Friday, March 8, 2013

Be Careful Reaching For Yield - You Could Get Burned

Over the past few years, "thanks" to record low interest rates, some investors have been starving for yield. Many have bought "investment" instruments with high dividend yields ( 5%-6%+) in search of income, with little regard to quality or price paid. Over the past few years the prices of many utility, telco's and pipeline companies have been bid up to very lofty levels ( I usually get a nose bleed around 20X earnings). Here's a quick look at 2 pipelines and 1 telco. Granted, some of these companies have had excellent financial performance and deserve a good multiple. The 3 companies listed below are good companies, just really pricey. However, as a whole, these utility type investments are well above traditional prices for low-growth, high capital expenditure, regulated businesses.

                                        P/E        P/B      P/CF   Div Yield*
TransCanada Pipelines      20X      2X       10X     3.8%   
Enbridge                           22X      3.5X     11X    2.7%
BCE ( Ma Bell )                15X      3X        6X     5.0%

* These yield may look low, but that's due to the rapid rise in the underlying stock price lately.

To be clear, owning a utility with consistently rising dividends is a good thing. As long as the price you pay is not excessive. If you overpay for the yield and the company-in-turn has a problem or encounters poor industry conditions, then the price can get hammered. Then, you're dreams of stable income forever are interrupted by a dividend cut and possibly a big capital loss.

Case in point: This past week investors were surprised when a Canadian power and infrastructure company, Atlantic Power Corp ( ATP.TO) reported results for 2012 along with a dividend cut. As little as 4 months ago, ATP was cruzing along with a market cap of 1.67Billion ( around $14/share ) and paying out a nice $1.15/share/year in dividends, for a yield of 8.2%. Paid monthly - starving income investors love that.
What people didn't realize is that ATP has been paying out virtually all of it's earnings as a dividend, leaving little to re-invest in a capital intensive industry like power generation. ATP has regularly raised both debt and equity to fund the business ( never good when you keep doing that long-term ). Management, all the while, inferring that the dividend was stable.

When the dividend was cut on February 28th to $0.40/share/year, a whopping 65%, the stock tanked some 50%. As I write, ATP is trading at $5.50. Had you been an owner at the $14 level you'd be sitting on a 60% capital loss and 2/3's less dividend income then you had expected. Not fun.

The message: it's OK to look for yield in the market, in fact it's the best place right now to get yield. But, you have to look under the hood before you invest - or risk getting burned. I too, have reached for yield, and was burned - anyone remember Amisco Industries??? Fortunately, it was many years ago and a very small amount of $$$ - but it still hurt.

Chart forAtlantic Power Corporation (ATP.TO)

If you're wondering if it's a good buy now? For me, I might get interested under $3. I'm not a fan of management's capital allocation practices and the shaky balance sheet.

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