UVV - 2 Dividend Champions For High-Yield Income Generation

2023-04-12 11:39:20 ET

Summary

• Dividend champions are a great source of ideas for investors seeking either high yield or dividend growth.
• In this article, I conduct a quarterly examination of the dividend champions to identify two stocks that may be suitable for high-yield investors.
• Given their yields that surpass inflation and decent dividend growth rates, both Altria Group, Inc. and Enterprise Products Partners L.P. are worth considering for high-yield investors.

It has been over four months since I presented a series of analyses on the dividend champions and dividend kings, aimed at screening high-yield and dividend growth investment targets.

Now, it is time to revisit the topic. In this article, I will focus on high-yield dividend champions, namely Altria Group, Inc. ( MO ) and Enterprise Products Partners L.P. ( EPD ). I've selected these companies using an investment approach that was outlined in two Seeking Alpha interviews, one in 2021 and the other in 2022 .

Two styles of income investing

There are two primary styles of dividend investing: high-yield investing and dividend growth investing ((DGI)). High-yield investing is suitable for individuals who are well into their retirement and frequently withdraw from their savings. In contrast, dividend growth investing is best suited for those who have, for instance, ten years remaining before retirement.

High-yield investing

At The Natural Resources Hub , we require a total return hurdle rate of 10% and a dividend yield higher than the CPI, which was pegged at 6.0% as of March 14, 2023 , for high-yield investing.

Why a 10% hurdle rate of total return? The S&P 500 index (SP500) averaged a dividend yield of 1.86% and a dividend growth rate of 6.37% between 2000 and 2021, resulting in a total return of 8.23%. Our stock-screening criteria indicate that stocks with a hurdle rate of 10% total return are expected to outperform the S&P 500 index by approximately 1.8%. Furthermore, retirees should anticipate that the dividend yield will surpass inflation.

There are five stocks that meet the above criteria: Altria, Enterprise Products Partners, Telephone and Data Systems, Inc. ( TDS ), The First of Long Island Corporation ( FLIC ), the holding company for The First National Bank of Long Island, and Universal Corporation ( UVV ), as depicted in Figure 1.

Dividend-growth investing

When considering a dividend-growth stock, we require that it has a total return of greater than 15%. Additionally, we stipulate that the dividend yield must compound and increase to at least 15% within a ten-year period.

Out of the 147 dividend champions, only four stocks meet our criteria for dividend-growth investing. However, a detailed discussion of these dividend-growth stocks falls beyond the scope of this article.

Altria

For decades, Altria has been the undisputed market leader in the U.S. tobacco industry. However, the company is currently undergoing a transformation of its product portfolio, with a focus on transitioning to smoke-free products, as you can see in Figure 2. To support this shift, the company is using the strong cash flow generated from its combustible tobacco portfolio, which includes popular brands like Marlboro, Black & Mild, and other niche brands. Altria also has approximately 10% stake in Anheuser-Busch InBev SA/NV ( BUD ), and a strategic investment in Cronos Group ( CRON ).

Dividend growth rate

Altria delivered a remarkable compound annual growth rate (or CAGR) of 12.93% in dividend payments between 1989 and 2006, before the spin-off of Kraft Foods ( KHC ) in 2007 and Philip Morris International ( PM ) in 2008. Following this golden period, the company continued to increase dividends, albeit at a slightly lower CAGR of 8.21% since 2009. However, as shown in Figure 3, the dividend growth rate has further declined to 5.24% from 2018 to 2022.

Looking ahead, it's likely that a dividend growth rate of around 5% will become the norm for Altria. In fact, during the 2023 investor day held on March 23, the company announced

"We are establishing a new progressive dividend goal that targets mid-single digits dividend growth annually. This dividend goal is an acknowledgement of our strong commitment to consistent dividend growth and shareholder return."

Dividend yield

Altria's dividend yield as of April 11, 2023, stands at an impressive 8.36%, in part due to the recent share price weakness as shown in Figure 4. However, the market perceives various risks associated with the company, such as the social stigma attached to being a 'sin stock' in a time when people are shifting to healthy living, the challenges posed by the shift to smoke-free products, and the broader macroeconomic uncertainty, all of which have contributed to the decline in the share price.

Risks

For those who are risk-averse, it's worth noting that cigarette prevalence and age demographic trends remain largely consistent with previous years. Moreover, with a national price elasticity coefficient of -0.35, Altria can raise cigarette prices to offset the approximately 2.5% secular decline rate. Furthermore, Altria generates significant cash flow annually that exceeds its dividend payments. This not only ensures the safety of dividends but also provides Altria with the flexibility to invest in smoke-free products, acquire other companies, repay debt, and buy back shares.

