Issue 11 | April 2008
DIVIDEND SUPERSTARS The World’s Best Income Investments
A Look Inside ... Page 4 Two Oil Stocks Page 5 Children and Money Page 6 Portfolio Update Page 8 Your Questions Answered ★★★★★★★★★★★★★★★★★★★★★★★
From The Editor...
he latest surge in oil and gas prices is a heck of a way to start off the summer driving season. As of April 23, the per-barrel price of crude oil had surged to $117, almost another 20% higher than it started the year (see chart). Unfortunately, paying more at the pump is just a fact of life right now. The good news is that you can put a little coin back in your pocket every couple of months by buying shares of dividend-paying oil & gas firms. Not only will these issues kick off regular income, but they will also add a little more diversification to your overall income portfolio. In this issue, I’ll give you an overview of the industry and tell you what company I recommend targeting right now. Sincerely,
Make the Oil Companies Pay You Back! Rising pump prices stink, but dividend checks can ease the sting …
’m not happy to see oil at record prices. In fact, I think the situation is downright awful. Crude is surging to record high after record high, and that’s translating to pain at gas pumps all across the land. Based on the April 20th Lundberg Survey, which polls 7,000 gas stations across the country, the national average price for gasoline jumped $0.16 in two weeks, and stood at $3.47 a gallon for regular self-serve. Even worse, the busy summer driving season is still ahead of us, and government analysts are suggesting we could see spikes north of $4 a gallon. To be sure, this is nothing to celebrate. But facts are facts. As investors, we can sit around complaining, or we can figure out the best ways to get some money back out of the system. In a moment, I’m going to tell you why the shares of major oil companies are the best way to get steady “refunds” from soaring gas prices. But first, I want to start with some background … Why Gas Prices Are Going Higher And Higher With No End in Sight Let’s start with just some of the latest tidbits that pushed crude to a new all-time high last week … X A militant group in Nigeria attacked two pipelines as part
of its ongoing efforts to hinder the country’s exports X A 150,000-ton Japanese oil tanker was attacked in Middle Eastern waters off the coast of Yemen X The president of the Organization of Petroleum Exporting Countries, Chakib Khelil said the cartel “does not need to raise output in the near future.” Keep in mind that OPEC accounts for about 40% of the world’s oil! X And Venezuelan energy minister Rafael Ramirez told reporters at the International Energy Forum in Rome that he believes “prices will remain around this level, at least around $90.” As you can see, spats around the globe threaten to keep bumping prices higher. And the guys who control much (Continued on next page)
Per-Barrel Oil Prices Keep Rising ...
DIVIDEND SUPERSTARS Oil Profits (Continued from cover)
of the world’s supplies aren’t willing to budge an inch on their pricing. In short, there’s a host of geopolitical undercurrents affecting the oil markets. Unfortunately, these events are simply the wild cards that can show up at anytime and tip prices over the edge. There’s an even deeper underlying problem — a supply and demand crunch that seems to worsen every year. The world consumes about 86 million barrels of oil a day, which is staggering when you stop and think about it. We fuel our cars, buses, and planes with it. We heat our homes and businesses with it. Most of our household plastic items can’t be made without it. And so here we are, beholden to black gold for most of our modern conveniences. The U.S. currently accounts for about a quarter of the world’s demand for oil. Even worse, as countries like China and India rapidly adopt our way of life, they also get more and more hooked on the stuff, too. Take a look at what’s happening, just in terms of car use: z Indian car sales are predicted to more than quadruple by 2016
China is already putting 500,000 new cars on the road every month z And according to automakers, auto sales in China should rise anywhere from 15% to 20% this year Heck, one of the scariest articles I’ve seen talked about China’s newfound appreciation for the very same SUVs that U.S. drivers are starting to shun. According to the piece, sales of luxury cars and SUVs are expected to jump as much as 45% in 2008! If oil was just gushing out of every crack in the ground, maybe our addiction wouldn’t be so bad. But new sources of oil are getting harder and harder to find, and old sources are running dry. Heck, we just learned that Mexican oil output fell 7.8% in the first quarter of 2008. And that’s a continuation of a longerterm trend there. The country’s state-run oil company, Pemex, says it only has enough proven reserves to last another nine years given current production rates. That’s right, in less than a decade, one of the U.S.’s biggest oil suppliers may have to start importing its own oil. It’s much the same story for other countries, too. For exz
