Update July 12. Cummins (CMI) announced today that it would increase its dividend to a quarterly $1.025 from the previous $0.957 payable on September 1 to shareholders of record as of August 22. That brings the foreword dividend yield to 3.45% from today’s closing price of $118.98. Last time I updated this Jubak Picks Dividend portfolio member back on November 11, 2015, the stock paid a dividend yield of 3.95%. The stock has been a member of that portfolio since October 12, 2015. The price appreciation since then is 6.32%.
Shares of Cummins have been stuck in a range between lows of $106.75 (June 27) to $108 (May 19) and highs of $117 (April 19) and $119 (today.)
In today’s ultra-low interest rate environment a yield of 3.45% a reasonably attractive. Of course, the yield would get more attractive if the stock were to pull back with the market during the current earnings season. (I think Cummins is certainly vulnerable to a strong dollar and slower growth in Europe. Watch for potentially disappointing guidance.) Cummins shares moved above their 50-day moving average today. The company next reports earnings on August 2.
The energy space, especially the energy income space, continues to reorganize itself through cuts in capital spending, the elimination of dividends, and the sale or reshuffling of assets.
One of the latest involves an MLP (master limited partnership), Targa Resources Partners (NGLS) that I hold in both the 12-18 month Jubak Picks portfolio and in my dividend income portfolio.
The general partner, Targa Resources (TRGP), has made an offer valued at $9 billion to buy the 91.2% of the master limited partnership that it doesn’t own. The deal, the general partner has said would give the master limited partnership greater access to capital at a lower cost since it would no longer have to pay distribution rights to the general partner. Investors in the master limited partnership would lose many of their tax benefits but, the general partner has argued, would be able to defer taxes over time by recapturing depreciation of the joint company’s pipelines and other system assets.
The move makes sense in the short term since it will get Targa through the current rough patch in the energy sector. It looks like Targa Resources Partners is coming close to the limits on its debt covenants. That would limit the master limited partnerships ability to borrow to fund new projects.
The deal isn’t bad deal—the price amounted to an 18% premium to Targa Resources Partners unit price at the time it was announced. And if projections are correct, the combined company will show 15% dividend growth in 2016.
But the deal isn’t a great deal. When, earlier, Kinder Morgan (KMI) announced a buyout of its master limited partnership it included cash in compensation for the capital gains taxes the investors in the master limited partnership would have to pay to step up units in the MLP to shares in the parent company. At the moment, there are no comparable funds in the Targa deal.
Kinder Morgan, with a project backlog of more than $20 billion, will also get more bang for the buck if it can, after the acquisition, raise more debt at a lower price. Targa has only $4 billion in potential projects so it will be able to put less capital to work.
Besides any disgruntlement with the lack of cash kicker to help pay investors’ taxes from the deal, there’s some bad feeling since the company turned down a $15 billion bid earlier, calling it inadequate. And now the deal is priced at $9 billion. It’s certainly possible to argue, and some investors are, that parent Targa is getting a bargain at the expense of holders of the master limited partnership.
I’m inclined to sell on the deal but I’d like to get a better exit price.
Units of Targa Resources Partners have rallied over the last few days, climbing 4.23% yesterday to $25.85 before declining in the oil sector sell off by 2.67% today. But the units still down significantly from the beginning of the month when they traded at $30.49 on November 2.
I think that drop is a result of the general sell off in oil shares and in other energy stocks. I’d be inclined to wait a few more days to see if today’s bounce gives you a more attractive exit point. The MLP has paid its quarterly 82.5 cent a unit quarterly dividend so all you’re waiting for is to see if the upward trend runs for a while.
If you’re looking for an alternative, I think Kinder Morgan (KMI) offers more leverage to the upside on its bigger portfolio of projects. Kinder Morgan pays a yield of 6.55% to a yield of 12.01 on Targa Resources Partners. Which, of course, does tell you what the market thinks of the relative risk in the two situations.
Tomorrow, October 23, I will add shares of Verizon (VZ) to my Dividend Income Portfolio. Verizon’s shares closed at $45.89 on October 22 with a 5.06% yield.
Verizon reported third quarter earnings on October 20. By and large the numbers were so-so.
Earnings of $1.04 a share beat Wall Street estimates of $1.02 a share by a not so whopping two cents a share. Total revenue in the wireless segment grew 5.4% year over year. The number of retail subscribers increased by 4.3%. However, retail total postpaid average revenue per account (ARPA) dropped 5.5%.
But for income investors there was one really important and exciting number. In the quarter total retail churn dropped to 1.21%, down from 1.29% in the third quarter of 2014.
Why is the churn rate so important? For Verizon and other wireless companies one of the biggest expenses is acquiring customers. Which means that any customer that doesn’t have to be replaced—who renews when the current contract expires—is extra valuable.
And you can see that drop in churn reflected in the big increase in cash flow. Cash flow from operations rose to $28.4 billion for the first nine months of 2015 versus $23.2 billion in the first three quarters of 2014. Free cash flow for that nine-month period was $15.9 billion against $10.5 billion in the first nine months of 2014. (The falling churn rate isn’t solely responsible for that increase but at a time when competitors are going aggressively after Verizon’s customers, a falling churn rate in an extremely important sign.)
That’s a lot of that cash stuff that income investors want to see. Remember that paying a 5.06% dividend takes a lot of cash and remember that in the current global economy slow growth in individual markets and volatile currencies can take a sudden bite out of the cash available to sustainably pay that hefty dividend.
Verizon’s falling churn rate and its huge free cash flow are big “sustainability insurance” policies.
