Dividend lovers often sacrifice dividend growth in order to get higher yields. That's an understandable trade-off if you are looking to maximize your income today. But there are some investment opportunities that let you get both a high yield and substantial dividend growth. Right now, you can get this ideal mix with midstream oil and natural gas player Magellan Midstream Partners, L.P. (MMP 0.88%) and giant U.S. utility Dominion Energy Inc (D 1.79%).
Growing the distribution at 8%
Magellan is a major U.S. master limited partnership, owning pipelines and other assets that help get oil and gas from where it's drilled to where it's used. It offers a distribution yield of roughly 5%, well more than twice the yield of the broader market. It has increased its disbursement every single quarter since it went public in 2001. It's currently projecting 8% dividend growth in 2018.
Magellan is one of the most conservatively run midstream players, with low leverage and a fee-based business model that's long been focused on self-funding. That last point is important because selling units to fund capital spending is a normal practice in the midstream space, but it dilutes current unitholders. Avoiding dilutive unit sales is a material benefit to those that own Magellan.
Growth over the past decade, meanwhile, was driven by $5 billion of successful investments, including construction and acquisitions. Over the next two years Magellan has plans to spend $1.1 billion on new construction and expansions at existing assets. Most of these projects already have customers lined up or are at facilities where demand clearly demonstrates a need for investment. It also has another $500 million worth of projects it's considering adding to the list, as well.
Another interesting feature of Magellan's business is that it bought out its general partner many years ago. That reduces its cost of capital by eliminating incentive distribution rights, a headwind that many of its peers have to deal with. All told, Magellan is a conservative partnership that offers a nice combination of yield and distribution growth, along with and a solid history of putting unitholders first.
Growing the dividend at 10%
Dominion Energy is one of the largest electric and natural gas utilities in the United States. It offers investors a 4.4% yield, which is more than twice what you'd get from an S&P 500 index fund. It has increased the dividend annually for 15 consecutive years. Dominion is currently calling for dividend growth of 10% a year through 2020.
As a largely regulated utility, Dominion has to get government approval when it wants to raise the prices it charges its customers. In order to justify price hikes, utilities invest in their assets. Right now Dominion is building a new natural gas-fired power plant, relicensing existing nuclear facilities, storm-hardening power lines, and working on energy storage projects, among other things. It's looking at growth spending of around $4 billion a year with the goal of net plant growth of 6% a year. This is the foundation that supports the utility's projected 6% earnings growth and 10% dividend growth.
If that were all that was going on today, Dominion would be well worth a deep dive for dividend lovers. However, Dominion is in the news lately because it is trying to buy SCANA Corp (SCG). SCANA is a smaller peer that is facing significant financial fallout from its decision to cancel an in-process nuclear power plant construction project after its contractor, Westinghouse, declared bankruptcy.
This adds a little uncertainty to Dominion's future, but not enough to change the long-term outlook. First off, it's an opportunistic move that will add customers in fast-growing southern states. Management believes the acquisition will push earnings growth from 6% to 8% (there's no change planned for the dividend growth rate). As for the financial risk, Dominion will indeed inherit SCANA's nuclear troubles. However, Dominion has set out a plan for dealing with this issue. If regulators don't approve that plan, management currently says it will walk away from the deal. If that happens, I'd expect Dominion's stock to rise and SCANA's to fall.
No matter how this goes, then, Dominion looks like it wins -- and so will its shareholders. There's clearly some headline risk here right now, but I think there's more positive news than negative for dividend investors.
Best of both worlds
You can certainly find higher yields than what Magellan and Dominion offer. And you can easily find higher dividend growth rates, too. But it's the mixture of high yield and sizable disbursement growth that make this pair so interesting. If you love dividends, these two stocks are a very enticing proposition.