3 GOOD DIVIDENDS FOR BAD TIMES

By Matthew Kerr, Equity Analyst 

The global economic recovery is facing considerable headwinds amid new waves of coronavirus infections, persistent labour market challenges, continuing supply-chain issues, rising inflationary pressures, and changes in fiscal policy. History shows that many past recessions were due to excessive tightening by the Fed; further, inflation is higher than it has been in 40 years, not just in the United States-but in Europe and other parts of the world as well. Geopolitical tensions (most notably the war in Ukraine) have resulted in oil prices skyrocketing;Russia produces around 10-12% of global crude oil supply and the conflict has slowed trade considerably. As an investor, being able to find the right companies to own during this period can be difficult. When people and businesses are forced to deal with rising prices during periods of recession and inflation,unnecessary purchases go out the window. If people don’t have extra funds to go out to eat, buy plane tickets or other kinds of nonessential entertainment, revenues and cash flow decrease for large and small businesses alike; without cash coming in, it cannot be returned to shareholders. As a result, consumer discretionary (non-essential) companies have historically been some of the biggest dividend cutters during recessions. Retail and hotel chains, automotive companies, and even banks historically have seen losses during times like these. Dividend stocks indeed are excellent instruments to fight against recessions and other tough economic circumstances and they have long been a cornerstone for portfolios during difficult periods, as their payments mitigate losses. However, not all dividend stocks will perform well during rough times. Many will see negative returns and/or slash the dividend. For investors, that can mean exiting discretionary-styled stocks whose entire business depends on consumer spending and economic health; and focusing mainly on strong names with low debt and a history of rewarding shareholders during the worst of times. 

Enterprise Products Partners (NYSE: EPD)

Enterprise Products Partners is an oil and gas storage transportation company. The company was founded in 1968 and has assets that allow it to collect fees on the transportation and storage of natural gas and liquids, crude oil, etc. It is structured as a master limited partnership. Because of this, some investors will stay away from it for tax reasons. However, having an MLP such as this one in a portfolio allows you to take advantage of a few things.

MLPs combine the tax benefits of a private partnership—profits are taxed only when investors receive distributions—with the liquidity of a publicly-traded company. MLPs do not pay federal income taxes, so they are required to distribute all available cash to investors. The “unitholder” (limited partners are called unitholders, instead of shareholders) does not pay income tax on the returns. Most of the earnings are tax-deferred until the unitholder sells their portion. Then, the earnings are taxed at the lower capital gains tax rate, rather than at the higher personal income rate, thus offering significant additional tax benefits. Unitholders must file a K-1 form

Enterprise Products Partners Dividend History

The company has paid an increasing quarterly dividend since 1998, with approximately $45 billion paid out to unitholders so far. EPD boasts a healthy dividend yield of 6.65% along with a payout ratio of 84.60%. While the payout ratio seems rather high, MLPs are required to payout cash to unitholders, as mentioned earlier.

 The 5-year dividend growth rate is 2.34%, which is lower than I would normally look for. However, the safety of dividend (coverage of 1.6x) combined with steady cash flow and the company’s famously conservative management leads me to believe that EPD will continue to raise its dividends long into the future. 

Growth and Resilience

EPD makes money by owning pipelines and charging fees to companies to use them- think of it as a toll road for natural gas, crude oil, etc. EPD’s network of integrated assets allows the business to quickly adapt to economic and market changes. Further, EPD has a number of large capital projects under development worth around $3.6 billion that are expected to be operational by 2023. The petrochemical and refined products division receives 68% of active investments- with natural gas, NGLs, and crude receiving 14%, 11% and 7%, respectively. The company has already been positioning itself for the move towards green energy; EPD has its hands in not only the hydrogen business but the ethylene and propylene business as well- all of which are vital to environmentally friendly products and renewable energy.

Shares of Enterprise Products Partners have increased 9.49% over the past quarter- and have gained 16.19% in the last year, easily outperforming the S&P 500. 

Revenue has increased nearly 12% in the last 5 years, with EBITDA increasing roughly 9.5%. Free cash flow improved significantly from 2019-2021 and should continue to rise despite the current market conditions. EPD has beaten earnings estimates the last 4 quarters. The increasingly high price of oil has been beneficial to the company. 