The company paid out $6.4 billion in dividends in the first nine months of 2015. That was easily exceeded by the $15.9 billion in free cash flow and the $28.4 billion in cash flow from operations in that period. Verizon spends a good chunk of cash each year on building out infrastructure and new products. Currently the company is spending big on its efforts to become a mobile purveyor of original content. And Verizon’s dividend history doesn’t show a record of generous increases in the quarterly payout. But at least with the company’s lines on cash flow, you can feel that the dividend is very safe.
That’s not a minor point for dividend investors looking to diversify a dividend portfolio heavy on energy holdings as my dividend income portfolio currently is. Energy plays offer very high yields right now but I don’t think we can say that those dividends are secured by a river of cash flow. At a time when finding sustainable cash flow in the energy sector is subject to uncertainty, I like the security of Verizon’s falling churn and rising cash flow.
Cummins (CMI) is a cyclical that’s good at being a cyclical.
Which is why I’ll be adding the stock to my JubakPicks Dividend Portfolio tomorrow. The shares closed today, October 12, at $111.98, down from the top of its 52-week range at $151 (and not too far off the 52-week low at $103.) At today’s closing price, the shares pay a dividend of 3.5%.
Profiting by riding the cycle in any sector isn’t nearly as easy as it might sound and I can think of only a handful of cyclical companies that understands how to profit from riding the ups and downs of the economy in its market.
In bad times, and, more importantly, in good times Cummins works hard to take costs out of its business. Facing a 50% drop in demand, largely from its mining and infrastructure units, Cummins has implemented a program to take down its break-even costs. Nothing too special there—that’s what all cyclical companies do when demand falls at the bottom of the cycle. Cummins, however, has worked just as hard at taking costs out of the company at the top of the cycle. One result, Morningstar notes, is that Paccar, which introduced its own heavy-duty truck engine to compete with Cummins four years ago, still makes the same profit on a truck whether it uses one of its own engines or buys one from Cummins. It’s hard to pick up market share against Cummins with that kind of economics.
And in good times, and, more importantly, in bad times Cummins continues to spend on research and development so that it’s technology seems always one step ahead of competitors. Cummins is already the largest manufacturer of natural gas and hybrid bus engines in the United States. On October 5, the company’s new ISL G Near Zero natural gas engine for the medium-duty truck and bus market got Near Zero NOx emission certification from the U.S. Environmental Protection Agency. (Cummins has partnered with Westport Innovation on the engine.) That engine’s ability to meet strict emissions standards in the United States and the EuroZone will enable Cummins to grow market share in those regions, and that engine should also help drive market share gains in India and China on anticipated emissions-reduction standards in those markets.
Cummins has been on something of a dividend growth jag recently. Dividends have gone from $1.80 a share in 2012 to $2.25 in 2013 to $2.81 in 2014 to $3.51 in 2015. Operating cash flow looks sufficient to keep the dividend growing.
Besides the dividend, I think the stock should record solid capital gains as end markets in stress sectors recover (at least somewhat) in 2016. A 12-month target price of $134 a share seems reasonable.
The company next reports earnings on October 27.
I’m going to use today’s (July 18) rather surprising upward move in US stocks-despite a big upswing in market nervousness yesterday-to sell Pfizer (PFE) out of my Dividend Income portfolio http://jubakam.com/portfolios/jubak-dividend-income/. (The Standard & Poor’s 500 index was up 0.96% as of 3:00 PM New York time.)
After the failure of the big drug company’s efforts to buy AstraZeneca (AZN), Pfizer seems a cash cow without a strategy. Not that the attempt to buy AstraZeneca was birilliantly creative-the deal would have let Pfizer move its tax-jurisdiction to the United Kingdom from the United States for huge savings. But it wouldn’t have done much if anything to fix the combination of ineffective research and expiring patent protections (Celebrex, the company’s $2.9 billion (in 2013 sales) arthritis blockbuster, is scheduled to go off patent in 2015) that are projected to slow sales growth to a crawl. Morningstar projects Pfizer’s sales growth at 1% a year over the next decade; share buybacks will raise earnings per share growth to 3% a year. In its year-by-year earnings per share projections, Credit Suisse calls for earnings per share to grow to $2.24 in 2014 from $2.22 in 2013, and then to $2.30 in 2015, and $2.61 in 2016.
Even with a 3.4% current dividend yield, those projected growth figures don’t add up to much in the way of upside capital appreciation.
If all I was looking for at the moment was safety, however, I’d consider hanging onto Pfizer.
But the combination of rising nervousness-the VIX volatility index climbed by 32% yesterday-and a rise in geopolitical tensions argue that I’d like to have a little cash on hand in case events in the Ukraine or in Gaze over the next few days result in a drop that might give me a buying opportunity in a dividend stock with a higher yield and better prospects for capital gains.
I would also probably hang onto Pfizer if I didn’t have a good replacement up my sleeve-but I do (and I’ll tell you what it is next week) and so it’s time to sell with a small 0.63% loss in share price (made up for by that near 3.5% dividend) since I added these shares to the Dividend Income portfolio back on February 6, 2014.
The stock goes ex-dividend on July 30 in case that income in hand (as opposed to capital locked up in the share price) is important enough to lead you to think about putting off a sale. (Share prices do tend to drop after the payout to match the dividend payout. Otherwise, if you think about it, dividends would create value for investors out of what is actually a distribution of cash that lowers the balance in a company’s treasury and raises it in shareholder wallets).
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I managed, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund shut its doors at the end of May and my personal portfolio is now in cash. I anticipate putting those funds to work in the market over the next few months and when I do I’ll disclose my positions here.