ample, Russia, another major oil exporter, recently saw its oil output drop for the first time since 1998, according to the International Energy Agency. And what about domestic production here in the U.S.? Same story … steady declines. We’re sitting near a 50-year production low, and watched our output drop about 50% between 1985 and 2005. So, increasing demand, dwindling supply, and plenty of international tensions all argue for high prices. Sure, some of the latest froth in the oil market has probably been exacerbated by big-money investors speculating and playing the momentum. But even if oil were to fall back to $70 a barrel, it would still be more than twice as expensive as it was four years ago! I would love to see the situation change. And I would especially love to see alternative sources of energy finally come to the fore. But I also recognize that we have an entrenched system, one that virtually guarantees … Big Profits for Big Oil! How the Industry Works ... No doubt you’ve seen the headlines about oil companies raking in record-breaking profits. As I just showed you, (Continued on next page)
C o p y r i g h t © b y We i s s Re s e a r c h , I n c ., D i v i d e n d S u p e r t a r s 1 5 4 3 0 E n d e a v o u r D r i v e , J u p i t e r, F l o r i d a 3 3 4 7 8 ; 561-627-3300. Sales: 888-745-3128. DIVIDEND SUPERSTARS (“DSS”) is published by Weiss Research, Inc. and written by Nilus Mattive. Weiss Research, Inc. and DSS do not provide individual investment/trading advice. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in DSS. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in DSS are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Julie Trudeau, and Marty Sleva.
DIVIDEND SUPERSTARS Oil Profits (Continued from page 2)
these firms sell a product that the world can’t live without. That allows them to bring in cash through good times and bad. It also allows them to pay out fairly consistent dividends in the process. What about a recession in the U.S.? Won’t that affect these companies? Possibly, yes. Oil demand usually slumps when business activity is waning. However, as I mentioned earlier, new sources of demand are cropping up around the world. That’s probably why we have yet to see a pullback in crude prices even though the U.S. is weak in the knees. And even in the U.S., consumers have remained fairly resilient thus far. I mean, a lot of people complain about high gas prices … but how many are truly altering their behavior? More importantly, how many are able to alter their driving habits? I don’t know anyone who can just stop driving to work every day. I would also point out that oil companies recognize the cyclicality of their businesses. They’re generally conservative, well-managed enterprises. And they know just how important it is to find new sources of oil. The very smartest firms are reinvesting some of their blockbuster profits into new exploration and production efforts so they can continue gushing money.
Obviously, the first step is finding oil. This is known as the “upstream” part of the business. Because it’s a very specialized and costly endeavor to drill, many major oil companies choose to outsource the task. There are companies that completely focus on searching out new oil finds, as well as a whole group of drillers and equipment & service providers that own and operate the rigs themselves. Those drilling rigs can be either land-based or in a body of water. The next step, once oil is out of the ground, is storing it and transporting it. In industry parlance, this is known as the “midstream.” You should already have exposure to some of these firms through your Master Limited Partnership investments in Kinder Morgan and Energy Transfer Partners. Finally, the oil needs to be broken up into an array of end products — gasoline, heating oil, motor oil, etc. The process of refining and marketing petroleum products is called … the “downstream.” S&P Energy Sector ETF (XLE)
Overall, it takes years for the cycle of discovering, transporting, and refining to play out. You can see why it’s hard for new companies to break into the oil industry. In fact, there are a very select number of firms with operations that span the entire process. Known as major integrated oil and gas companies, these are the names that have become synonymous with what we put in our cars. That’s especially true of the so-called “supermajors” — the handful of firms like ExxonMobil, BP, and Chevron that operate not just across the industry but around the entire globe. While these household names have already seen price gains along with the run-up in crude, I think they remain attractive for long-term income investors. Even in the event of a sharp pullback in oil prices, they are likely to remain profitable and continue doling out healthy dividend payments. What’s more, investors are careful not to bid up the shares too far, too fast. Most of the major integrated oil & gas stocks are still trading at highsingle-digit or low-double-digit price-to-earnings ratios. Bottom line: I’m not happy about the oil situation, and I’m sure you’re not either. But if we can’t beat them, we might as well join them. For more on my favorite integrated oil & gas firm, as well as a special situation I’m watching carefully, see page 4.
