The High Dividend Stock Investor's Collapsing Dollar Survival Guide, Part 6B

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Includes: DSX, NAT, PRGNF, SSW
by: Cliff Wachtel

What every high yield investor must know before considering shipping stocks.

1.MARKET STATUS

Before ever considering investing in stocks, we must always first look at the overall market, since almost all stocks follow the major indices. See Part 6A, Market Update: Warning: Do Not Feed (Yourself to) the Bears.

2.THE CASE FOR AND AGAINST THE US DOLLAR

See Part 1 and Part 2 of this series.
3.WHAT MAKES A HIGH YIELD STOCK USD INFLATION RESISTANT?
See Part 3 for the full details, but here’s the summary.

Outstanding Business: Before anything, the underlying business should be robust. So as always, the first criterion is great fundamentals and reliable revenue streams that can support and grow distributions, even in recessions.

Based in Hard Assets or a Monopoly-Like Position in Vital Services:

There are a variety of such niches, but there are two basic types.

  • The business owns, sells, or otherwise profits from assets with strong intrinsic demand that allows enough pricing power for revenues to keep pace with or exceed inflation. This includes firms tied to energy, vital agricultural or industrial commodities, precious metals, water, etc.
  • Alternatively, a provider of critical services that for some reason dominates its market, like a major well run utility or dominant communications company.

Non-USD Denominated: Shares and/or distributions are priced in another currency, ideally a commodity based currency like Canadian or Australian dollars, but any other major currency would provide some hedge. We can include here U.S. dollar denominated and U.S. firms that get the majority of their earnings in other currencies.

In short, we’re seeking stocks of strong companies that mostly earn and distribute a high dividend in a non-USD currency and have a dominant position in a market for an essential product or service.

In this installment, we’ll continue to look at international opportunities. Since avoiding the wrong investments is at least as important as finding the right ones, in this installment I focus on warning high yield investors away from a sector that has been very good to us – shipping.

4.SHIPPING NEWS: ARE THESE STOCKS FOR HIGH DIVIDEND INVESTORS?

Perhaps the one distinct upside of a world-wide stock market collapse is that prices get so beaten down that the previously modest yields of many blue chip companies suddenly become high, as scared investors demand a higher risk premium. For the best of these, their price declines are not due to deteriorating fundamentals, but mostly due to hedge and mutual funds dumping shares to meet redemption and/or other requirements.

For the past number of years, the shipping sector has brought some wonderfully high yields and price gains to income investors. However, times change, and while the below mentioned shipping stocks will probably return one day to being great income plays, avoid them for now.

They deserve mention for their future potential for when conditions improve, so keep an eye on them for the future. Like financials, they provide a necessary service and will at some point be excellent investments when conditions discussed below improve.

All amounts quoted are in U.S. dollars (USD) unless otherwise noted. All stock symbols are New York Stock Exchange unless otherwise noted.

A.International - Continued

Because one of our criteria is that the stock price and distribution must be pegged to a non-USD currency, no surprise that most of the best USD hedge high yield stocks based outside of the U.S.

1. Shipping: A Once and Future Dividend King – Currently Dethroned.

For many years there have been good stocks with reliable high yields backed by solid businesses. Many of these businesses are still solid and will survive. Unlike other beaten down sectors, however, there is excessive risk to the dividends themselves in every company that I’ve looked at. There are simply higher yields with less risk in other sectors.

Note that while the market tends to treat the shippers as one group, dividend size and reliability can vary considerably, due to significant differences in their business models. Different conditions apply to dry bulk shippers, oil tankers, liquefied natural gas (LNG) shippers, container shippers etc. Some work mostly on long term contracts, others at spot rates, others use a mix. Different sizes of ships can command different rates under different conditions, so the fleet composition of a given company can be very important.

So what’s the problem?

The main problem is the deteriorating demand vs. supply for most kinds of shipping, and the uncertainty about how much the growing supply of ships ordered during the boom years will hurt revenues as world trade slows. In particular:

  • Shipping indices like the Baltic Dry Index (for dry bulk shipping rates) are still seeking a bottom.
  • Many shippers bear significant debt.
  • Dramatically expanding supply: About 9000 ships under construction worldwide in the dry bulk category alone (CNN April 22 2008 in Hellenic shipping news March 22). While it’s unclear how many will ultimately be built, clearly many of those ordered during the boom years will hit the seas, so supply is expanding. Since the ships are so expensive, they can’t be parked like airliners until rates improve. Thus even slight oversupply can drive down rates significantly as owners struggle to keep ships active in order to keep up construction debt payments.
  • This sector is notorious for renegotiating contracts when conditions deteriorate. Thus even firms with long term leases could become vulnerable to collection problems or deeply reduced fees if the supply of ships gets too far ahead of demand. This is a real possibility in a number of the shipping sectors.

