3 New Mega-Trends to Brace for in Q2: Coal, Dividend Yields and Shorted Oil Operators

by: Investment Underground

We witnessed a 200,000 plus contract position initiated recently in S&P 500 ETF (NYSEARCA:SPY) puts around 60 cents apiece. This put buyer was taking out what we think is reasonably priced insurance on the market through April 15, 2011 expiration of these contracts. With earnings season right around the corner after a strong rebound to February 2011 highs, we think the caution may be warranted. The insurance premium was around $12 million.

Earnings misses and upside surprises may reveal a mixed bag. We reviewed all Dow Jones 30 stock earnings here and here.

Volatility has fallen sharply following the sharp rise in the VIX (^VIX) and its iPath Short-Term Futures ETN (NYSEARCA:VXX) to lower levels. If earnings come out strong, deterioration in the VIX and especially the VXX should continue. Forward month contracts are still elevated and suggest traders are anticipating a rise in volatility.

1.) The Coal Bull Is Still Charging

Coal stocks should continue to be winners in quarter 2:

Cloud Peak Energy (NYSE:CLD): Cloud Peak generated $1.37 billion in revenues in 2010, which was a decrease of 1.96%, after rising 12.78% in 2009. The EBT margins in 2010 and 2009 were 15.46% and 18.2%, respectively. The respective ROEs were 8.6% and 150.9%. The 30-day put/call ratio is 0.5. Share price is up 1.6% since December 17, 2010. Cloud Peak Energy is the third-largest U.S. coal producer and the only pure-play Powder River Basin coal company.

Arch Coal (ACI): ACI is the second-largest coal producer in the U.S. and operates mines primarily in the Powder River Basin, an oligopoly-controlled coalfield with easy-to-mine, low-sulfur coal, allowing miners to extract at one-fifth the cost of industry peers in the Central Appalachian region. Because of its excellent position in the industry, Arch has built a small moat for itself in an industry with a bright long-term future, as Asia continues to demand this commodity, driving prices upwards for all producers (even those that don't directly supply to Asia, like Arch).

Alpha Natural Resources (ANR) With its acquisition of Foundation Coal (NYSE:FCL), ANR is one of the largest coal miners in North America. ANR is now going after Massey (NYSE:MEE) to round out its mining portfolio. The company extracts, processes and markets metallurgic and steam coal everywhere from Colorado to the Central Appalachian region to the Powder River Basin. Should metallurgic prices remain high into next year, ANR will be in a very solid financial place, providing investors with an opportunity for above average returns.

2.) Rising Dividend Payments Will Attract Yield-Seekers

Johnson & Johnson (NYSE:JNJ)

  • Expected increase announcement: April 21.
  • Current dividend: $2.16 (0.54/quarter); current yield: 3.65%.
  • Increased dividend: 48 straight years.
  • 1-year growth rate: 9.3%.
  • 5-year growth rate: 10.6%.
  • Payout ratio: 45%.

Johnson & Johnson has increased its dividend for 48 straight years, ranking it 13th among active dividend increase streaks. True, there’s uncertainty today about pharmaceuticals, but this has been a long-time favorite for income investors. For the past three years, investors have seen dividend increase announcements on the last or second to last Thursday of April. Past increases have been in the 6-10% range, and with JNJ paying out less than half its profits, expect this trend to continue. A modest increase to $0.58 a quarter, from $0.54, seems reasonable: a 7% increase in yield on cost.

Pepsi (NYSE:PEP)

  • Expected increase announcement: May 3..
  • Current dividend: $1.92 (0.48/quarter); current yield: 2.97%.
  • Increased dividend: 38 straight years.
  • 1-year growth rate: 6.3%.
  • 5-year growth rate: 13.7%.
  • Payout ratio: 49%.

Recently, Pepsi has been in the news for taking a back seat in sales to both Coca-Cola (NYSE:KO) and Diet Coke. However, don’t let this trend fool you, as the whole soda market has steadily been decreasing. Pepsi has increased its dividend for 38 straight years and is well diversified in a plethora of other beverages and snacks. Paying about half of its profits, Pepsi is well-suited to keep growing in emerging markets. A dividend increase announcement has been made the last three years on the first Tuesday or Wednesday of May, with increases marking 7%, 6% and 13%. Even a three-cent increase on the quarterly dividend to $0.51 would allow for a 6% increase in your yield to cost.

Procter & Gamble (NYSE:PG)

  • Expected increase announcement: April 18.
  • Current dividend: $1.9272 (0.4818/quarter); current yield: 3.17%.
  • Increased dividend: 54 straight years.
  • 1-year growth rate: 9.6%.
  • 5-year growth rate: 11.6%.
  • Payout ratio: 53%.

If you want to talk consistent dividend increases, talk PG. With 54 straight years of increasing dividends, it ranks sixth among active dividend increasers. The payout ratio and growth rate are reasonable and demonstrate a strong commitment to dividend growth. The dividend increase announcement has been somewhat sporadic over the last four years, coming on either the second Tuesday or the third Monday of April. Regardless, a dividend increase announcement around 10% looks promising. This would bump quarterly dividends up to much more, even $0.53, a 10% increase in yield on cost.

The expected increase announcements for the four companies listed above are simply that: Expected. However, each company has a strong track record of paying and increasing dividends. Further, the yearly increase announcement has been a relatively certain signal in recent years. Buying a stock before this increase announcement can add value in two ways:

  1. The increased dividend might not yet be factored in the stock’s price.
  2. It almost immediately increases your yield on cost.

What to look for to predict dividend announcements:

  • A long history of paying dividends.
  • Four quarters of the same dividend
  • A pattern of increasing dividend at certain time. Use the company’s website and search for the dividend increase announcement in recent years to find a pattern.

3.) Short Squeezes Could Make Nervous Shorts React

Sandridge (NYSE:SD) has made its way higher after a successful switch to oil and liquids drilling, moving from a low of $4 per share last fall to $13 per share currently. We think two highly shorted operators could follow the same trajectory.

ATP Oil and Gas (ATPG): This oil company primarily focuses on extracting oil from regions on the continental shelf that larger companies are no longer interested in. This continental strategy appears promising and has worked in the past. Apache (NYSE:APA) and Andarko Petroleum (NYSE:APC) began with the same humble beginnings as ATP, looking for cheap, proven reserves to drill profitably. Volatility has steadily reduced as fears over the BP (NYSE:BP) oil spill subside and the pace of permit approval from the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) picks up again. The stock trades at $18.59 at the time of writing and reasonably close to a break out near the 52 week high of $23.97. The 52 week low of the stock is $8.16 and the price-earnings ratio is -2.67. Earnings per share were negative last year given ATPG's capex program and collateral costs from the BP spill. We think ATP is ripe for a short squeeze. For our full valuation of ATPG, click here.

GMX Resources (GMXR): Unlike ATP, GMX Resources focuses on land-based continental oil and gas exploration. As tensions in the Middle East ease and oil prices percolate through to earnings, GMX will pick up profits from its prescient purchases in the Niobrara and Bakken shale oil plays. The company recently opened an office in Denver to provide support for these drilling operations. We think GMX could get 25% of revenues from oil by 2013. The company posted a loss of $141.41M in 2010 and analysts have bleak expectations for next quarter. GMX is following in the shoes of Sandridge Energy (SD), which started as a natural gas driller and then purchased significant oil acreage with Arena Resources. We think GMX got a better deal, and it is only a matter of time before shorts face potential upside surprises from GMX. The current price of the stock is $5.59.

Disclosure: I am long GMXR.