Not All Dividends Are Created Equal

Guaranteed income is a creature comfort that fixed-income investors had become accustomed to before the financial crisis of 2008. In the rearview mirror, the yield on the popular 10-year Treasury was north of 5%. Unfortunately for retirees and other income-seeking investors, that percentage has crumbled under the weight of Federal Reserve purchases and has remained below 2% since the end of March 2012. 

In an environment like this, dividends can be an investor's best friend, especially if the payouts are rolled back into more share ownership, thus compounding returns over the long term. But some investors can be blinded by high guaranteed returns and ignore the warning signs such as unsustainable payout ratios. (The payout ratio is calculated as dividends per share divided by earnings per share). 

The good news is that the payout ratio of the S&P 500 constituents has come down over the past several decades. The historical average is around 50%, but a white paper by Global X Management, an ETF provider, shows that the ratio is now south of 30%. 

Taking this key metric into account, I ran a screen for dividend payers in the energy and materials sector, trading on a major U.S. exchange with yields better than the 10-year Treasury and an even more sustainable payout ratio of less than 25% -- lower than the S&P 500 average. That low ratio gives the following five companies a tremendous runway to boost payments in the future with a very slim likelihood of having to trim the distribution. 

Sand castles
Topping my screen with a 10.4% yield and a 15.4% payout ratio is Hi-Crush Partners (NYSE: HCLP  ) . Although you might be unfamiliar with this company, you're almost certainly aware of hydraulic fracturing and its current revitalization of North American energy production. Aside from water and chemicals, proppants are one of the most important aspects of the process. They keep the fissures open after the fracturing has taken place. Without them, the tremendous production rates that fracking allows for in tight geologic formations would not be possible. That's where Hi-Crush comes in, with its monocrystalline sand.

Although the company is relatively new, so is the explosion in fracking. Add the fact that Hi-Crush is tremendously solvent, with zero long-term debt, and that it operates with 58% net income margins in the booming demand for proppants, and investors should feel comfortable here. 

Digging up yield
With its core product coming out of the earth, Tronox Limited (NYSE: TROX  ) supplies its titanium ore, titanium dioxide, and other mined minerals to buyers ranging from paint manufacturers such as Sherwin-Williams to paper producers. After a rough go of it during, and after, the financial collapse, Tronox reinstated its dividend in 2012 to the tune of a 4.8% yield. 

Listening to the company's recent conference call to close out 2012, management was very bullish on the company's current position and its ability to sate both income and debt investors. When peppered with questions, company Chairman and CEO Tom Casey showed that he was more than comfortable with the annual $1-per-share dividend and the company's ability to take advantage of any strategic opportunities that might present themselves.

Improving liquidity and confident management bode well for this company's future. The overall yield might deteriorate slightly if the stock price bounces back, but it should remain well above the 10-year Treasury rate, barring any change in strategy at the Federal Reserve.

A bumper crop
Have you noticed crop prices rising over the past few years? Without the help of companies such as PotashCorp  (NYSE: POT  ) , things would probably be a lot worse. The triumvirate of fertilizers that Potash mines adds diversity to the revenue stream that the likes of CF Industries and Mosaic don't enjoy, as they concentrate on just one or two fertilizer options. 

An improving balance sheet and consistent cash generation from its operations have allowed management to reward investors with annual dividend increases over the past three years. Traditionally, the payout ratio for PotashCorp has remained below 10%, but a slight dip in EPS and a considerable increase in the dividend now place it at 22.5%. However, I view this development in a very positive light, because it radiates confidence, and any uptick in EPS will bring the ratio back in line with historical norms. 

Refined dividend payments
Barely making the cut was Murphy Oil (NYSE: MUR  ) . This company operates internationally as an "integrated" oil and natural gas company, although in reality, its exploration and production operations merely supplement its revenue stream with 16% of total 2012 sales, leaving the lion's share attributable to its U.S. and U.K.-based downstream business. 

A steady stream of business has allowed Murphy Oil to increase its dividend per share at a compound annual growth rate of nearly 12% over the past five years, a time frame in which the entire refining industry has been fighting to come back from the financial collapse of 2008. Stable cash from operations has made Murphy Oil's recovery possible, along with considerable capital expenditures to fund growth without taking on an inordinate amount of debt. 

Rounding out the bunch is Delek US Holdings (NYSE: DK  ) . After slogging through 2009 and 2010, the downstream operator has rebounded nicely to achieve record revenues and net income over the past two years. Delek offers a very similar 2% to that of Murphy Oil, but its payout accounts for only 4.6% of its EPS. So on a dividend sustainability basis, it appears Delek holds the ace up its sleeve. 

A diversity of sustainable dividends
Exposure to multiple industries and global locations is a vital component of portfolio construction. The companies I've mentioned here encompass multiple sectors and have sales all around the globe. If your goal is to create a well-rounded income portfolio, these would be great places to begin looking. 

Why PotashCorp might be my next buy
With less and less arable land available around the world, increasing yields from existing plots could become vitally important to keeping up with expected population growth. Cheap and effective fertilizers could be the key to achieving this goal. As the global leader in potash production, PotashCorp has established several barriers to entry that make it nearly impossible for competition to break through. Click here now to access The Motley Fool's premium research report that covers precisely what these barriers to entry are and details several other key reasons PotashCorp presents such a compelling investment opportunity today.


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  • Report this Comment On March 26, 2013, at 1:29 PM, IlluminatInvest wrote:

    HCLP's payout ratio is only listed as 15.4% because it just recently IPOed and thus has not paid out a full year of dividends yet.

    Actual payout ratio is about 83% based on eventual full year payout of $1.90 and expected earnings of $2.30.

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