typically be thought of as basic materials.
Hurdle Rates
TickerNameRisk Free Rate BetaEquity Risk Premium Hurdle Rate
MONMonsanto Company3.3%0.86.0%8.3%
SUSuncor Energy Inc.3.3%1.66.0%12.8%
NUENucor Corporation3.3%1.06.0%9.5%
CLBCore Laboratories N.V.3.3%0.86.0%8.2%
ENBEnbridge Inc3.3%0.76.0%7.4%
ESVENSCO plc3.3%1.26.0%10.3%
UGPUltrapar Participacoes S.A.3.3%1.06.0%9.4%
CRRCarbo Ceramics, Inc.3.3%0.66.0%6.7%
MURMurphy Oil Corporation3.3%1.06.0%9.2%
ADMArcher-Daniels-Midland Company3.3%0.26.0%4.7%

Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011.

The next key component is the forward dividend yield which is based on the current dividend yield projected with the historical dividend growth rate. I capped this figure at 20% as well. It should be noted that this had limited impact on the results. Projected growth rates are the largest driver of the results with the adjustment from current dividend yield to forward dividend yield having the smallest impact.

Forward Dividend Yields
TickerDividend YieldHistorical Dividend GrowthForward Dividend Yield

Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011.

Putting it together shows the top 10 stocks as well as their "outperformance" measure.

Top 10 Stocks adjusted for Yield, Risk and Growth
TickerNameForward Dividend YieldGrowth UsedHurdle RateDRG Index Industry
MONMonsanto Company2.0%24.1%8.3%17.7%Agricultural products
SUSuncor Energy Inc.1.1%23.0%12.8%11.2%Canadian Integrated Oil
NUENucor Corporation3.7%15.0%9.5%9.2%Steel Production
CLBCore Laboratories N.V.1.3%16.0%8.2%9.1%Oil Field Services
ENBEnbridge Inc3.4%12.8%7.4%8.9%Production and Pipelines
ESVENSCO plc2.9%16.0%10.3%8.6%Oil & Gas Drilling
UGPUltrapar Participacoes S.A.3.0%14.8%9.4%8.4%Production and Pipelines
CRRCarbo Ceramics, Inc.0.6%14.4%6.7%8.3%Oil Field Services
MURMurphy Oil Corporation1.7%15.0%9.2%7.5%Integrated Oil & Gas Firm
ADMArcher-Daniels-Midland Company1.9%10.0%4.7%7.2%Agricultural products
Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011.

The stocks ranked 11 - 20 are listed below and include their industry groupings:

Stocks Ranked 11-20 for Yield, Risk and Growth
TickerNameYieldMarket CapIndustry
NENoble Corporation0.4%10,606Oil & Gas Drilling
SQMSociedad Quimica y Minera S.A.0.9%15,234Mining/Chemicals
XECCimarex Energy Co0.3%9,392Exploration and Production
EOGEOG Resources, Inc.0.6%29,798Exploration and Production
RRCRange Resources Corporation0.3%8,814Exploration and Production
PXPraxair, Inc.1.9%32,540Diversified Chemicals
ARGAirgas, Inc.1.7%5,810Diversified Chemicals
CCJCameco Corporation1.4%11,615Other Mining
NBLNoble Energy Inc.0.8%16,942Exploration and Production
POTPotash Corporation of Saskatchewan Inc.0.5%47,352Agricultural Chemicals

Data is provided by services downloaded on April 29, 2011 and is current as of April 28, 2011.

This analysis attempts to dig deeper than just looking at yield. However, it is still just a screening tool since it does not look at the fundamental valuations of any company. Nor does this analysis address any strategic questions or other qualitative assessments of the companies listed. Additional fundamental analysis would be critical prior to making any sort of investment decision; however, this offers a great starting point with a focus on the basic materials industries. The high level conclusions:

  1. The partnership and trust companies typically provided the highest overall yields. For an investor seeking current income, these are potentially the best opportunities. They also performed well on the adjustment for risk and growth. However since that list was close to the initial top 10 list, I excluded it from consideration but those stocks and tickers are: Legacy Reserves (NASDAQ:LGCY), Encore Energy Partners (NYSE:ENP), Cheniere Energy Partners (NYSEMKT:CQP), Targa Resources (NYSE:NGLS), Alliance Holdings (NASDAQ:AHGP), LInn Energy (NASDAQ:LINE), Terra Nitrogen (NYSE:TNH), Spectra Energy Partners (NYSE:SEP), El Paso Pipeline Partners (NYSE:EPB), Western Gas Partners (NYSE:WES). The exclusion was largely over questions of the sustainability of their historical dividend growth and overall long term growth prospects.
  2. The top yielding basic materials stocks were driven by Oil and Gas companies from various sectors. While this analysis is naturally focused on U.S. and some Canadian companies due to stock listings, SCCO, a Peruvian company, had one of the two highest yields. Increasing demand for copper and rising copper prices may make this a very attractive investment.
  3. The top yielding basic materials stocks when adjusting for risk and growth had no overlap with the highest yielding stocks. The closest was NUE which had a yield of 3.1% and an estimated forward yield of 3.7%. Some of these stocks had yields less than 1%, but scored well since they had very strong growth prospects. Furthermore, these companies appeared to represent a more diverse group of industry segments further suggesting that they might represent growth champions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

Source: Balancing Risk and Growth When Looking for Basic Materials Dividend Stocks