Introduction
By Tim Plaehn
In December 2008 the Federal Reserve Board lowered the Fed Funds Discount rate to a target of 0% to 0.25%, basically a zero interest rate policy (ZIRP). The Fed Funds rate controls short term interest rates and has a powerful effect on intermediate term rates. The purpose of ZIRP was to stimulate economic growth, but now over six years later, the economy remains sluggish, ZIRP is still in effect, and the Fed and government policies continue to fail to help out the economy. In the meantime, investors and savers have been saddled with very low interest rates on most types of "safe" investment products. I am sure you are aware that earning 1% on your money and then paying taxes on that interest does not leave much to either grow your account value or provide cash to pay the bills.
To fight and win in the War on Your Income, we look to the stock market, but not at the familiar corporations that pay billions in corporate income taxes, leaving enough after-tax profits to pay investors 2.5% to 3% in after-taxable dividends. Instead, we go with
companies using alternative, but perfectly legal, business structures that reduce the tax burden, leaving more money to be paid out as dividends to you. In these hidden corners of the stock market, you can find 5% to 8% yields with a high degree of safety
concerning future dividend payments.
Our investment selection criteria include focusing on stocks that function under a beneficial section of the tax code, have stable business models that allow them to generate high levels of cash flow from which to pay dividends, and a past history plus current focus on increasing dividend rates over times. One "secret" of dividend investing is that a company that has increased its dividend in the last year is many times less likely to reduce that dividend compared to a company with a history of level dividend
payments.
Ship Finance International Ltd (NYSE:SFL)
Hamilton, Bermuda www.shipfinance.bm Last: $14.90
Dividend & Yield: $1.68 (11.25%)
Market Sector: Specialty Financial Services
Ship Finance International Ltd.
I first developed an interest in the shipping industry and related stocks almost 10 years ago. The period of 2005 through 2008 was exciting for both shipping companies and their investors. The record prices for commodities like grains, crude oil and iron ore made it very profitable to buy a new
crude tanker or dry bulk carrier vessel and lease them on the spot market at tremendous profit margins.
Of course all of the ship buying happened with borrowed money and when the bottom fell out of shipping rates, many of these high-flying shippers suddenly could not generate enough revenue to cover operating costs and interest payments. As shipping rates fell, so did the market value of vessels owned by these companies.
By 2009, the stocks of some of the biggest names in shipping had lost over 90% of their values and banks were no longer interested in financing any of the ships these
companies had ordered during the glory years. While some companies that I covered during this period went bankrupt, others still survive, but with share values 95% below their heyday prices.
Ship Finance received 47 tankers from Frontline, which were leased back to FRO on long term contracts. Splitting off Ship Finance allowed Frontline to increase its risk/reward profile as tanker spot rates moved up or down. Ship Finance received steady lease payments enhanced with a modest profit sharing agreement with Frontline. As a result, Ship Finance was able to pay steady dividends with moderate distribution growth and use the profit sharing payments to diversify away from a dependence on the crude tanker market.
The Modern Ship Finance
Over the last decade, Ship Finance has expanded into the ownership of almost all classes of ships including crude oil tankers, car carriers, container vessels, dry bulk carriers, chemical tankers, jack-up drilling rigs, ultra-deepwater drilling units and offshore supply vessels. The company now owns 73 vessels, which includes just 20 tankers remaining from the original fleet obtained from Frontline. As of the end of 2013, just over half of the company' revenue came from the offshore portion of the fleet, about a quarter was from tankers, and the remainder split between dry bulk and container ships.
Long-term lease contracts remain the stabilizing factor in the business model. The average remaining contract time is over 10 years. The Ship Finance ships are now spread among 15 customers, which include some of the largest names in shipping such as Seadrill, Maersk and Hamburg SUD.
The shipping industry contacts and financial strength of Ship Finance make the company a go-to source for the financing of the most expensive vessels on the market. For example, last June the company structured the purchase of a $600 million jack-up drilling rig with a 15-year lease back to the selling company. The rig is being modified in Norway and is expected to return to operation in May 2014. Over the term of the contract, Ship Finance will earn 15% per year on the invested equity.
