One of The Motley Fool's goals is to teach investors to invest sustainably. Specifically, this means investing with solid fundamental principles that have worked in the past and are likely to work in the future as well. One of these principles is the importance of dividend/distribution yield (and reinvestment) and how it can help investors achieve financial independence during retirement.
A rule of thumb for retirement is that individuals should cash out no more than 4% of their portfolio annually to live on (to avoid running out of money). My goal is to help investors avoid selling shares (or units) of great companies and live exclusively off dividends/distributions. This requires two things.
First, a yield of 4% or greater and second, dividend/distribution growth greater than 4% (to outpace inflation and preserve buying power). Inflation has averaged 3.22% since 1913 and about 2% since 2000. So a 4% growth rate is double the rate of recent inflation.
Of course, the 4% rule of thumb assumes an investor has a portfolio of sufficient size (4% yield on $750,000 portfolio=$30,000/year in retirement), and many people haven't been able to save that much. Thus, I'm always on the hunt for great companies that yield more than 4%, preferably double that (8%) or more, to help less affluent investors thrive during retirement.
One final criteria I like to see is monthly dividend/distribution payments. Bills and other living expenses must be paid on a monthly basis so it's nice to see companies pay on the same schedule.
The following two companies offer income investors of all kinds (both young and old) high, secure yields and strong long-term distribution growth prospects.
Vanguard Natural Resources (NASDAQ: VNR) is a fast-growing E&P (exploration and production) MLP that focuses primarily on gas production. The fundamental growth story that is likely to fuel its strong distribution growth (5.78% CAGR over the last seven years) can be summarized in three parts.
First, Vanguard is a master of accretive acquisitions. Since IPOing in 2006 the partnership has made 20 purchases totaling $3.4 billion. Its most recent, a $581 million acquisition of Wyoming natural gas fields, increases its total reserves by 80% and production by 55%. Management has since announced an aggressive investment program to increase production yet further.
The second catalyst is dropping production costs. Due to increased economies of scale Vanguard is guiding for 2014 production costs of just $6-$7/barrel of oil equivalent, a 50% decrease from 2011 levels. Current production is also aggressively hedged at very favorable levels: 80% of gas through 2017 hedged at $4.42/Mbtu, 80% of oil through 2015 hedged at $93.07/barrel. These hedges represent a 30% and 12.7% increase in gas and oil prices over what the partnership received in 2013.
Due to its aggressive growth strategy (both acquisition-fueled and organic) the partnership is guiding for:
- 2014 production to increase by 46%-56%
- 2014 Adjusted EBITDA to increase by 30%
- Capital expenditure (capex) to increase of $57 million
Given the guidance capex figures we can determine a likely $48 million in additional distributable cash flow in 2014. This would raise the distribution coverage ratio from 1 in 2013 to 1.24, ensuring distribution security, and allowing for solid growth going forward.
QR Energy (NYSE: QRE) is a smaller and newer E&P MLP, one primarily focused on oil (68% of reserves) as opposed to natural gas. The partnership is well situated to take advantage of the oil boom in the Permian Basin in east Texas, the Woodford Shale in Oklahoma, and along the Gulf Coast. The distribution growth story for QRE can be summarized in two points.
First, the partnership's small size creates a small base to grow quickly from. For example, in the third quarter of 2013 revenues increased by 20% and distributable cash flow (DCF) by 26%. When combined with the second catalyst, future distribution growth seems likely.
The second catalyst is the partnership's recent buyout of its general partner. This ended the very unitholder-unfriendly management fee structure in which management was paid in unit grants that diluted existing investors (up to 10% per quarter). The terms of the buyout include one final 20% dilution, but spaced out over four years. The deal is immediately 7% accretive to DCF/unit, and with the distribution coverage ratio at a healthy 1.2 future distribution growth should be strong.
Foolish takeaway
Both Vanguard Natural Resources and QRE Energy make for fantastic long-term investments -- no matter what stage in life an investor is in. Young investors can benefit from high yields and monthly compounding to grow wealth while retirees can enjoy secure, monthly income to cover living expenses. Both companies enjoy strong growth catalysts, secure distributions, and distribution growth rates that are likely to preserve and grow wealth over time.
