This article marks the 10th month that I've been keeping track of John and Jane's Taxable portfolio and continued to discuss the dividend raises that continue to benefit the income produced by the portfolio.
The story over the last month has remained consistent in that the market continues to reach all-time highs and the economy as a whole continues to look strong. Although it can be tiresome to write these articles after working a full day, I still believe it is incredibly important to help show the "average investor" that a dividend growth portfolio doesn't need to be complicated and when set up correctly, can produce strong results with minimal effort.
As I mentioned in my last article, transparency has helped me become a better investor because it has forced me to acknowledge my mistakes along with my successes. I am thankful that John and Jane's Taxable portfolio has continued to benefit from a number of industries that continue to flourish.
It's All About The Cash Flow
It is worth reminding the reader (as well as myself) that most of these gains are temporary as John and Jane are likely to continue holding almost all of these stocks for years to come. What I continue to focus on in this situation is cash flow, which strictly means I am more concerned about the continued growth of earnings per share (EPS), distributable cash flow (DCF), and funds from operations (FFO). Let's look at where each of these measures is most important.
Earnings per share or EPS is the classic way of viewing how much of a company's profit is attributable to each outstanding share of common stock. A growing EPS usually indicates that the company has implemented a good business plan and is executing its strategy in an efficient manner. EPS is calculated by taking the company's bottom line (net income) less any preferred dividends divided by weighted average shares outstanding.
EPS is a relevant measure for the majority of corporations. Dividend investors can view the dividend payout ratio to judge how safe a dividend is along with the potential for future dividend increases. To calculate this, all we need to know is the annual dividend per share divided by EPS.
Anything less than 100% means that the dividend is entirely covered by EPS (although anything close to 100% means that there is very little room for error). Anything over 100% means that the company is paying out more in dividends than the net income they are actually bringing in. Any company with a payout ratio over 100% will only be able to maintain these types of payments for a short period of time.
Distributable cash flow or DCF is primarily used to value Master Limited Partnerships (MLPs). MLPs are a structure typically used by midstream oil, gas, and chemical companies. For instance, Spectra Energy Partners (SEP), TransMontaigne Partners (TLP), and Westlake Chemical Partners (WLKP) all operate under the MLP structure. In this model, we should look for DCF Coverage instead of earnings because earnings are distorted by the high cost of depreciation associated with the physical structures (think oil pipelines, storage facilities, and refineries for example).
DCF per unit is calculated by taking DCF/weighted average shares outstanding. Additionally, DCF Coverage is calculated by taking DCF per unit (annually) divided by the annual distribution per share. For example, TLP in FY 2017 made distributions of $61.4 million and had a total DCF of $88.7 million. This means that TLP had a DCF coverage ratio of approximately 1.44x FY 2017 (which is considered to be well-covered). Any DCF Coverage ratio greater than 1.00x means that the distribution is entirely covered by cash flow. Anything below 1.00x means that the distribution is not covered and could potentially be cut.
Funds from operations (FFO) is primarily used to help us assess Real Estate Investment Trusts (REITs). FFO can be broken down into the following formula: Net Income + Depreciation + Amortization - Gains on Sales of Property. The main reason for using FFO is that it is a more accurate view of a REIT's earnings because GAAP accounting requires the depreciation of properties over time. Since the value of a property tends to increase over time (compared with the original price it was purchased for), we must add back depreciation and amortization to the net income to get a more accurate view of a company's earnings.
One of the greatest benefits of a REIT is that it does not have to pay any taxes as long as it distributes at least 90% of all taxable income. Many REITs distribute more than 90% of their net income which is why many REITs' dividends payouts look like a red flag to investors who aren't familiar with them. Let's use Realty Income (O) as an example of what I am referring to.
GAAP accounting shows that O has an EPS of $1.09, $1.13, and $1.10 in 2015, 2016, and 2017, respectively. During this time, they paid dividends of $2.28, $2.49, and $2.54 per share respectively. How can they do this? It's because O's FFO during these same time periods was $2.70, $2.84, and $3.04, respectively. This means that the payout ratio for O was 84.4%, 87.7%, and 83.6% during those same years.