Cash Flow to Ensure Steady Dividend Payments
Ship Finance may be the poster child of cash flow analysis compared to the traditional net income per share to determine the safety and potential dividend payments. Over the last four quarters, SFL has reported net income per share of $0.20, $044, $0.24, $0.37. Over the same period the dividends paid were $0.41, $0.41, $0.41 and $0.42 per share. So you have net income of $1.25 per share and $1.65 per share was paid in dividends.
There are several reasons why Ship Finance can pay this level of dividends: A large portion of Ship Finance's charter business falls under the capital lease
Also, as an owner of assets, Ship Finance will book a non-cash depreciation charge every quarter. This expense currently runs at about $60 million per year, which is $0.75 per share that does not show up on the net income line.
To get a firm handle on Ship Finance's true ability to pay dividends, we start with the earnings before interest, tax, depreciation and amortization (EBITDA).
Since quarterly results can vary with the sale or disposition of vessels, it is better to look at a full year's worth of cash flow.
In 2014, Ship Finance generated EBITDA of $553 million. Interest payments totaled $121 million, and since it is domiciled in Bermuda, the company pays no income tax. In addition, for 2014 $234 million was paid to amortize loan balances. Subtract the real cash payments from EBITDA and the remaining free cash flow is $198 million. Ship Finance has about 79 million shares outstanding, so the cash required to pay last year's dividends was $130 million. Even though the reported net income was less than the dividend, the actual cash flow was enough to cover the dividends by a factor of 1.5 times.
2015 To Be a Year of Cash Flow Growth
During 2013, over $1 billion was invested to add to the company's fleet. The cash flows for those investments have started to have a meaningful impact. The dividend has been increased for two of the last three quarters.
A potential additional source of distributable cash is profit sharing payments from Frontline. In late 2011, Ship Finance and Frontline restructured the lease agreements on the tankers owned by SFL. Frontline received some lease rate relief in exchange for an up-front cash payment and new, lower profit sharing thresholds based on the earnings rates per day generated by the tankers. In the first quarter of 2015, tanker rates have finally moved up to levels that will generate profit share payments from Frontline to Ship Finance. These payments have the potential to add between 20 and 40 cents per share to the free cash flow available to pay to share owners.
Potential dangers for investors would be if any of the Ship Finance customers ran into financial troubles and were not able to make lease payments. The board of directors has shown in the past that it is not afraid to temporarily reduce the dividend rate of current and forecast cash flow are determined to not be high enough to support the dividend rate. For example, when Frontline got into trouble in 2011, the SFL dividend was
reduced to $0.30 from $0.39 for one quarter until the situation was worked out with the tanker company.
High Yield Stability with Potential for Growth
At the current $14.90 per share (as of publishing) and the $0.42 quarterly dividend, SFL yields 11.25%.
While we have this stock as a strong BUY for income investors, you may be able to get a lower average cost by spreading out your total investment into three or four parts and investing on the dips. I have no trouble recommending SFL at the current share price, but dips below $14.50 are definite buy opportunities.
This recommendation is not dependent on future dividend increases, but if the
distribution rate does go up during the year, it is unlikely that SFL will see the underside of $15 again. When the market realizes that SFL is starting to grow its dividend, the share price will be bid up to push the yield down to a range of 7.5% to 8%, which means a share price above $21.
Ares Capital Corporation (Nasdaq: ARCC)
New York, NY
www.arescapitalcorp.com Last: $17.14
Dividend & Yield: $1.52 (9.8%)
Market Sector: Commercial Financial Services
Ares Capital Corporation (ARCC)
Ares Captial is organized under special tax rules as a business development company (BDC). The laws governing a BDC require the company to focus its business on providing debt and equity financing for small to mid-sized corporations. Think of a BDC as a combination of a venture capital firm and a
business bank. If the company meets the tax code requirement to pay out 90% of net income as dividends to investors, a BDC does not pay corporate income taxes, reducing by one big one (the 35% corporate tax rate), a level where the government can suck away investment earnings.