Worth noting also is EPD’s management owns around 32% of common units. While MLPs usually have higher insider ownership, EPD management has increased its stake over the past few years.

Finally, the company’s sheer size (one of the largest oil and gas pipeline companies in the U.S.) along with a fundamentally resilient business model allows the company to handle all sorts of economic circumstances, both long-term and short-term. The company has a long history that supports this- through energy sector selloffs, geopolitical tensions, and market crashes, EPD has managed to consistently increase cash flow while also keeping its debt to reasonable levels.  EPD has an investment-grade rating (BBB+) and management reports one of the lowest debt ratings in the industry at 3.3.

Summary

Even with some investors moving away from traditional energy towards newer alternatives, recent events around the world have shown that orthodox power sources are still immensely necessary. By extension, companies who transport these resources are essential also. Even with the growing alternative energy sentiment, the majority of what Enterprise Products Partners’ does should be able to adapt to the changing times. Management has done a particularly nice job growing the company at a reasonable, safe rate. While EPD isn’t as fancy as some other companies, it has a proven track record during the worst of economic events.

NextEra Energy, Inc. (NYSE: NEE)

Founded in 1925, headquartered in Juno Beach, Florida, NextEra Energy is the largest utility company in the world- it also dominates the wind and solar energy production market. It has two subsidiaries- Florida Power and Light and NextEra Energy Resources.

Florida Power and Light Company is the largest vertically integrated rate-regulated electric utility in the United States based on electricity produced and sold, serving more than 11 million residents across Florida. With the influx of people in Florida, FPL is poised to continue to do well, adding nearly 82,000 customers in the fourth quarter of 2021. The company also seems to be liked by regulators, as customers of FPL have some of the lowest electric rates in the United States.

 NextEra Energy also owns a competitive clean energy business, NextEra Energy Resources, LLC, which, together with its affiliated entities, is the world’s largest generator of renewable energy from the wind and sun and is considered a world leader in battery storage. NER has constructed more than 9,500 megawatts of renewables and storage projects.

 Further, NextEra Energy also has a limited partnership (NYSE: NEP) that pays an even higher dividend yield and accounts for about a fifth of the company’s income. NEP is a “yieldco” affiliated with NextEra Energy that acquires and owns clean energy projects with stable, long-term cash flows. It takes on debt to purchase projects from NEE, to both company’s mutual benefit. Essentially, this allows the company to “recycle” capital to fund additional growth opportunities. NEP realised a total unitholder return of 30% in 2021 and grew distributions per unit by 15% from the previous year. As with Enterprise Product Partners, it is important to consider the tax implications of investing in MLPs.

NextEra Energy’s Dividend History

NextEra Energy is a dividend aristocrat that has provided investors with the highest growth of any United States based utility company over the past decade while also having arguably the best future growth prospects.

The company has paid a quarterly dividend since 1995 and has increased its payout since inception. The company’s dividend yield is 2.28%, with a payout ratio of 60.54%. The dividend also has a 5-year growth rate of 11.83%.

Growth and Resilience

The growth of NEE is driven by the number of development projects that the company completes, along with the contracts it sells. NextEra Energy currently has a lot of renewable projects in the works and the number is rising every quarter, which is also helping to cut company emissions. Over the past 10 years, NextEra has delivered compound annual growth and adjusted earnings per share of approximately 9%, which is the highest among all U.S. power companies. More recently, NEE has beaten earnings estimates the past 4 quarters, and the company’s adjusted earnings per share grew roughly 10% year over year, with both its utility and clean energy businesses performing better and better during the period.

The most recent quarters have been so strong that the company says it will be unhappy if it is not able to meet the higher end of upcoming EPS estimates. For 2023 through 2025, NextEra Energy expects to grow roughly 6% to 8% from the expected 2022 adjusted earnings per share range. The Russian invasion of Ukraine has been pushing the price of oil to highs and is causing nations across the world to pay greater attention to cleaner, alternative sources of energy. Because of this, the company is well positioned for commodity inflation. Its clean energy business has considerable growth potential, while its utility business should shine in volatile markets. 

