Commodity prices are notoriously volatile, which makes it harder for producers to maintain a steady dividend when they unexpectedly drop. That's why many of companies that operate in the sector look for ways to insulate themselves from that exposure, while others have opted for a more flexible dividend policy. That way these companies can offer investors the opportunity to collect a higher yield without taking on as much risk.
Three high-yield options that come with a lower risk profile are Terra Nitrogen Company (NYSE:TNH), ONEOK (NYSE:OKE), and BHP Billiton (NYSE:BHP). Here's why we think income-seekers should take a closer look at these three stocks.
A great company in a brutal market
Tyler Crowe (Terra Nitrogen Company): Being a shareholder of Terra Nitrogen Company has not been a fun ride for the past couple years. The changing dynamics of the global nitrogen fertilizer market have wreaked havoc on prices for ammonia and urea-ammonium nitrate (UAN). Prices for these products are at 12-year lows, and oversupply in the market is likely to keep prices down for a while.
This isn't exactly a glowing recommendation for a company that manufactures nitrogen fertilizer products exclusively, but there are reasons to think that Terra Nitrogen is still a great investment. One reason is that the company is incredibly nimble. Thanks to Terra's access to cheap domestic natural gas as a feedstock for its facilities, it is the lowest-cost producer out there. Even with nitrogen product prices in the doldrums, the company was still able to post a net income margin of 41% because its operating and overhead costs are incredibly low and it has no debt on the balance sheet. So there is no worry that the company will be in financial trouble at these low prices.
The company also has a variable rate distribution to its unitholders. This means that all available cash is paid out at the end of each quarter. The advantage to this model is that the payout can fluctuate when necessary and take the decision out of management's hand. The downside for some investors is that it isn't a fixed amount to rely upon every quarter.
I can't sit here and predict that the nitrogen fertilizer market will get better. There is a distinct possibility of it happening as higher-cost manufacturing facilities get retired and demand increases. That said, an investment in Terra today is still a stock that yields 10.1% with a decent chance for significant upside in the coming years.
This company moves commodities, but avoids the price risks
Jason Hall (ONEOK, Inc.): One of the biggest risks of investing in companies which deal in commodities is their exposure to price risk. The ongoing oil downturn has provided investors will a lot of evidence of this, with dozens of oil and gas producers going belly up when oil prices went down and then stayed down.
ONEOK, on the other hand, is a fantastic way to invest in the strong -- and growing -- demand for natural gas and natural gas liquids (NGLs), while avoiding much of the commodity price risk that affects commodity producers. This is because ONEOK almost completely removed its direct exposure to NGL market prices in prior years, and now operates almost exclusively under long-term contracts based on volumes, not market prices.
While this may limit the upside, it also limits the downside and reduces the risk of a dividend cut if commodity prices fall. That's far more important for dividend investors, and is a key reason ONEOK has been one of my favorite dividend stocks for several years. With a current yield of 4.8% -- and steady cash flows that are more than sufficient to support it -- dividend investors should love ONEOK.
But it gets even better. The company has plans to grow payouts in coming years, as increased demand is supporting investment in new pipeline and gathering projects. This will increase distributable cash flow for many years to come, and should help ONEOK remain an excellent way to invest in commodities while avoiding the biggest risk.
A policy geared toward rewarding investors
Matt DiLallo (BHP Billiton): Global resource giant BHP Billiton offers investors one of the top dividends in the metals and mining sector, with a current yield of around 4%. However, there is a catch: The company's payout will fluctuate with commodity prices. That's by design because BHP has a flexible dividend policy. At a minimum, the company intends on paying out 50% of its underlying earnings each year, with the potential to return additional cash to investors at its discretion.
When times are good, this policy enables investors to collect a bigger paycheck. For example, thanks to rising commodity prices this year, BHP Billiton has paid out $3.3 billion in dividends under the minimum policy, or $1.26 per share. However, because it generated more cash than it needed to maintain a healthy balance sheet and invest in growth projects, the company chose to distribute another $1.1 billion, or $0.40 per share, to investors this year, which brought total dividends up to $4.4 billion, or $1.66 per share. That said, the downside of the policy is that the payout will likely fall alongside commodity prices, which was the case last year when it only paid out $0.60 per share in total dividends. Meanwhile, it's possible that BHP Billiton could pay nothing to investors if it were to lose money amid a significant plunge in commodity prices.
That said, for investors looking for a way to cash in on rising commodity prices, BHP Billiton is an excellent choice because it has designed its dividend to reward them when prices rise while still offering some income when times are tough.
Jason Hall owns shares of ONEOK. Matthew DiLallo owns shares of BHP Billiton. Tyler Crowe owns shares of BHP Billiton and Terra Nitrogen. The Motley Fool owns shares of and recommends ONEOK. The Motley Fool has a disclosure policy.