The long-term prosperity of the business depends on whether the strategic shift to smoke-free products will be successful. While it's true that Altria may encounter setbacks in its pursuit of smoke-free products, such as the Juul fiasco , it cannot rely solely on its in-house development projects (see Figure 2). In March 2023, Altria acquired NJOY Holdings, Inc. , a manufacturer of e-cigarettes and vaping devices, for $2.75 billion. With an expected payment of $1.7 billion, plus interest, from Philip Morris International by July 2023, as well as access to credit markets and bank financing, Altria can comfortably finance the acquisition without compromising its dividends.

Altria is a buy

Warren Buffett once said, " Uncertainty is the friend of the buyer of long term values. The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values. "

To benefit from an 8.36% dividend yield and a 5% dividend growth rate, investors in Altria must be prepared to accept the risks and uncertainties mentioned earlier. It's likely that Altria will continue to face various challenges in the foreseeable future. Nevertheless, these challenges also present an opportunity for investors to purchase a dividend king at a forward P/E of 8.8X .

Enterprise Products Partners

Enterprise Products Partners L.P., one of the largest publicly-traded master limited partnerships (or MLPs), provides midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, refined products, and petrochemicals.

EPD owns over 50,000 miles of pipeline, 260 million barrels of liquid storage, 29 natural gas processing plants, 25 fractionators, 2 propane dehydrogenation (or PDH) facilities, 2 isobutane dehydrogenation (or iBDH) facilities, and 20 deepwater docks, as shown in Figure 5. In addition, the company has major projects totaling $5.8 billion that are currently under construction.

Enterprise Products Partners, like Altria, is also confronting perceived uncertainty about its long-term future. If fossil fuels were to be phased out as suggested by some radical environmental activists, the petroleum industry as a whole would enter a terminal decline, leading to a rapid erosion of EPD's asset value.

However, upon closer examination, it becomes evident that the business is thriving.

U.S. after the shale revolution

Since the shale revolution, the United States has transformed from a net importer to a net exporter of crude oil and oil products. Additionally, the U.S. has emerged as a major exporter of liquefied petroleum gas (or LPG). During the Ukraine War, the U.S. demonstrated its capacity to act as a reliable supplier of liquefied natural gas (or LNG) for Europe, as shown in Figure 6. Enterprise Products Partners plays a crucial role in transporting and storing natural gas and liquids to enable their export.

Enterprise Products Partners: a growing business

Enterprise Products Partners achieved a CAGR of 10.6% in adjusted EBITDA and 32.0% in adjusted free cash flow per unit over the last five years, as shown in Figure 7.

Distributable cash flow (or DCF) is a metric that is commonly used by MLPs, such as EPD, to measure their ability to distribute cash to its unit-holders after covering all expenses, taxes, and maintenance capital expenditures. Figure 8 demonstrates EPD's robust history of generating enough operational DCF to cover distributions, even during challenging periods like the global financial crisis, recent oil bear market, and the Covid-19 pandemic

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Dividend yield and dividend growth rate

As of April 11, 2023, Enterprise Products Partners boasts an impressive yield of 7.39% , likely attributed to the recent decline in share price illustrated in Figure 9. This share price weakness is possibly related to the carbon neutral rhetoric popular among both Wall Street and retail investors.

From October 1998 to January 2023, EPD increased its distributions at a CAGR of 6.28%. However, due to the oil price collapse in 2014 and the Covid-19 pandemic, the distribution growth rate slowed to 4.12% over the past ten years.

Although it's uncertain when the market will begin to rerate energy equities like EPD, high-yield investors who don't mind dealing with K-1 forms may want to consider investing in Enterprise Products Partners. The safety of the distributions and high yield make it an attractive option. While EPD may not be the cheapest midstream stock, with a forward P/E of 10.24X and a forward EV/EBITDA of 9.34X, it's still reasonable for a wide-moat dividend champion.

Investor takeaway

After conducting my latest analysis of dividend champions, I have identified two high-yield targets: Altria Group, Inc. and Enterprise Products Partners L.P. Despite experiencing a period of weakness in their share prices, their business fundamentals seem to continue supporting their current dividends (distributions) and raises.

Currently, Altria offers a slightly higher yield and dividend growth rate than EPD. However, I anticipate that EPD will ramp up its distributions more aggressively during up-cycles in the upcoming years.

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