Of the two dozen BDCs, Ares Capital stands out as the largest, with a $5.2 billion market cap. The large size allows the company to diversify its portfolio, and at the end of 2014 Ares Capital carried debt or equity contracts with 205 different companies. Ares provides a range of financing options and the year-end portfolio consisted of 41% first lien senior secured loans, 21% second lien senior secured loans, 23% of the company's pooled senior secured loan program, 6% senior subordinated debt, and the remaining 9% was preferred and other equity positions. The bottom line is that Ares Capital is the senior lender on 80% of the securities in its portfolio, putting it first in line if one of the client companies runs into financial difficulty.
Why we like ARCC
Ares Capital combines the high-yield, pass-through tax characteristics, safety of the dividend, and distribution growth that are the cornerstones of the investments selected for The Dividend Hunter portfolio and integral to winning the war on your income. A dividend has been paid every quarter since the company's initial public offering in 2004. In 2009, when many BDCs ran into serious financial difficulty and suspended dividend payments, Ares Capital reduced its dividend to $0.38 from $0.42, maintaining a high payout to investors. The current quarterly rate of $0.38 per share has been paid since mid-2012. However, four bonus dividends totaling $0.20 per share have also been paid out over the last two years.
With a high-yield, high-payout stock investment, an important analysis check is to see if the company has the required free cash flow to cover and maintain the dividend rate. In 2014 Ares Capital generated net investment income of $1.94 per share, covering the dividend payments by 124%. ARCC has a current yield of 9.8% and investors can expect slow to moderate growth in the dividend payments. The slower growth rate is
compensated for with the high current yield and bonus dividend payments.
Investment hint: ARCC has a historical tendency to fall by several percent points after each dividend payment and then recover by the next earnings report. Timely share
purchases can lower your average cost of ownership. Try to get in after the share price dips after the dividend is paid out. ARCC has typically paid dividends between the 11th and 13th of the months in March, June, September, and December.
W.P. Carey, Inc. (NYSE: WPC)
New York, NY www.wpcarey.com Last: $68.72
Dividend & Yield: $3.81 (5.6%)
Market Sector: Financial, REIT - Diversified
W.P. Carey, Inc. (WPC)
Real estate investment trust (REIT) is another type of business tax organization choice that allows a company to avoid the corporate tax bite in exchange for paying out 90% of net income to investors.
As the classification implies, REITs own real estate assets, with different REITs typically
focusing on just one type of commercial real estate, such as shopping centers, apartment buildings, office building, or industrial space. W.P. Carey is classified as a triple-net (NNN) REIT. Long term lease contracts with built-in rent increases and a customer base of clients who take whole properties are what set NNN REITs apart. This category or REITs also often owns real estate across a range of property types.
Started in 1973, W.P. Carey has grown into a company with a $7.3 billion market cap and a property portfolio valued at over $15 billion. The company stands out due to its diversified asset base; owning office, industrial, warehouse, distribution and retail properties. As of the end of 2014, the company owned 783 properties with 219 different tenants. Geographically, properties are located in 45 states and 10 European countries. W.P. Carey also has a significant fee generation business as a manager of non-traded REIT companies. Over the last two years, W.P. Carey has merged with two of the non-traded REITs it managed, bringing immediate, additional value to WPC shareholders. Why we like WPC
The standout feature of W.P. Carey as an investment is the company's long history of dividend growth. The dividend rate has been increased every year since the company went public in 1998. The current dividend rate is just 85% of the cash flow available, called funds from operations (FFO) in REIT jargon. Going forward, the company will generate growth through property acquisitions and built in rent increases. 98% of W.P. Carey's lease contracts include some type of annual rent escalator.
Approximately one-third of the company's properties are in Europe, which provides diversification away from the U.S. commercial real estate market. There is a much lower level of competition in Europe, which allows W.P. Carey to generate higher profit margins on its European acquisitions.
WPC currently yields just under 6% and that cash return will just continue to grow as the company increases the dividend year after year.