Thus I present the following merely as stocks to watch for when shipping rates improve, but to avoid for now.

Diana Shipping (NYSE:DSX): Like other dry bulk shippers, (DryShips (NASDAQ:DRYS), Eagle Bulk Shipping (NASDAQ:EGLE)), Diana has suspended dividends until further notice in order to survive. Thus no longer an income stock.

Nordic American Tanker (NYSE:NAT): Buy under 26, Strong Buy under 22. Yield over 20% suggests investors are pricing in a dividend cut, though no indications at this time. An oil shipper. No debt, considering acquisitions, and Q4 profits up over nine (yes, nine) times over Q4 of 2008. P/E of about 9x. As good a bet as any for the oil tankers. A spot shipper, so its fortunes are subject to increase in supply of tanker ships. I was not able to find reliable info on this. Suggestions?

If there were one oil shipper to choose, this would be my choice.

Paragon Shipping (PRGN): If you insist on exposure to this sector for diversification, then it rates a Buy under 4, Strong Buy under 3. Yield over 6% at current price of $3.27. Like all other bulk shippers, it's cut its dividend. Unlike many, it still has one, and it appears sustainable for the coming year at least. Its fleet is fully booked for 2009 at good rates. Half of 2010 is booked, which could become good news if rates firm. Fourth quarter results were good. It earned about $10 million, or 37 cents per share, up from $7.7 million or 29 cents per share in Q4 of 2007. Excluding a one-time charge, they would have earned 52 cents per share for the quarter. Revenues for the quarter rose 47% to $44.7million.

Currently the best of the bulk shippers for income investors, though again, there are better, safer yields available.

Seaspan Corp. (NYSE:SSW): Watch but avoid for now. While it’s among the best container shippers, and the company that will very likely survive current conditions, avoid until further clarification of dividend. If management signals long term commitment to the dividend, then in the current market it’s a Buy under 10, Strong Buy under 8.

The current yield of over 20% suggests investors are pricing in a dividend cut, and there are plenty of signs suggesting that or complete suspension. These include:

  • At some time in the next couple of years the firm will need about another $400 million to complete their building program. Cutting out the dividend for about 3 years would provide the funds without needing to add debt or issue shares, if in fact those options are open to them (?).
  • In a recent Reuter’s interview, senior management stated: "But capital is very precious today, so it's much better to hunker down and stay healthy," he said. "Unless we have some good sense of where the capital markets will be, we will be very cautious to use the capital we have."
  • I emailed their investor relations department regarding my concerns about the dividend. I received the following response. "Decisions on dividend payments are based on market conditions at the time.” Hardly reassuring.

Unlike much of the shipping industry, all of SSW’s ships are leased on long term usually 10-12 years) contracts, thus revenues and expenses are very steady and predictable. The firm is on schedule to almost double in size through 2011, because it has contracts to build and deliver another 32 ships with long-term charters in place to their current fleet of 35 ships. Improving financials, steadily rising dividend combined with beaten price combines for a dividend around 20%, but as noted above, there is a real chance of that disappearing.

At some point in the future, SSW may well again be a great income play on improving prospects for China and shipping to/from China, which is actually still seeing solidly positive GDP growth

For now, the dividend’s fate is unclear.

This sector will again be worthwhile for high dividend investors, and there may be some stocks I’ve missed. For now, however avoid the sector unless you really do your homework on a given stock.

B. Oh Canada

If you could only invest in one country’s stocks for combined high dividends and USD hedge, Canada would be the clear choice.

Due to the abundance of stocks with solid fundamentals, low tax structures, and their CAD denominated prices and very high yields I give “my Canadians” their own category. In addition to great fundamentals and dividends, these stocks and their yields are in Canadian dollars. The CAD is a prime commodity based currency backed by one of the healthier banking systems. In addition to their share prices being down with the overall market, these carry an extra discount due to the CAD’s recent decline against the USD. Prices quoted are in USD.

Except for the energy producers (their revenues and dividends rise and fall with energy prices), the companies we’ll be discussing are prospering and offer some of the very best risk/reward combinations anywhere.

In part 7 we’ll begin to look at these in depth.

Disclosure: I have positions in most of the above mentioned investments.