The point of all this is that it is important to be aware of the corporate structure of the companies you are investing in because there is no one-size-fits-all calculation that can simplify all earnings reports so that they are a common language. Understanding how a company's tax/earnings structure will help you make better decisions when investing and can help provide insight into the decisions made by management.
Dividend And Distribution Increases
There were a total of five companies that paid increased dividends in the month of August.
Helmerich & Payne (HP)
Spectra Energy Partners
Simon Property Group (SPG)
Westlake Chemical Partners
Helmerich & Payne - The punishment endured by the oil industry over the last several years isn't news to anyone and it has impacted every business throughout the supply chain. HP operates in the arena of contract drilling for oil and gas wells in three business segments: U.S. Land, Offshore Platform, and International Land. Although the earnings report was nothing to celebrate at -$.01 EPS (it was still a major improvement over the -$.25 EPS in Q3-2017).
My continued optimism towards HP stems from its size (it currently has around 21% of the U.S. Land Market) and its various technological advantages. The U.S. Land segment (which is by far its largest) has seen revenue rebound significantly since reaching a bottom at the end of 2016. I would like to thank contributor Leo Nelissen for recently creating the following YCharts graph (which I have recreated) in his article Helmerich & Payne: I'm Adding. As long as we continue to see margins increase I am confident in the future of HP.
Helmerich & Payne's dividend was increased from $.70/share per quarter to $.71/share per quarter. This represents an increase of 1.4% and a new full-year payout of $2.84/share compared with the previous $2.80/share. This results in a current yield of 4.52% based on a share price of $62.78.
Spectra Energy Partners - There has been a lot of news associated with SEP as we get closer to the date when Enbridge (ENB) will acquire SEP in an all-stock exchange offer. Previously, on May 17, SEP shareholders had been offered 1.0123 ENB shares per SEP common unit. At the end of August, this offer was sweetened to where SEP shareholders will receive 1.111 shares of ENB for every common unit. This deal is expected to close sometime during Q4-2018. I expect SEP's share price to track ENB's share price (plus the additional 1.111 ratio) very closely until the deal closes.
Spectra Energy Partners dividend was increased from $.75125/share per quarter to $.7638/share per quarter. This represents an increase of 1.7% and a new full-year payout of $3.05/share compared with the previous $3.01/share. This results in a current yield of 8.08% based on a share price of $37.73.
Simon Property Group - SPG's performance since the beginning of May has been nothing short of spectacular and it continues to be supported by strong FFO growth, guidance increases, and regular dividend increases. Even with the current dividend increase to $8/share annually it still leaves plenty of room for safety based on 2018 FFO guidance of $12.05-$12.13 per share. Although the Amazon (AMZN) threat remains relevant, SPG's superior portfolio of malls and retail locations continues to exceed expectations at every turn. It is also worth noting that SPG has increased its dividend every quarter for the last four quarters straight.
Simon Property Group increased its quarterly dividend from $1.95/share per quarter to $2.00/share per quarter. This represents an increase of 2.6% and a new full-year payout of $8.00/share compared with the previous $7.80/share. This results in a current yield of 4.40% based on a share price of $181.69.
TransMontaigne Partners - I am slightly concerned about TLP's recent acquisition offer from a subsidiary of ArcLight Energy Partners, which has put the share price in limbo. Personally, $38/share seems low and I think a better offer should be on the way. With that said, is it worth the risk of continuing to hold when funds could be allocated elsewhere? The most recent quarter saw DCF coverage of 1.25x and the distribution increase represented the 11th consecutive increase.
TransMontaigne Partners' distribution was increased from $.785/share per quarter to $.795/share per quarter. This represents a 1.3% increase quarter over quarter with a new full year payout of $3.18/share compared with the previous $3.14/share. This results in a current yield of 8.24% based on a share price of $38.58.