 As mentioned previously, the improving Florida economy and FPL’s historically reliable services are expanding its customer volume every quarter.

 NextEra Energy also has a favorable outlook regarding company debt. Debt for the company is not particularly high for a utility company, with Q4 2021 Debt to Equity being 1.47. Generally, debt to equity levels between 1.0 and 1.5 are considered good levels for a utility. Further, it has more than enough liquidity to meet its near-term debt obligations. All ratings agencies rate NextEra bonds as investment grade; S&P rates NEE’s credit at A-, and Moody’s rates it at Baa.

Summary 

NextEra Energy combines the safety of a huge utility company with the growth potential of renewable energy, making it highly attractive to investors looking to gain exposure to the steadily growing alternative energy market without taking too much risk. Further, as the world’s largest producer of electricity from solar and wind, it is relatively insulated from inflation; although it is worth noting that utilities sometimes don’t perform as well in high inflation environments. However, the company’s diverse business model and the Biden administration’s push for the development of renewable energy should be beneficial for the company and the industry it occupies.

Realty Income Corporation (NYSE:O) 

Realty Income Corporation is a diversified Real Estate Investment Trust founded in 1969. The company rents property to only the best retailers- and avoids malls. Its tenants include CVS, Kroger, Walgreens, Wal-Mart, to name a few. The company holds around 11,280 properties under long term net lease agreements in all 50 states, Spain, Puerto Rico, the United Kingdom, and Spain. 

Realty Income Corporation Dividend History

The company prides itself on its dividend, and its payout history reflects that. The company is a member of the S&P 500 and is a Dividend Aristocrat. As of this writing, it has raised its dividend for 53 years, with 622 consecutive monthly dividends paid, and 98 consecutive quarterly increases. Realty Income offers a yield of 4.34%, and a 5-year growth rate of 3.75%.   

Growth and Resilience

The company is a “triple net-lease REIT”; it owns properties but the tenants themselves are responsible for the majority of operating costs. The company focuses on mostly necessity-based businesses such as grocery and convenience stores, which are able to pay rent even when the economy is lousy. The company is also highly diversified, with no one tenant making up more than 4.5 % of the portfolio. The company’s size reduces risk also- it has a massive enterprise value of $58.1 billion. The company has generated 15.5% compounded annual returns since going public in 1994- with shares growing over 700% since the listing.

The company has an average median occupancy rate of 98.2% and stands to benefit from higher inflation rates, as 85% of its leases have rent escalation clauses. Additionally, 53% of properties have leases with set increases. These rent “escalators” protect shareholders from skyrocketing inflation because they result in growing cash flow from existing leases. Furthermore, Realty Income’s monthly dividend is increasing, which helps to mitigate the impact of rising consumer prices.

 Regarding debt,Realty Income’s bonds are investment-grade. Moody’s rates the company at A3. Debt-equity is the lowest it has been in more than 5 years, at 63.75%.

Summary

Realty Income is poised for more steady growth despite the current volatility in the market. Its portfolio of properties is diverse and has an excellent track record of providing consistent returns in the most difficult of economic circumstances. The company continues to make acquisitions in 2022 and in the future, and it will benefit from rising consumer prices as inflation pushes real estate values and rents higher.

With the Federal Reserve raising rates aggressively to fight inflation, the expectation is that this will cause the economy to head into a recession; if this is the case, triple net lease REITs like Realty Income should thrive. The company has a careful lease structure, is hugely diversified, and retains a strong balance sheet; if history is any indicator, it will navigate a recession quite easily.

In conclusion, dividend-paying stocks provide a way for investors to get paid during rocky market periods, when capital gains are hard to achieve. They provide a nice hedge against inflation, especially when they grow over time. They are tax advantaged, unlike other forms of income, such as interest on fixed-income investments. Dividend-paying stocks, on average, tend to be less volatile than non-dividend-paying stocks. A dividend stream, especially when reinvested to take advantage of the power of compounding, can help build tremendous wealth over time, if an investor is increasingly selective with the companies they choose. Generally, companies with a long history of paying dividends, low debt, conservative management, and necessary products are the best choice. These three companies check all of those boxes.