I believe 2012 will be a difficult year in the high dividend selection process. Many dividend stocks have increased far above their typical valuation metrics. Dividend investors must pay crucial attention to their income stocks and how they fit into the economic landscape. If a dividend investor is going to manage his portfolio, then tough changes have to be implemented on a regular basis.
A portfolio can not contain an excessive amount of dividend names. The investor simply can not manage a large amount of holdings within time constraints. One's best ideas working in unison with the aggregate portfolio holdings is crucial. In this articles, I'll highlight 5 dividend stocks to own, and one to avoid.
Buy American Capital Agency Corp. (AGNC)
I presume we are in a deflationary economic environment. In time, inflation will appear. There are limited economic progressions made in the current economic landscape. Agency mortgage real estate investment trusts (mREITs) are, however, one sector that should thrive in a low interest rate environment.
American Capital Agency is an agency mREIT. The company borrows at short term rates and buys longer duration Government Sponsored Entity mortgage backed securities. The term "agency" refers to the government agencies that sponsor the GSE securities such as Freddie Mac. The assets are 100% implicitly guaranteed by the Federal Government.
Although I recommend investors buy American Capital Agency, they must be aware of the potential risks. The mortgage real estate investment trust (mREIT) is currently trading at elevated prices. The September 30th book value per share was $26.90. The mREIT is now trading at $29.06, which is a 7.4% premium to book value.
Risk
On December 1st, management filed a SEC form 424(B)(2). This allows management to sell up to an aggregate of 26,162,000 shares through their sales agents. The selling of shares at book value per share could cause the premium to book value per share to decrease. This could cause financial heartburn.
Long term shareholders know this risk. Traders are likely to trade in and out of the stock. My goal is to sell an out of the money covered call at $30, assuming the stock continues its current course. The yield is 19% and has, in my view, the industry's top management team in place.
Buy Annaly Capital Management (NLY)
Annaly is also an agency mREIT. Annaly is currently trading at $16.53. This is a 1.9% premium to the September 30th book value per share. This is a compelling purchase especially with January 23rd's Treasury Bond market results.
The crucial issue is the widening of net yield spreads. Per the below table, the investor can note 5 consecutive days of rising Treasury Bond yields. This increases the net profit margin for agency mREITs.
Buy MarkWest Energy Partners, LP Co (MWE)
MarkWest Energy is a midstream master limited partnership which engages in the gathering, processing, and transportation of natural gas. The midstream operations are a toll booth model based upon a fixed fee price for transportation costs.
MarkWest Energy's 2011 3rd quarter distribution increased by 14% year over year. The amount was 73 cents in 2011's 3rd quarter versus 64 cents in 2010's 3rd quarter. The company has provided unit holders a constant annual growth rate in distributions of 12%.
Buy Enterprise Products Partners (EPD)
Enterprise Products Partners is a midstream master limited partnership. The company provides midstream energy services to producers and consumers of natural gas, NGLs, crude oil, refined products, and petro chemicals.
The company's recent purchase in the Seaway oil pipeline has caused a significant interest in the master limited partnership. This will provide a major catalyst for Enterprise Products Partners. The 50% stake with Enbridge (ENB) has major implications for the transportation of energy in the U.S. The two companies will reverse the flow of Seaway.
Here is a chart of the West Texas Intermediate versus Brent Crude price differential:
Previously Seaway transported oil from the Gulf Coast in Texas to Cushing, Oklahoma. The reversal will allow oil to flow from Cushing to the Gulf Coast in Texas. The project could be up and running by April 2012, and further expansion could result in 400,000 barrels of output a day. The initial estimate, in April 2012, is for 125,000 barrels per day.
The net impact will decrease the Brent versus West Texas Intermediate spread. The spread has been higher because Cushing had an oversupply of oil and could not deliver the oil to major refineries. The spread was reduced to less than 10% after the Seaway news. Prior to the Seaway news, the spread had been as high as 30%.
On January 17th, the company announced its 30th consecutive quarterly distribution increase. The new quarterly payment will be 62 cents per share or $2.48 per year. This represents a relatively low annual yield of 5.1%. The equity has been scooped up by unit holders as the Seaway news should provide substantial payoffs down the line.
Buy Rentech Nitrogen Partners, L.P. (RNF)
Rentech Nitrogen is a 2011 initial public offering in the fertilizer space. The company engages in the production of nitrogen fertilizers for agricultural end uses. The company primarily offers ammonia, urea ammonium nitrate solution, liquid and granular urea, nitric acid, and food-grade carbon dioxide. Natural gas is an 80% key feed stock expense for ammonia for production. The company has benefited by the reduced natural gas costs.
The company is a pass through entity similar to CVR Partners (UAN) and Terra Nitrogen (TNH). Rentech Nitrogen clearly has the weaker parent when compared to CVR Partners and Terra Nitrogen. There are put options available to mitigate risk on the downside with puts. In addition, investors can sell covered calls to enhance returns.
The 2012 distribution is expected to be $2.34. Part of this, 20 cents, is from the IPO proceeds. The company is selling at $21.75. The $2.34 represents a 10.75% annual yield. I like owning a position in this security with the inclusion of put options. I am not comfortable owning equities if I can not purchase, as needed, some downside protection.
Per the January 17th fertilizer data, ammonia and urea ammonium nitrate did drop. The fertilizer pricing power remains the key component in potential increase or decrease of distributions to unit holders.
Avoid Kinder Morgan Energy Partners, (KMP)
Kinder Morgan Energy Partners' distribution yield is 5.3%. The price doesn't support the yield.
On January 18th the company announced 2011's total distribution was $4.61. The 2010 4th quarter distribution was $1.11 and the 2011 4th quarter distribution was $1.16. This represents a 4.5% distribution growth quarter over quarter.
I believe investors should selectively choose a master limited partnership that is paying a growing distribution versus a stagnant yield. An example is MarkWest Energy.
Avoid Terra Nitrogen Company
Terra Nitrogen is involved in the production and sale of nitrogen fertilizer products for agricultural, industrial applications, and end user purposes. The company primarily offers anhydrous ammonia and urea ammonium nitrate solutions.
The company has had a terrific run over the years. Long term holders are quite comfortable holding onto their shares accumulated at lower prices.
New shareholders must decide how they will manage their position with the equity trading at 52 week highs. As mentioned above, ammonia and urea ammonium nitrate are soft per the January 17th fertilizer pricing update. Terra Nitrogen's yield is 8.4% versus a 10% yield on Rentech Nitrogen.
Action
I believe it is imperative that investors recognize that investors are chasing yield right now. If Treasury Bonds offer a meager 3.15% for a 30 year security, then investors must find income elsewhere. Stocks have increased over the last 3 months. The charts indicate the demand for dividend shares. The January 23rd Treasury Bond market continues to confirm positive news on widening margin yields for agency mREITs.
Income investors are buying positions in high yielding trusts, MLP's, partnerships, and common stocks. As many of these stocks are at 52 week highs, I would advise caution considering the lofty valuations of some names or hedging their portfolio for any downside risk. Natural gas has taught investors that what goes up can come down.
Disclosure: I am long EPD, MWE, RNF, AGNC, NLY.