SUPERSTAR SPOTLIGHT BP Plc (NYSE: BP) Recent price: 69.25 Indicated yield: 4.69% Estimated P/E: 9.43 I first profiled BP in my bonus report, “Top DividendPaying Foreign Companies to Snap Up Now.” And I continue to think the company is one of the best integrated oil & gas companies out there, especially when it comes to value for your investment dollars. Why? Well, in 2007, the company hit a bit of a stumbling block in terms of profits. BP’s earnings fell 5% even though revenues rose 5%. Two of the factors: Charges related to service station sales and restructuring costs. That has kept the share price bouncing around in a range. But in my view, investors have focused on this short-term bump too much. After all, BP has a lot of things going for it: X Many new projects should begin between 2008 and 2009, leading to more upstream production X The company says, based on $60-a-barrel oil, it BP Plc (NYSE: BP)
could support its current production of about four million barrels a day all the way through 2012 … without any additional discoveries X Earnings should rebound substantially for all of 2008, and continue trending higher X The company recently boosted its dividend by 25%, and the stock’s yield is well above those of most peers In terms of business units, exploration and production (17% of 2007 revenues) and refining
and marketing (77%) are BP’s two biggies. However, I would note that BP is also pursuing alternative energy sources. The company boasts good geographic diversification, too. The U.K and the rest of Europe each account for about 20% of the company’s business, with the U.S. representing 40%. I think the shares would make an attractive addition to the core income Dividend Superstars portfolio. But to make sure you get in at a very favorable price, I recommend purchasing 50 shares at $65 or better.
Stretching for Yield Special Alert: Watch This Refiner and Marketer
s I was researching the oil & gas industry for this issue, I came across a very interesting company called Calumet Specialty Products Partners (CLMT). It’s a Master Limited Partnership that’s focused on refining and marketing specialty oil and gas products like fuels, solvents, and waxes. Generally speaking, the company’s focus on refining means it is hurt by rising oil prices. And you can see that the market has recognized that, pushing the shares down to all-time lows. While there could be more downside ahead, and the company could see another bad year in 2008, I have to wonder what the 4
shares will do if crude pulls back. My guess is the stock could really pop. I would also note that the current yield of 12.1% is pretty appetizing. While I’m not ready to add the stock to the Dividend Superstars portfolio right now, I wanted to point it out as a very interesting niche oil & gas highyield play. If I see a time to buy, I will let you know. Calumet Partners (CLMT)
SUPERSTAR INSIGHTS Teaching Kids About Money My daughter is only ten months old, but I’m already anticipating the day she comes asking me for money to buy the latest designer handbag. In fact, I’m envisioning how I’ll use her request as a way to talk about the importance of money and sound spending habits. Last time I checked, very few elementary schools — or even high schools, for that matter — were teaching kids anything about finance. And that’s a shame because not every student will ever use their knowledge of frog anatomy, but every single one will have to make major financial decisions. So, if you have a child or grandchild in your life, I encourage you to do all you can to help set them along a path of financial independence. Here are just a few ideas to consider: #1. Get them started on an allowance early. When it comes to money, I think it’s important that kids get their hands dirty. They need to receive a set amount of cash to call their “own.” Heck, it’s easy to ask grandpa to buy something for them. It’s a little different when grandpa gives them the money and makes them spend it on their own. The personal connection with the exchange becomes far more real. Depending on the child’s age and inclination, you may even let them direct many of their own basic purchases (for
example, school clothes) so long as they stay within predetermined criteria. #2. Teach them about budgets. This dovetails with the idea of an allowance. Children, even at a fairly young age, are perfectly capable of keeping a little notebook that tracks how much money they’ve been given and what they’ve spent it on. Have them write down a future purchasing goal, then help them track their progress toward that end. #3. Open up a savings account … and let them see the progress! If you’ve established some sort of savings account — whether a taxsheltered college plan or a regular passbook account — that’s terrific! But I think it’s equally important that you show the beneficiary the account’s progress. Nothing brings home the power of compounding interest like seeing it in action. You might even consider doing a simple chart that shows how the account is increasing, and what it will likely become a few years down the road. #4. Explain your own choices and purchasing decisions. Is it time to shop for a new car or dishwasher? Major purchases are a great way to teach the importance of research, comparison shopping, discounts, and negotiation. Ideally, you can have them help you read through reviews, calculate price discrepancies, or even accompany you on the actual purchase day. 5
#5. Show them how the markets work. When I was young, I was fascinated with the business section of the newspaper. I would watch the prices of various stocks every day. Now, children can create dummy portfolios through various websites or check realtime prices online. Having some adult guidance to explain the various moves would be a terrific learning experience. #6. Give them an investment of their own. Watching those stock prices got even more exciting once I owned a few shares of IBM! Sure, when the value fell, I was upset. But it also taught me a great deal about risk and volatility. Heck, model portfolios only go so far … and that’s why, if you have the means, I suggest giving a child a few shares of a major brand-name stock. Plenty of kids know about Disney, Nike, and Coca-Cola … why not let them “own” a little piece of the firm, and explain the benefits (especially the importance of dividends, of course!). Those are just six ways to get started, and surely there are plenty of others. You may have your own approach, or various ways to tweak my suggestions. That’s great — every child is different and every person has their own teaching methods. But the important part is showing our kids the importance of making sound financial decisions before they come asking to borrow our credit cards!
