Desperately Seeking Yield Through Equities: Part 9 - Dividend Anticipation Strategy

Includes: ACAS, FUN, GPT, RAS, SAR
by: Philip Mause

At the outset, I should warn readers that the strategy described in this piece is somewhat risky and controversial and does not provide immediate yield in the form of dividends. I am not referring to the often discussed "dividend capture" strategy (buying a stock shortly before the ex-dividend date). I will be discussing purchasing shares of companies that are not paying dividends or that are paying relatively low dividends in the expectation that dividends will be resumed or increased in a reasonably short time frame and that the stock will shoot up upon that event.

In terms of waiting for the resumption or increase in dividends, I use the term "anticipation" in honor of Carly Simon's great 70s song describing waiting for a date with Cat Stevens and used by Heinz (HNZ) in some great catsup commercials. This is what it has come to for some of us retirees - conjuring up pop culture memories while we sit around waiting for dividend checks. And I guess I should disclose that, with some of these stocks, we may have to wait for dividends a lot longer than Carly had to wait for Cat.

As we have seen, certain categories of stocks have special attraction for investors seeking yield. The "constituency" of these stocks tends to be a group of dividend oriented investors and managers. It is, therefore, not surprising that when a stock in one of these categories eliminates its dividend, the stock plummets in value as dividend oriented investors scramble to unload it.

Of course, the cancellation of a dividend by a Real Estate Investment Trust (REIT) or a Business Development Company (BDC) is a very bad sign of deteriorating fundamentals and clearly justifies a mark down in the valuation of the stock. The hard question is whether, at least in certain cases, the mark-down is overdone. I have done very well betting against the "thundering herd" of selling investors in a few instances. Of course, this may mean that the easy money has already been made.

I am going to recommend that investors take a hard look at several stocks here. Let me reiterate that I am not recommending these stocks for investors seeking high current yield from their portfolios. On the other hand, for an investor willing to tolerate some risk and willing to wait several quarters for dividends to resume, these stocks offer some potential for significant appreciation.

1. Cedar Fair (NYSE:FUN) - This publicly traded partnership went on somewhat of an acquisition spree prior to the panic of 2008. It got loaded up with debt and decided in the fall of 2009 to discontinue dividends. Its stock went down like a paralyzed falcon - from over $10 to a low of $6.09 in several weeks. I got in at $8. There was a takeover offer north of $10 a few weeks later and now we are up to $20.66. FUN still has a lot of debt but it also has some very popular properties that offer families a somewhat less expensive and less transportation intensive alternative to Orlando for the kids. I am somewhat biased here because my kids had a great time at a couple of these parks and a few of my friends worked there (not in management). I like the "wide moat" feature of these parks because it is difficult to assemble large blocks of land to build new ones. On the minus side, the debt level is still large: however, a recent agreement with senior lenders seems to make the debt manageable. There is definitely some risk here but FUN should be able to work its debt load down and resume sizeable dividends by 2012. Hey, and remember - it was Cat Stevens who sang "Where do the children play?"

2. American Capital (NASDAQ:ACAS) - One of the largest BDCs, ACAS got pounded by write downs and lender problems. In March 2009, the stock got down to 59 cents a share. I got in below $2. In early 2010, Paulson bought a bunch for $5.25. It now trades at $9.99. It is trading at about 83% of book value and there is significant potential for book value to increase due to loan write ups, some promising equity positions and earnings retention until dividends are resumed. It has gotten debt down way below the level at which ratio problems arise.

3. Saratoga Investment (NYSE:SAR) - It is the successor to a troubled BDC. An investor group injected significant capital last summer and SAR now trades at $20.61. This is about 78% of book value. SAR is relatively small and will probably use cash flow to fund more investments. It has no net debt. It manages a CLO and a good deal depends on how that works out, although the discount to book provides an investor with some insulation from bad news on that front.

4. Gramercy Capital (GKK) - GKK is a commercial mortgage REIT and manages a bunch of CLOs. I have described the complexity of sorting out this kind of a situation in earlier articles. GKK got as low as $1.23 but is now up to $3.06. It still is thrashing out a nasty issue with its lenders but it appears that, even if that dispute is resolved badly for GKK, the non-recourse nature of the debt and the value of GKK's other assets give investors some support at this price level.

5. Rait Financial (NYSE:RAS) - Another commercial mortgage REIT and another near death experience. RAS now trades at $6.86 (it just went through reverse split) and does pay some dividends. It owns some properties outright and manages a number of CLOs. It appears to have its lender nightmares behind it and there is considerable appreciation potential if the CLOs work out reasonably well.

I should again caution investors that all five of these have some risk and that these stocks are not going to provide generous dividends immediately. On the other hand, in each of these situations there is a strong likelihood that dividends will ultimately be resumed or increased and that when, or by the time that, the resumption occurs, there will be significant appreciation in the stock price.

Disclosure: I am long FUN, ACAS, SAR, GKK, RAS.