If one of my resource investments manages to maintain or increase reserves over time I'd be ecstatic, and some will. However, I don't want to buy a resource company with a dependence on infinite reserves growth and an unknown return of capital.
The following screen identifies resource stocks with the potential to pay high dividends to investors for a long time. The first step identifies resource stocks with a market capitalization over $10 billion, dividend yield over 4% and p/e ratio under 15. Here is a selection of 7 stocks that I came up with:
|SCCO||Southern Copper Corp.||11.14||8.18%|
Based on these dividend yields, the payback period is shown in the following table. For the sake of argument, assuming the dividend remains constant, reserves are fully depleted and the stock price consequently falls to zero, the payback period shows how long it would take to break even. Ideally, you want to invest in a company with a reserves life longer than the payback period. (Note: if reserves were truly depleting, it is possible that the dividend would decline over time.)
Of course, some resource companies are maintaining or increasing reserves and may increase dividends over time. Moreover, even if reserves deplete, rising commodity prices could still translate into higher earnings and a rising dividend. A calculation that considers rising dividends would have a shorter payback period.
|Company||Payback Period (years)|
|Southern Copper Corp.||12.22|
Since my approach to resource companies is reliant on stable income, I next determine whether these 7 companies pay sustainable dividends. (Note that if resource companies were truly annuities based on depleting reserves I would expect the dividend payout ratio to be 100%. Since I realize that reserves can be maintained/increased through retained capital, in reality I expect a portion of earnings to be ploughed back into the business. Also, if these were truly securities with a finite term, current valuations would need to be lower and dividends could decrease with time.)
The following chart displays the payout ratio for these companies, most of which are reasonable:
Since sustainable dividends must be derived from sustainable earnings, it is important to look at the operating margins for the 7 companies. A company with fat margins has a buffer to continue paying dividends as revenue fluctuates from year-to-year. Operating margins range from 5-55%, with Southern Copper Corp as the standout.
Finally, after financial (and operating) leverage is applied earnings, and a company's ability to pay dividends, can swing wildly. For this reason I prefer to identify companies with low total debt-to-equity ratios. Moreover, with the view that resource companies are annuities with declining reserves (a.k.a. assets), I don't want to end up holding a bag of negative equity. For these reasons I prefer companies with lower debt/equity ratios.
Screens are only a start. Given the data above, I think all 7 companies are candidates for further research. Some suggestions for next steps are to look at reserves life, exploration successes and risk. Moreover, DCF valuation based on a range of reserves lifespan estimates would help identify an appropriate entry point.
Disclaimer: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.