Finding a high-yielding dividend stock that sells on the cheap isn't that hard. There are plenty of high-yield stocks out there that sell for bargain-basement prices. The real challenge is finding a quality business with those credentials that can be held for a long time to let the wonders of reinvested dividends do their magic. When you add that little caveat, the list becomes much, much smaller.
Three companies that look to have the traits investors want in a cheap, high-yield dividend stock are General Motors (GM +0.72%), Terra Nitrogen Company (NYSE: TNH), and Alliance Resource Partners (ARLP 0.29%). Here's a quick breakdown as to why you may want to put these stocks on your radar.
Image source: Getty Images.
The top of the automotive cycle?
The idea that the U.S. automotive market is at the top of the sales cycle has been going on for more than 18 months, and that made some investors consider that this may be the end of a great run for General Motors. That's why the company's stock trades at a very modest enterprise value to EBITDA of 5.4 times and carries a dividend yield of 4.2%. Basically, the market is saying that earnings are going to contract from here and valuations will revert to the mean.
Perhaps that is true, but that seems to discount a couple things. One is that the recent sale of Opel and Vauxhall to Peugot S.A. will shed the company of a business unit that has been losing money for decades. This not only boosts profit margins, but it will also free up capital to be deployed to higher-margin segments or will simply lead to more free cash flow.
Another is that while total sales may be at the top of the cycle, the mix of sales is continuing to favor manufacturers as consumers are buying more higher-margin SUVs and trucks and fewer lower-margin sedans. If these trends continue, the company should be able to produce higher profits while possibly taking a modest hit to revenue.
On top of all of this, a 4.1% dividend yield is already a decent yield for a stock at the top of the cycle. General Motors is clearly in a better place than a few years ago, and a decline isn't the end of the world for this stock. If you are looking for a cheap stock with a strong payout, then General Motors is certainly worth a look.
The bottom of the agricultural cycle?
The agriculture business has been going through a rough patch lately, and fertilizer producers have been hit particularly hard. Not only has demand growth stalled for fertilizers but we have been wrapping up a period of rapid expansion in the business. For nitrogen fertilizer producers like Terra Nitrogen Company, the abundance of cheap domestic natural gas has led to its building of several new facilities. The hope was that these new, low-cost facilities would take market share from more expensive sources such as anthracite coal-based fertilizers made in China and other countries in the Asia-Pacific region. These costlier facilities have been slow to shutter, and it has created a glut of capacity. This led urea and ammonium nitrate prices to reach 12 year lows in November 2016.
Image source: CF Industries investor presentation.
There are two reasons why investors in Terra Nitrogen need not worry too much about this. First, the company's natural gas-based facility is one of the lowest-cost sources of urea out there. Even in the fourth quarter of 2016, with urea prices at their nadir, Terra Nitrogen produced a 47% net income margin. Close proximity to America's corn belt and lower transportation costs, a strong relationship with parent company CF Industries, and no debt on the balance sheet are all major contributing factors to why it is able to produce such high rates of return on what is a commodity product in a tough market.
The other reason to be confident is that we're starting to see the response in the market that all those natural gas producers were hoping for. Close to 9 million tons of annual ammonia manufacturing was shuttered in China in 2016, and net reductions are expected in overall capacity between 2017 through 2021 based on current construction plans. As a result, we've seen more than six months of consecutive increases in urea prices.
Terra Nitrogen may not be a growth company -- it has only one facility -- but the company's high distribution yield of 7.3% makes up for a lack of share price growth. And with shares trading at a modest 7.2 times EBITDA, now seems like a good time to consider Terra Nitrogen.
The end of the coal cycle?
There is little evidence to suggest that coal consumption in the U.S. is going to increase ever again. The low cost of natural gas and the continued cost decline for alternative energy make coal-fired power plants one of the more expensive options for a new power plant today, and that is even before considering any emission regulations that may push decision makers toward other sources as well -- if not by the current administration, then potentially from the following one.
It is also true, though, that the slump in coal consumption across the country won't be as sharp as many might expect, and those trends are going to vary from coal basin to coal basin. The largest decreases are expected to happen in the Powder River Basin, where transportation costs are high, and in the Appalachia regions, where coal seams there have been tapped for more than 100 years and are getting more expensive to recover.
An exception is the Illinois Basin, right where Alliance Resource Partners has a majority of its coal assets. Its mines have the benefit of being in a low-cost, centrally located region so they can undercut transportation costs from other basins. Alliance has coupled that benefit with a management team that has no delusions of grandeur like other coal companies that took on mountains of debt to consolidate at the beginning of the decade, only to go bankrupt in this recent down cycle.
I can't say with great confidence that Alliance is a buy-and-hold-forever kind of investment, but it certainly is a cheap, high-yield stock that has some staying power for a while. With a distribution yield of 8% and an enterprise value to EBITDA of 2.9 times, Alliance can expect to generate a decent return over the next several years, provided it avoids the debt pitfalls that so many other coal companies fell into.
