Look for Rising Payouts in Utilities

01/30/2013 6:00 am EST


Ari Charney

Analyst and Associate Editor, Canadian Edge and Personal Finance

There's a simple way to make sure your income stocks are performing up to snuff, and that's to make sure their payouts are either rock-solid or rising for the right reasons, notes Ari Charney of Personal Finance.

After an incredible run amid the mar­ket tumult of 2011, dividend-pay­ing stocks were due for a breather in 2012. As such, our holdings gained 7% last year versus a 16% re­turn for the S&P 500.

Aside from the global economic mal­aise, our stocks faced the additional headwind of Congress’ contentious negotiations to avert the so-called fiscal cliff. The deal that was finally struck at the outset of the New Year came too late as far as the market’s fourth-quarter performance was concerned.

Although our stocks suffered in sym­pathy with the broad market, they once again demonstrated their ability to pre­serve wealth when the market drops. That’s despite the fact that dividend stocks sold off as income investors fret­ted over a possible change in dividend taxes that largely failed to materialize. While the market lost 0.4% dur­ing the fourth quarter, our stocks gained 0.4%.

Over the long term, safe businesses coupled with growing dividend payouts result in a portfolio that beats the mar­ket while incurring less risk.

That gulf in performance may not sound like much, but thanks to the magic and power of compounding, it means a difference of almost 54 per­centage points—for a total return of 146.5%. Almost as important, our portfolio achieved this outperfor­mance with significantly less volatility than the market. That’s the sweet spot of successful investing.

While we’re perfectly happy to watch our stocks rise in value, a substantial portion of these returns is due to the reinvestment of dividends. Over time, a growing payout will entice investors and push share prices even higher. To that end, the 16 stocks that have been in our portfolio for a year or longer enjoyed an average growth in payout of 4% over the past year.

One of the best examples of the rela­tionship between payout growth and capital gains also happens to be our top performer for the year: Genesis Energy (GEL). The midstream mas­ter limited partnership (MLP) posted a total return of 35.2% along with distribution growth of 10.5%.

The MLP generates mostly fee-based income from storing and transporting crude oil, which largely insulates it from the vagaries of commodity prices. Genesis boosted its most recent quarterly distribution to 48.5 cents, the 30th consecutive quarter in which its payout has risen and the 25th time it’s done so at an annualized rate of at least 10%.

Even so, the MLP tends to conserva­tively cover its payout with a ratio of cash flow to distribution of 1.2 to 1. Management intends to continue the MLP’s record of double-digit distribu­tion growth in 2013. Genesis Energy LP is a buy.

APA Group
Over the short term, a stock’s payout doesn’t necessarily have to rise for it to produce outstanding gains, as evidenced by our second-best performer of the year, APA Group (APAJF).

Australia’s leading natural gas infra­structure company produced a total re­turn of 31.7%, with much of that gain coming during the fourth quarter, following improved guidance for 2013 due to its acquisition of Hastings Diver­sified Utilities Fund. Meanwhile, its div­idend rose just 0.3% year over year.

Similar to Genesis, APA Group spe­cializes in the distribution and transmis­sion of a key energy commodity. The company’s expansive footprint of 14,000 kilometers of gas pipelines in the Land Down Under, along with government forecasts of a doubling in gas vol­umes over the next 20 years bode well for further gains.

The company also benefits from Aus­tralia’s enactment of a carbon tax, which favors natural gas over coal for power generation. APA Group is a buy.

Our worst performer for the year was telecommunications company Wind­stream (WIN), which dropped 22%, with much of that fall occurring during the fourth quarter.

Windstream’s shares have been beat­en down by investor skepticism over the company’s ability to maintain its 25-cent quarterly dividend. Nevertheless, man­agement has repeatedly affirmed its divi­dend guidance, and free cash flow con­tinues to cover the payout by a comfort­able margin.

We suspect Windstream is largely suf­fering from guilt by association with other rural telecoms that have stumbled in repositioning their businesses. The company’s management team has pursued an aggressive acquisition strategy to transform the company from a rural wireline telecom with a limited footprint into a company that provides advanced business communications ser­vices on a national scale.

For now, the dividend appears to be safe, so Wind­stream Corp remains a buy.

Although we only just added Exelon (EXC) in mid-August, it managed to drop 19.9% by year-end, earning it the dis­tinction of our second-worst performer.

Exelon’s acquisition of the former Constellation Energy means that it’s now the premier play on US nuclear power generation. However, the com­pany still derives roughly half its revenue from wholesale power generation, an unregulated market where pricing can be volatile.

The company attempts to hedge its exposure to electricity prices, but now faces an “earnings cliff” as its hedges come off the books and wholesale pric­ing remains weak. Barring an improvement in the next few months, management has warned that a dividend cut could soon be in the offing. Exelon is rated hold.

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