Income from my investments is essential for my retirement. That income will not only support my spending; it will also help insulate me from potential turmoil in the markets.
Too many investors divide their desired dividends by their portfolio value and just go seek yields that match that ratio. This is fine if the ratio is 4% or less, except that picking any investment based primarily on its yield is a bad idea.
But the larger that ratio gets, the more treacherous it becomes to just match yield to desire. To be a candidate for my portfolio, a company must have a robust ability to sustain the dividend and grow it.
What I Look For
I seek securities from companies …
- With solid balance sheets
- With safe payout ratios on Cash Available for Distribution or CAD
- With business models that can grow those distributions with inflation or faster
- In business areas I understand in depth, which happen to be REITs and energy
I avoid securities from firms …
- Whose structure involves financial engineering
- With leverage secured by anything other than hard assets
- With leverage I judge to be dangerously large
- Heavily dependent on regulatory developments (think health care)
- In business areas I do not understand in depth
This latter list keeps me mostly away from mortgage REITs, most business development companies, and many other leveraged products. These often pay yields near 10%, but I frankly do not trust them.
For the last 20 plus years, the Fed has bailed out pretty much every financial investment. Across the 20th Century, they mostly did not.
For me, the question is whether I think the firm would survive another Great Depression. If not, I don’t invest.
With no further delay, here is my list:
- Enterprise Products Partners (EPD) [7.1% Yield]
- EPR Properties (EPR) [8.3% Yield]
- Canadian Natural Resources (CNQ) [5.3% Yield on TTM dividends]
- W. P. Carey (WPC) [6.3% Forward Yield]
- TC Energy (TRP) [7.8% Yield]
- VICI Properties (VICI) [5.8% Yield]
Remember that what matters here is dividends, not stock price. The reason dividends are high is often that the market has some reason for skepticism about the company, which has suppressed the price. This is where deep sector knowledge comes in, to consider whether the dividend is threatened.
Enterprise Products Partners (EPD)
EPD is one of the largest midstream energy firms, with a majority focus on natural gas and NGLs — natural gas liquids — think sources for plastics, propane, and butane, among other products.
Among midstream energy firms, EPD is the adult in the room. They have a deeply researched and highly integrated view of the hydrocarbons business.
Their track record of execution is stellar. Their history of growing shareholder returns is too.
EPD long since has stopped issuing stock to raise funds. They paused their issuance of debt in 2020 when it seemed that the capital markets might become closed to fossil fuel companies.
Once they had adapted to that, dividends began growing again. And by now, with Debt to EBITDA down to 3.0 and a credit rating of A-, it makes good sense to issue leverage-neutral debt as they grow.
If the press and other fools or worse have made you afraid of “peak oil,” then I suggest three cures. Read these three things:
- The EPD investor deck.
- “How the World Really Works” by Vaclav Smil
- The Substack posts on future oil demand by Arjun Murti
Ironically, one does not see those fools or worse eschewing the use of plastics, the support of which is a major area of activity for EPD. Too bad since that would keep them away from keyboards.
You might also note that EPD has some 2060 bonds that are fully priced.
EPR Properties (EPR)
EPR Properties is an experiential REIT, focused on drive-to properties where people can go for activities that get them out of the house. As a result of their history, movie theatres provide more than a third of their revenues, a fraction that is slowly decreasing over time.
EPR had their properties nearly all shut down by government fiat during the pandemic. That did produce a pause in their dividend, but EPR came through the other side in good shape.
EPR may never be valued sensibly compared to other REITs. Or they may not be until after an eventual bankruptcy by AMC Entertainment (AMC) and perhaps also a substantive further reduction in their fraction of revenues from theatres. For now, their high yield is delightfully hard to believe.
Their other major theatre tenants have very solid balance sheets. And their master lease with AMC, put in place during 2020, was designed to survive bankruptcy. In fact, since that time EPR management has been actively encouraging AMC to file.
But that market nervousness is fine for income investors. They are well run and have excellent balance sheet management.
What’s more, EPD has a nice safe low payout ratio. This also enables them to grow CAD by about 4% without needing to issue any stock.
There is risk, as my articles discuss. But to my mind this is a good hold.
Canadian Natural Resources (CNQ)
CNQ is a highly innovative oil producer who invested the money a decade ago to be able to mine the oil sands and convert the bitumen into high-grade crude oil that sells for a premium. Between that and other things they do well, they pay a substantial dividend and will continue to grow it rapidly, a rare combination.
CNQ is a financial machine. They now have their total debt where they want it.
