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Why I dropped Potlatch (PCH) from my dividend income portfolio on February 3
02/23/2012 8:31 pm EST
The reason, I argued then, was that the growing popularity of dividend paying stocks at a time when income vehicles such as Treasuries and CDs pay almost nothing had created a glorious but still real problem for income investors. As investors flocked into dividend-paying shares, they drove up share prices. That was great for investors already fully invested, but for investors looking to get into new positions or for investors looking to put more cash into existing positions, it meant that yields were in constant danger of erosion. In this situation, income investors needed to look for stocks that paid higher yields now and that were also positioned—by their growing cash flows and by management disposition—to keep raising dividends. Look for those stocks, I advised, and beware dividend payers that didn’t seem to be in a position to keep raising dividends.
And with that as background I tweaked this portfolio by adding General Electric (GE), Westpac Banking (WBK) and Kinder Morgan Partners (KMP) while dropping Potlatch (PCH), Merck (MRK) and Abbott Laboratories (ABT).
Today I’m going to give you more detail on one of those drops, Potlatch (and also actually make the change on the dividend portfolio page. (The remainder of these six changes will follow in what I will try to make short order.)
In 2010 Potlatch saw cash flow from operations of $125 million and the company paid out $82 million in dividends. That year the company paid out a high but not frightening high 66% of its cash flow from operations in dividends. (Fortunately, the company didn’t have big capital spending plans that year as capital expenditures amount to just $5 million.)
In 2011 net cash flow from operations dropped to $77 million. Dividend payouts fell slightly to $74 million as the company cut its final 2011 dividend payment to 31 cents in 2011 from an earlier 51 cents a share.
Can you see the problem?
It’s not the extraordinarily high payout ratio. Potlatch is organized as a real estate investment trust (REIT) and by law REITs are required to pay out 90% of net income in dividends.
It is, however, that falling cash flow from operations number and the miniscule capital spending figure. Potlatch saw falling cash flows from operations in 2011 and, if we believe Wall Street analysts, is likely to see a similar decline in 2012. The Wall Street consensus calls for a 27.4% drop in earnings per share in 2012.
And even after earnings growth turns around—forecast by Wall Street for 2013—I worry that the company is going to have to increase its capital spending to make up for what it has deferred in taking its capital spending down to just $5 million a year in both 2010 and 2011. In 2008 the company’s capital spending came to $16 million and in 2007 it was $64 million. Raising the capital budget back to something like the pre-global financial crisis level takes more cash out of dividend payouts.
At the current 31 cents a quarter dividend rate, Potlatch’s trailing 12-month yield will fall from the current 5.9% to just 4% at the end of 2012. On February 17, the company’s board voted to maintain the current 31 cents a share payout for another quarter.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Potlatch as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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