We spend a lot of time talking about dividend growth investing because many value our independent opinion on these high-yielding entities. Some of the most valuable articles we've posted that have helped Seeking Alpha readers better understand risks include, among others: We Don't Think Seadrill's Dividend Is Sustainable, in April 2012, and "The Mortgage REIT Business Doesn't Work..." in June 2013. We highlight these calls to provide perspective of the efficacy of our analysis and opinion, and why groupthink could be painful at times. That said, let's update our opinion on five popular dividend growth stocks - a few we like, one in particular we don't, but all are popular and worth paying close attention to: Annaly (NYSE:NLY), Energy Transfer Partners (NYSE:ETP), Emerson Electric (NYSE:EMR), HCP (NYSE:HCP), and PPL Corp (NYSE:PPL).
Annaly is a mortgage REIT - mREIT - with principal business objective to generate net income for distribution to shareholders. Being critical of the mREIT business is certainly unpopular, and we understand that many retirees generate vital income streams from such investments. Bulls and bears, however, both benefit from our independent voice, and we call out risks as we see them. Annaly and American Capital Agency (NASDAQ:AGNC) are not investments for the faint of heart. The blogosphere has become overcrowded with supporters of these types of companies, and we can't help but feel the primary reason is to attract unsuspecting investors to buy them. For general industrial/retail operating entities, we tend not to put much weight into book value, but for financially-tied firms, book value is important in the valuation process (it is the starting point of any residual income valuation model). In Annaly's third quarter, book value declined to $12.87 per share from $13.28 in June 2014, revealing a fundamental make-up moving in the wrong direction. We think there are much better ideas than risky mREITs for yield-seeking investors.
Forward-Looking Commentary: Annaly is trading below book value, but we think that this spells difficult times ahead, not a valuation mispricing. In any residual income model, for example, the future relationship between ROE (return on equity) and COE (cost of equity) is going to determine whether a firm's share price should trade below or above book value. If future expected ROE is below the firm's COE, then the company trading below book value is justified. We think this is the scenario with respect to Annaly, and we're not falling for a perceived value trap. Our forward-looking assessment is that troubled times remain in Annaly's future.
Energy Transfer Partners
One of those better ideas is our favorite master limited partnership (MLP), Energy Transfer Partners. Kinder Morgan (NYSE:KMI), which we added to the Dividend Growth portfolio recently, has decided to re-consolidate its MLP holdings, and while we have held Kinder Morgan Energy Partners (NYSE:KMP) in the portfolio in the past, the latter will cease trading once the re-consolidation is complete.
Energy Transfer Partners currently yields 6.1%, and the firm's distribution has returned to growth as of late. In the MLP's third quarter, distributable cash flow, which is a unique measure for MLPs that excludes growth capex, advanced by $77 million over the same period a year ago, to $610 million. Its distribution coverage ratio was 1.13x in the quarter and 1.25x through the first nine months of the year. Future distribution expansion is on the horizon at Energy Transfer Partners, and we like capitalizing on such income growth potential in the Dividend Growth portfolio.
Forward-Looking Commentary: The energy markets have been in free-fall as of late, as crude oil prices continue to tumble. Though this may indicate that demand for energy is slowing, Energy Transfer Partners, as a midstream operator, is not subject to energy price volatility. Instead, the MLP is rather insulated, unlike upstream MLPs, which have fallen out of favor as of late. Though we're not expecting blockbuster performance from Energy Transfer Partners in coming periods, we think its distribution is solid and on much firmer ground than its upstream peers. Looking ahead, we think Energy Transfer Partners will outperform most of its energy peers because of its relatively "energy price-immune" business model.
Former Dividend Growth portfolio holding Emerson put up a solid fiscal fourth quarter. Underlying sales increased 4% in the period thanks to strength in North America and emerging markets, though expansion in Asia slowed to 2%. Earnings per share, excluding charges, increased 10% thanks to gross-margin expansion of 120 basis points, to 42.4%. Emerson's Process Management and Industrial Automation segments were the primary drivers behind the profitability improvement.
Perhaps most impressive was that the firm put up record operating cash flow of $3.7 billion in fiscal year 2014, showcasing the primary driver behind continued dividend growth. The year also marked the 58th consecutive year of dividend increases, and management is now targeting a dividend increase of 9%, to $0.47 per quarter in the first quarter of fiscal 2015.
Forward-Looking Commentary: It's hard not to like Emerson. With US GDP growth now hovering the mid-single-digits and unemployment nearing pre-recession lows, industrial strength should continue for the foreseeable future, and Emerson will be a prime beneficiary. We may add back Emerson to the Dividend Growth portfolio at the right price, and that may happen in the event oil prices stay at current depressed levels for some time. The firm's shares have an anticipated forward yield of ~2.9% at the time of this writing.
The healthcare REIT posted fantastic third-quarter results and raised its full-year guidance. Funds from operations were $0.75 per share on an adjusted basis, and the REIT achieved comparable cash net operating income growth of 3.2% for the period. HCP recently raised its full-year guidance for adjusted funds from operations to $2.98-$3.04 per share (was $2.97-$3.03 per share). The REIT paid its most recent quarterly dividend of $0.545 per common share on November 25, revealing a ~4.9% annualized yield. HCP is the first healthcare REIT selected to the S&P 500 and the only REIT included in the S&P 500 Dividend Aristocrats Index. The firm will remain a key holding in the Dividend Growth portfolio.
Forward-Looking Commentary: From a technical standpoint, HCP looks really good here. We recently added this gem to the Dividend Growth portfolio, and we're not looking back. The Fed recently stated that it will be patient with any future interest rate increases, and this should spell continued resilience from the REIT industry. We expect HCP to be a relative outperformer versus peers on the basis of its Dividend Aristocrats stature and high yield. Very few firms are as loved as this REIT.
The only utility in the Dividend Growth portfolio, PPL Corp continues to defy gravity. The company has skyrocketed from under $30 per share at the beginning of 2014 to more than $36 per share today, while paying a nice dividend along the way. In its third-quarter report, earnings per share advanced to $0.74 on a reported basis from $0.62 in the year-ago period. Management was very optimistic, crediting strong year-to-date performance in both the regulated and competitive energy supply business. Such strength has led to increased guidance for 2014 earnings from ongoing operations to the range of $2.37-$2.47 per share, a 5%+ increase over the previous range of $2.20-$2.40 per share.
Forward-Looking Commentary: The spinoff of PPL's competitive generation into Talen Energy remains on track, and while we're not exactly comfortable with transformative deals, PPL will remain in the Dividend Growth portfolio for now. We're waiting to get a better feel for how the market responds to PPL's shares following the completion of the spin off. At present, PPL yields ~4.3%, a healthy payout.
Wrapping Things Up
We trust you continue to value our opinion on these high dividend-paying equities! Please be sure to continue to follow our work. You never know when we'll highlight the dividend-related risks of the next Seadrill (NYSE:SDRL) or mortgage REIT before they slash their payout. You won't get the warning, unless you're tracking our writings. Thanks for reading!
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Some of the firms mentioned in this article are included in the newsletter portfolios.