SPY - Icahn Enterprises: How Good Is This 25% Yield?

2023-05-03 11:30:00 ET

Summary

• IEP has been the subject of a short report.
• IEP has a history of massively beating the market.
• The dividend yield has soared to a very high level -- it might be maintained, but a dividend cut shouldn't be ruled out.

Article Thesis

Icahn Enterprises L.P. (IEP) has always stood out with its massive dividend yield. Following a short report by Hindenburg, shares dropped substantially, which has made the dividend yield soar from an already high level of around 15% to 25%. While the dividend looks safe due to the fact that Icahn himself is receiving dividends in the form of new shares, investors should not necessarily buy the company for the dividend yield alone.

What Happened?

Icahn Enterprises has been the target of a short report by Hindenburg Research. The short seller argued that Icahn Enterprises was overvalued, calling IEP's units "inflated" (see link above). While there are no allegations of fraud or manipulation, the short report still resonated with the market, as IEP's share price slumped massively following the release of Hindenburg Research's report:

IEP's shares generally aren't very volatile, they traded in the low $50s for most of the last month. In the two days following the release of the short report, IEP stock experienced a price decline of more than 30%, however. That has made IEP slump to a multi-year low, comparable to where the stock traded during the peak of the COVID panic when equity markets were in turmoil. Prior to that, IEP's shares had not traded in the low-$30s for a long time.

Company Overview

Icahn Enterprises is, as the name suggests, a company founded by Carl Icahn around 35 years ago. Carl Icahn, or "Icahn the Titan" is one of the best-known investors today, having built a fortune of around $18 billion. He is an activist investor but has also been making passive investments in companies such as Apple. Especially during the 1980s, he was described, by some, as a corporate raider. It is very clear that his investments have been successful in the past, making him a multi-billionaire, thus it's not surprising that retail investors were interested in becoming part of the Icahn empire by buying shares in Icahn Enterprises when the opportunity arose.

Icahn Enterprises has been traded publicly for a while, but the vast majority of shares, close to 90%, are directly or indirectly owned by Carl Icahn. That means that retail investors don't have a lot to say, especially since Icahn Enterprises is a limited partnership. But on the other hand, there is strong alignment between key personnel and the company's retail investor base -- when Icahn and his management team make the right decisions, both Icahn and the retail investor base will benefit. Likewise, if the management team makes bad decisions, they suffer themselves. That's positive for the retail investor base, as they don't have to fear that management has its own agenda -- interests are well-aligned.

Icahn Enterprises owns stakes in companies that are either fully owned or majority-owned and consolidated, such as CVR Energy ( CVI ), in which IEP owns a stake of a little more than 70%. But IEP also owns investments that are not consolidated, via its Icahn Capital subsidy, which owned $4.2 billion worth of market-traded investments at the end of the fourth quarter. On top of that, IEP also owns real estate assets via several real estate subsidiaries. These real estate assets include single-family properties, a hotel resort in Aruba, a country club, and so on. Last but not least, IEP held a cash position of more than $2 billion as of the end of the fourth quarter, providing ample liquidity for the partnership.

Icahn Enterprises: Recent Results

Icahn Enterprises invests in a wide array of companies and other financial assets. These change over time, with some being core holdings and others being shorter-term trades. Some of the companies IEP invests in are not profitable (yet), e.g. when IEP buys stakes in still relatively young but fast-growing tech companies. This makes IEP's results pretty hard to analyze, as there are major changes in IEP's portfolio on a year-over-year basis.

Looking at the company's most recent quarterly results , for the fourth quarter of 2022, we see the following:

The company wasn't profitable during the quarter, and also generated a net loss for the entire year, at least on a GAAP basis. EBITDA, or earnings before interest, taxes, depreciation, and amortization, was close to $800 million for the year, however. IEP's share count is 354 million, which translates into a market capitalization of a little more than $11 billion at the current share price of $32.

The company stated that its indicative net asset value, as of the end of the fourth quarter, was $5.6 billion. That's considerably less than the current market capitalization, suggesting the price to net asset value ratio is around 2.0 right now -- accounting for the massive share price decline over the last couple of days. Before that, the price to NAV was even higher, at around 3.0. Of course, not every investment should be valued at 1.0x net asset value. When companies have a history of destroying shareholder value, they should be valued at less than the net value of their assets, of course. Likewise, when a company has a history of generating a lot of value for shareholders, a premium to its net asset value is justified.

Looking back over the last 25 years, it's pretty clear that Icahn Enterprises has indeed delivered a lot of shareholder value:

IEP has not only trounced the broad market's ( SPY ) returns, but IEP has also beaten the performance of Berkshire Hathaway ( BRK.A )( BRK.B ), the investment vehicle of another investment giant -- Warren Buffett. History will not necessarily repeat, and past returns do not guarantee future returns of a similar magnitude. That being said, IEP's strong track record of creating wealth for its owners -- Carl Icahn and the retail investors that own a stake in IEP -- is a positive sign. In the long run, IEP has done quite well, despite its opaque earnings and the fact that the value of IEP's investments fluctuates.

IEP's Massive Dividend

Icahn Enterprises has been paying out $2 per share per quarter for the last couple of years:

Before that, the company raised its dividend from time to time, but not very regularly. This $8 per year dividend translated into a pretty high dividend yield in the 15% range when IEP was trading in the low $50s, but following the recent share price slump, the dividend has soared to an even higher level of around 25% at the time of writing. That should give investors pause -- how safe can a 25% dividend yield be?

In IEP's case, the answer is that the dividend might be safer than what many might expect at first. Carl Icahn takes his dividends in the form of new shares, and since he owns the vast majority of the shares, the cash dividends that IEP pays out to its retail investor base aren't very high. While IEP's total dividends are roughly $2.7 billion per year, the cash dividends that IEP pays out are just around $300 million per year. For a company that is valued at more than $10 billion, that's not very much -- and considering the fact that IEP generated $1.1 billion of operating cash flows last year, the cash portion of the dividend seems sustainable. Also, IEP's cash position of around $2 billion is large enough to pay the cash portion of the dividend for years. Of course, this does not mean that IEP's dividend will be maintained -- if the dividend were to be maintained, the share count would rise very drastically over the coming years, due to new units being issued to Carl Icahn at a hefty pace, and the company might decide that this isn't great. So I believe that a dividend cut is very possible -- but it does not seem necessary. Some companies are clearly forced to cut their dividends, and there's no way around it. In IEP's case, a dividend cut shouldn't be ruled out and may very well occur, but it does not seem necessary for now, due to the somewhat unique fact that the majority owner does not seek cash payments.

If IEP were to cut its dividend in half, the dividend yield would still be in the 12% range. If the dividend was cut by two-thirds, the dividend yield would still be around 8% -- that wouldn't be a disaster for someone buying today. In these scenarios, the cash portion that IEP pays out to its retail investors would decline dramatically, and the rate of dilution would decline as well, as fewer new units would be issued.

Takeaway

Carl Icahn has a great track record, and his IEP has a strong, market-beating track record as well. That being said, the company is also trading at a substantial premium to its net asset value, thus IEP is priced as if the market-beating performance will continue.

The dividend yield has soared to an ultra-high level, and could actually be maintained right here, as Icahn does not take the dividend in cash. That would cause substantial dilution, however, thus a dividend cut shouldn't be ruled out.

For someone looking to invest alongside this Wall Street titan, the recent sell-off could pose a buying opportunity -- and even if the dividend was cut by 50%-70%, the dividend yield would still be quite high.

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