Westlake Chemical Partners - WLKP kept chugging along as noted by the following information in their Q2-2018 earnings call.
The most recent dividend increase represents a 12% increase over Q2-2017. This is the 14th consecutive quarterly distribution increase since IPO.
DCF coverage improved from 1.13x (previous quarter) to 1.21x Q2-2018.
WLKP's share price has improved nicely (especially when compared with the parent corporation Westlake Chemical (WLK) since the last update in May.
Westlake Chemical's distribution was increased from $.3975/share per quarter to $.4088/share per quarter. This represents a 2.8% increase quarter over quarter with a new full year payout of $1.63/share compared with the previous $1.59/share. This results in a current yield of 6.18% based on a share price of $25.00.
August Income Chart And September Income Estimates
I have created the following chart to assist with keeping track of John and Jane's taxable portfolio. As mentioned in the intro, I've built these tables so that we can easily compare month-to-month and YoY changes.
Green represents when dividends were actually received.
Yellow represents dividend estimates.
**Please note that cash reserves have dropped slightly as we decided to add another 50 shares of Southern Co. (NYSE:SO) and that the dividend income will not be reflected on the dividend payout in September.
I think it is important I reiterate the following:
- Dividends are not reinvested. John and Jane are at the point where they don't need the money, but we also want to build a cushion that allows us to purchase additional stocks in case the market drops and equities become more attractive.
- Since dividends are not reinvested, the only time payments increase is when the dividend is raised or when additional shares are purchased with excess cash.
John and Jane's Taxable Portfolio has reached an all-time high valuation and has generated nearly $8500 in dividends in the first 8 months of the year. This means that the portfolio is (on average) generating more than $1000/month ($1062.5 to be exact), which suggests we should see similar rates for the last four months of the year. If these baseline assumptions are met then John and Jane should have generated approximately:
- $12,750 in dividends.
- 5.4% yield on the original cost basis of $234.5k.
- Assuming the current gains hold level then the dividend + capital gains will represent a gain on the original investment of 10.1% annualized.
We expect John and Jane to receive a total of $639.88 of dividend income in the month of September.
Final Note: If you enjoy my articles, please take the time to follow me. While I enjoy performing analysis, following me is the best method for showing me that SA subscribers are finding my work useful. I welcome all meaningful feedback and I enjoy using the Seeking Alpha platform to enhance and improve my own knowledge as well. My promise to readers is to be as open and transparent as I can be. The numbers presented are accurate as of the time I wrote this article.
In John and Jane's Taxable account, they are currently long the following mentioned in this article: Apple (NASDAQ:AAPL), Arbor Realty (ABR), Archer Daniels Midland (ADM), Apple REIT (APLE), BP (BP), Buckeye Partners (BPL), Cardinal Health (CAH), Cincinnati Financial (CINF), Clorox (CLX), Cummins (NYSE:CMI), ConocoPhillips (COP), Eaton Vance Floating-Rate Advantage Fund A (EAFAX), Emerson Electric (NYSE:EMR), EPR Properties (EPR), Energy Transfer Partners (ETP), General Mills (GIS), Helmerich & Payne (HP), Hormel (HRL), InterDigital (IDCC), Iron Mountain (IRM), Johnson Controls (JCI), LTC Properties (NYSE:LTC), Macquarie Infrastructure (MIC)), Altria (MO), Mesabi Trust (MSB), New Residential (NRZ), Realty Income (O), Old Republic International (ORI), Stepan Co. (SCL), Spectra Energy Partners, J.M. Smucker (SJM), Tanger Factory Outlet Centers (SKT), Southern Corp. (SO), Simon Property Group (SPG), AT&T (T), TransMontaigne Partners, Verizon (VZ), Washington Trust (WASH), Westlake Chemical, W.P. Carey (WPC), and Exxon Mobil (XOM).
Disclosure: I am/we are long GIS, T, SCL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article reflects my own personal views and is not meant to be taken as investment advice. It is recommended that you do your own research. This article was written on my own and does not reflect the views or opinions of my employer.