Plains All American Pipeline (NYSE: PAA)
Houston, TX www.paalp.com Last: $49.06
Dividend & Yield: $2.70 (5.5%)
Market Sector: Materials, Oil & Gas Pipelines
Plains All American Pipeline (PAA)
Master limited partnerships (MLP) are a third type of pass-through structure that allows a company to pay less in taxes and more to investors. Investors in an MLP are technically limited partners who own units and receive partnership distributions. However, MLP units trade just like stock
shares on the stock exchange and you can buy and sell shares exactly the same. The difference between LP and stock share investing is the tax consequences. The distributions you earn from an MLP like Plains All American Pipeline are classified as tax-free return of capital. At the end of the year you receive a Schedule K-1 that lists your share of the company's profits to claim on your tax return. An MLP like Plains All American Pipeline is constantly adding and upgrading to its energy transportation network, which provides large amounts of tax sheltering depreciation. The tax burden of MLP ownership often works out to much less than the taxes you would pay on a stock paying taxable dividends.
With a market cap of $20 billion, Plains All American Pipeline is one of the largest MLP and infrastructure companies in the U.S. The company owns an extensive portfolio of energy transport and storage facilities and equipment including:
18,150 miles of crude oil and fuels pipelines 120 million barrels of liquids storage 97 billion cubic feet of natural gas storage
Facilities to handle 235,000 barrels per day of energy liquids fractionation 8.5 billion cubic feet per day of natural gas processing capacity
24 crude oil and natural gas liquids rail facilities 7,400 crude and NGL railcars
840 truck tractors and 1,700 liquids trailers 60 tug boats and 130 barges
As an MLP, Plains All American Pipeline offers an infrastructure investment that pays an attractive distribution yield with steady year-over-year growth in the distribution rate per unit. With the U.S. Energy Information Agency forecasting 20-plus years of future growth in domestic oil and gas production, this company fills the very important need to move crude oil from the drilling regions to the refineries. Plains All American Pipelines also provides pipeline transport of crude oil from Canada to the U.S. refineries. If the Keystone XL pipeline is approved and built, it will be years before the pipeline competes with Plains and projected growth in Canada's oil production will more than take up the extra capacity.
Why We Like PAA
This MLP offers a conservative way for investors to get started with MLP investing. The company provides the combination of an attractive yield, steady and even more attractive distribution growth, and a conservative management philosophy.
PAA currently yields 5.5% and has increased the distributions paid to unit holders by a compounded 8.4% over the last 10 years. For the next couple of years, PAA
management has provided guidance of 10% distribution growth per year. In 2014, the company generated enough free cash flow to cover the distributions by 1.3 times, so you can count on an 8% to 10% increase. A steadily growing distribution will result in a share price that also increases over time. As a result, you can expect an average annual total return of about 15% from PAA, and a large portion of that return will be tax-advantaged cash distributions into your brokerage account cash balance.
Dear Investor,
Thank you for reading through my new report with my top dividend and income recommendations to help you fight the War on Your Income. It’s my sincere hope that you’ll find profits from these recommendations just like my current subscribers. I’d like to share with you how my 30 Day Dividends subscribers are dialing in a string of
consistent winning trades month in and month out – all without taking on unnecessary risk from swing trading or tying up their money for years in really long term holdings. What if I told you there’s a way you can book annualized returns like 23.5%, 44% and 157.1% in as short as 30 days with dividend paying stocks?
And not only will you book higher-than-normal returns, you’ll also collect profits before shareholders receive their regular dividend.
I call this opportunity “Primary Dividends,” and I want to tell you about it today — even give you 3 new plays that my indicators tell me could be double digit gainers in very short order.
Just click here for access to my short briefing and instructions on how to collect from your first 3 Primary Dividend opportunities.
Best Regards,
Tim Plaehn Editor
30 Day Dividends
P.S. I discovered Primary Dividend opportunities during my years as a certified financial planner and income stock analyst. They’re based on two principles which all “rich” people use… click here to discover them.
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All data, including equity prices and yields current as of when this report was published.