SUPERSTAR PORTFOLIO A Sideways Month for Stocks, But the Dividends Keep Rolling In! Altria finally completed its spinoff of the international tobacco business. The two entities are now trading separately on the New York Stock Exchange — the domestic tobacco company remains listed under the old “MO” ticker and the new unit, Phillip Morris International, trades under the symbol “PM.” Essentially, nothing is different — you own precisely the same amount of the overall businesses that you did before the split. However, the market is now able to better value each segment. What will happen next? I expect MO will be viewed as a stable, income-generating stock and enjoy slow, but steady appreciation while kicking off nice dividends. On the other hand, PM should see its share price rise at a faster clip. And apparently, I’m not the only one who expects that — JPMorgan analyst Erik Bloomquist began coverage of the shares with an “overweight” rating and set a price target of $62 a share. Because our focus is dividends and income, I definitely recommend holding MO. And I also think you should continue to hold PM because the market will likely bid the shares up. If and when I see an opportune time to take profits, I’ll let you know. Kinder Morgan Partners posted great first-quarter results on April 17. The company said
profits amounted to $0.63 a unit vs. a loss of $1.23 a unit in the same period a year earlier. Analysts had been expecting a per-unit profit of $0.53! The even better news was that KMP boosted its quarterly cash distribution payment to $0.96 a unit vs. $0.92 last quarter and $0.83 a year ago. So far, the shares are up 14% from my initial recommendation, and that doesn’t include dividends. Great, keep holding! Consolidated Edison announced its next quarterly dividend payment on April 17. The $0.585 per-share payment will go to shareholders of record as of May 14 and will be payable on June 15. Bank of America reported weak first-quarter earnings of $0.23 vs. $1.16 a share in the same period a year earlier. The poor performance is not much of a surprise, given the lousy conditions plaguing financial firms right now. On the positive side, the company said it is building up its cash reserves to protect against future losses. I would also point out that BAC is at least maintaining its profitability at a time when most of its peers are losing money left and right. So while I don’t expect a quick return to the halcyon days, I continue to think the shares are a solid holding. Gannett’s earnings dropped 9% in the first quarter of 2008 because of weaker demand for advertising. The company cited real estate classified ads as a particularly challenging area. The 6
company’s online businesses posted a slight revenue increase in the quarter, which I take as a positive sign. Overall, I think the shares are near a bottom, but it remains to be seen whether the publishing industry can regain investors’ confidence. Pfizer posted an 18% drop in its first-quarter earnings. Results were hurt by tougher generic competition for the company’s blood-pressure drug Norvasc and allergy treatment Zyrtec. Pfizer pulled in $0.41 a share in the quarter, but would have earned $0.61 excluding costs associated with two acquisitions. A lot of investors are treating the poor earnings as a death knell for the company, especially since Lipitor — PFE’s biggest product — will also lose patent protection in 2010. However, I’ve watched countless drug stocks go through these cycles before, and I continue to believe it’s smarter to buy when things look the worst. This is still the world’s largest drug company … it still delivers big, fat dividend checks … and it is making strong moves to reorganize its operations and focus on new drug development. For all those reasons, I remain positive on the shares. Integrys Energy declared a quarterly dividend of $0.67 a share, which is payable on June 20 to shareholders of record as of May 30. In the same release, the company reminded investors that it has paid dividends for 68 straight years and increased its payment annually for (Continued on next page)
SUPERSTAR PORTFOLIO COMPANY NAME
NUMBER OF SHARES
5-YEAR DIV. GROWTH
HOW DIVIDENDS ARE PAID
Bank of America
Energy Transfer Partners
Kinder Morgan Partners
TOTAL RETURN Biovail Colgate-Palmolive McDonald’s
Nam Tai Electronics
Philip Morris International
American Capital Strategies
Consolidated Comm. Holdings
The table includes all open positions recommended in the monthly Dividend Superstars newsletter or flash alerts. The model portfolio assumes a total investment of $100,000. If your portfolio is larger or smaller, you should adjust the specific recommendations accordingly. Dividend data is sourced from Bloomberg. Data date: 4/23/2008 * One-year growth # Spun off from MO on this date; prices adjusted to reflect the transaction; dividend figures will be readjusted when new declarations are made.