At US$65/bbl oil, they generate about $6 of cash flow after the capex necessary to sustain production growth near 5%. This covers the base dividend with enough left over to buy back a couple percent of the float. Note that they can then increase the dividend that couple percent with no increase in total dividend payouts.
By $85/bbl oil, they can buy back 5% of the float, increase the base dividend by 5%, and pay a significant special dividend and/or buy back more shares. The yield is not high, but the dividend growth will excel.
W. P. Carey (WPC)
Unloved since their spinoff and dividend cut last fall, WPC now has a high-quality portfolio and is finally in a position to steadily grow their dividend faster than inflation. And there will at some point be some upside when the market decides to love them again.
I’ve been following WPC in detail for quite a while. A few years ago, I thought they were overhyped and overvalued because their dividend growth and growth potential were anemic.
WPC today is priced a little below where they were at the end of 2015. Their per share Cash from Operations was about the same in 2023 and will be a bit smaller in 2024. The WPC forward dividend payout today is about where it was then and so is their yield.
No reason to buy is found in the comparison. But since 2015, and especially recently, they have made changes for the better.
Their portfolio today is of much better quality and their payout ratio is now finally low enough to provide for dividend safety and internally funded growth. In my view, going forward they will grow their dividend above the rate of inflation and above the rate of most other net lease REITs.
One thing to watch here, though, is their European tenants. One overleveraged tenant (Hellweg) recently failed, leading to decreased rent. The question is how many others there might be. This is a big question for me from quarter to quarter.
TC Energy (TRP)
The market over-reacted in 2023 to some cost over-runs on the massive Coastal GasLink project. And now there is uncertainty as TC Energy prepares to split into a gas company and a liquids pipeline company.
This all sows confusion. They’ve promised to sustain the total dividend across their split, but also project reducing debt over time thanks to decreases in capex.
Still, TC Energy has some of the best assets in midstream. They have significant gas pipelines in Canada, the US, and Mexico. Their Keystone liquids pipeline is a key link for North American crude oil. And they have lots of other facilities.
TC Energy had a peak in capital expenditures in 2023, and between that and the Coastal GasLink over-run had to sell some assets. Debt to EBITDA went up and is now on its way back down. The market disliked all of that, but it is in the past.
Capital expenditures will be down from their peak in 2023 by a third this year and by half after that. They should be below their target of 4.75x for Debt to EBITDA by the end of this year. Clarity will re-emerge once the spinoff is complete.
All this noise has made today’s yield appealing. Plus they have a clear path to growth of EBITDA and dividends. Yet, compared to midstream peers, more of the dividend is either rate regulated or take-or-pay and the payout ratio on EPS is lower.
I have no idea how their stock price will move compared with other midstreams, but locking in the current dividend seems great to me.
VICI Properties (VICI)
VICI Properties (VICI) started as a Casino REIT and is now adding other experiential elements as they seek continued growth. Considering that some of their assets have values above $5B, it is no wonder that within a few years, VICI became one of the top ten REITs in Enterprise Value.
Still being that big comes with a challenge. Growth becomes hard. Quality growth becomes harder. So we see that Simon Property Group (SPG) grows Net Operating Income quite slowly, that Realty Income (O) has been rapidly downgrading the quality of their portfolio in order to sustain growth, and so on.
Still, VICI has an advantage in that their leases have comparatively large escalators. Plus from the start they have maintained a sensible payout ratio, so they generate significant funds internally to support further growth.
VICI aspires to a growth rate for cash earnings per share exceeding 6%. While achieving that seems far from certain to me, generating growth above 4% seems likely.
And that will flow through to the dividend. The TTM dividend per share paid is up 40% in the past five years.
That too will slow down. But a dividend above a 5% yield likely to grow at near 5% is a pretty good place to be for investors.
The Future
These are all investment-grade companies with solid business models. They all should prove able to grow their dividends at rates above average inflation. They take up 35% of my overall portfolio.
This week GlobeSt. quoted Ben Kadish, the President of Maverick Commercial Mortgage. He noted that “at one time many properties traded at 10% cap rates with interest rates at 8%. The lower rates the industry has enjoyed since the global financial crisis are likely not coming back anytime soon: Gone are the 3% and 4% cap rates across the board.”
Note that such a doubling or tripling of cap rates would imply that earnings multiples on real estate would drop by a factor of two to three and so would stock prices. This is only one of many possibilities, but it IS possible.
My usual refrain: Dividends will stay and grow. Do not count on total return over the next treacherous decades.