a half century. Not too shabby! Separately, Integrys announced the potential purchase of 500 megawatts of electric capacity, energy and renewable attributes from Manitoba Hydro Electricity. The deal is worth about $2 billion and would span a 14-year period. McDonald’s reported earnings on April 22, and things looked very good. The company’s first-quarter profit rose 24% vs. the same period a year earlier. Results were helped by very strong international growth — European
sales gained 23% and Asia/Middle East/Africa revenues increased 24%. And the slumping U.S. dollar makes all those foreign sales far more lucrative! Consolidated Communications declared a dividend payment of $0.38738 per share, which will be paid on May 1 to shareholders of record as of April 15. Not much else has happened with the stock since my initial recommendation, but that single payment represents a very nice little return on your 7
investment. Moreover, it’s encouraging to see these ultrahigh-yield plays continue to reward shareholders even during very tough economic times. Lastly, the two positions I recommended last month — Huaneng and Nam Tai — have produced mixed results so far. Huaneng is still attempting to bottom out, but I’m confident it represents good value right now. Nam Tai, on the other hand, is already in positive territory. Continue holding both!
QUESTIONS & ANSWERS Q: Why do you not include anything about Canadian Royalty Trusts? Are you against them, consider them unsafe, or what? A: Canadian royalty trusts operate much like Master Limited Partnerships and REITs here in the U.S. They have been granted special tax exemptions from the government so long as they pay out their income to unit holders in the form of dividend distributions. That means very high, relatively stable yields for their investors. Unfortunately, the Canadian government is planning on removing that special tax exemption beginning in 2011. Any current trust will then automatically begin paying corporate taxes just like other regular Canadian companies. This removes a trust’s incentive to pay out big distributions to shareholders, and makes reinvesting profits into the business a more logical choice. What will happen in the interim? Hard to say. The laws could change yet again, and the trusts could end up keeping their current structures. In fact, just a few weeks ago, Alberta recanted on some of its announced changes, giving trusts relief worth about $237 million a year. The government’s moves were aimed at appeasing the companies and to encourage development of new deep oil and gas wells.
However, some trusts may very well convert to regular corporate structures before the 2011 deadline. Others may simply fold up their operations or reduce their payouts. It is precisely this uncertainty that has kept me away from the segment altogether. Bottom line: There are still some attractive Canadian Royalty Trusts out there right now, but you need to be very selective, and aware of the risks currently surrounding these investments. Q: What are fiscal years and why do companies have them? A: A fiscal year is simply the business calendar that a company uses to report its results. The majority of companies follow the regular calendar – in other words, their fiscal years end on December 31. However, roughly a quarter of U.S. companies choose to end their years with a different month. Some have good reason to do so. For example, retailers often end their calendars in January. That allows them to record all their holiday sales into their current fiscal year. While it technically doesn’t matter what year they record the sales, I suppose they like to go out with a bang. A lot of technology companies also have wacky fiscal years. In many cases, this is simply related to the date of their initial public offering or because their competitors also use the same fiscal year. 8
The only reason I suggest paying attention to a company’s fiscal year is so you’ll know when to expect quarterly earnings releases as well as dividend payment announcements. The two tend to go hand-in-hand. Q: It seems like a lot of companies have been cutting their dividends recently. Should I be worried? A: There’s no question that the slumping U.S. economy is forcing some firms to reduce, or suspend, their dividend payments. And it has certainly made it harder for firms to increase their payments. According to recent data from Standard & Poor’s, 83 U.S. common stocks decreased their dividends in the first quarter of 2008 vs. just 19 in the same period a year earlier. That’s a 337% rise! What’s more, 19.2% fewer companies increased their dividends during the quarter. But I don’t want to paint all firms with the same brush. Larger companies, particularly those with longer histories of dividend payments, look far more likely to continue their streaks. In fact, S&P noted that large-cap stocks had a far greater tendency to increase their dividends (27.2% vs. 18.7%) and a lower tendency to decrease (2.1% vs. 5.7%). Moreover, they continue to expect S&P 500 constituent companies to boost their payments 9.3% this year.