“Dividend Superstars: Part 2 … Shipping and Secret Investments”

by Travis Johnson, Stock Gumshoe | August 2, 2008 12:36 pm

This is the continuation I promised on the “Dividend Superstars[1]” teaser from Weiss Research[2] — we looked first at the rural telecom company with the 10%+ yield, and now we’re moving on to a secret investment company and a shipping company, both with yields over 15%.

If you’d like to hear my introductory blathering and read about the telecom pick, you can either go back in time or click here to catch up. For the rest of you, let’s move on …

“Dividend Superstar#2: 15.7% Yield from a Secretive Investment Company That’s Paid Dividends for 43 Quarters Straight”

What kind of clues do we get for that?

“… you can buy this company’s shares and it pays very juicy, steady dividends[3]. It currently has about 220 businesses in its portfolio. That gives it tremendous diversification across sectors and industries.

“What’s more, because of the way this company is structured … It must keep its debt under control, making it one of the least leveraged publicly traded financial companies in the U.S., and …

“It must pay out 90% of its profits to shareholders in the form of dividends!

They have paid a dividend for 43 quarters in a row, for all of their 11 years as a public company, for a total payout over that time of more than $2.3 billion. Doesn’t help us much, I suppose, but that’s a fair chunk of change.

And their dividend has compounded at a growth rate of 12%. Not bad.

The company, dividends included, has returned about 18% a year for the last decade.

So that all sounds lovely, no? What is our fine divvie king?

Thinkolator sez …

This is American Capital Strategies (ACAS)[4]

ACAS is one of several BDCs[5] and similar mid-market lenders who are based within a stone’s throw of my home in Washington, DC — Allied Capital and CapitalSource are two other nearby ones. A BDC, for those who don’t know, is a Business Development Company, and they have quite similar rules to REITs[6] — they are not taxed on the corporate level, but have to restrict their leverage (1:1, I believe, meaning they can borrow only 100% of their portfolio value, versus investment banks that typically have levered up 30:1), and pay out most of their earnings as taxable dividends to shareholders.

What do these guys do? Essentially, ACAS and most of their competitors, compalies like Allied Capital, Gladstone Capital, and Apollo Investments, raise money by selling equity, and use that money to lend to midsize companies that are too large to go to the neighborhood bank, and too small or disinterested to be publicly traded. This can take several forms, sometimes they are straight loans, sometimes they are equity investments combined with loans … these are essentially private equity companies that don’t use much leverage.

So … because they’re lending to these relatively small companies and taking equity positions in many cases, they can get higher returns than a bank might, even with lower leverage, so they have tended to have very nice dividends, 6-7% when they were popular investments in past years, and often 20% now that everyone is terrified of companies that do any kind of lending.

I can’t tell you all about ACAS here — it was started by a very colorful guy in his apartment in Bethesda, MD not much more than ten years ago, and has been an incredible grower during that time — they really have paid out more than $2.3 billion in dividends since they went public in 1997, not bad for a company with a current market cap of about $4 billion.

And they are hated, hated, hated right now. The teaser indicated this was a 15% yield, and it was not long ago, but the shares have taken quite a beating, down 20% in just about two weeks. They release earnings next week, on August 6 — an august day, indeed, being also the anniversary of the birth of the mighty Gumshoe.

I’ve been intrigued by this company from afar for a long time, but haven’t been willing to take a chance on them just yet — it’s getting to the point where the shares are so inexpensive that I might get interested soon, they do have a very diversified portfolio of equity and debt holdings, and they just spun off an IPO[7] of a company that will invest in agency (mostly mortgage) debt, so they’re not standing still during this turbulent period. There was a big volume selloff of the shares a few weeks ago, but other than that the shares have not traded anywhere near this low since 2003.

There are absolutely some risks with this one — they took a hit when they had to adopt new accounting rules in the first quarter of this year, essentially the same mark-to-market rules that made all the banks look bad (they have to write down a loan to fair current value and report that change on the income statement whether or not they sell the loan). At the price it’s trading now, a significant discount to last quarter’s book value, I have to assume that investors are afraid of more writedowns or future dividend cuts — management has said that they expect $4 in dividends this year, which would mean maintaining the current rate, though who knows if that promise extends to 2009. The cash earnings that they have to pay out as dividends (at a 90-98% rate, generally) are not the same as the accounting earnings, since with the mark to market writedown last quarter they actually reported a loss, but still paid a hefty dividend of over $1.

The big question for ACAS investors, or investors in any of these BDCs, is whether you think they’ll take a beating on loan defaults from their portfolio companies — will the nonperforming loans spike up if and when the economy continues to struggle? It’s certainly always possible, and that rate has gone pretty high during tough economic times before — I like that ACAS has a relatively large and diversified portfolio, and has a history of openness about their portfolio positions, but that’s no guarantee that they won’t suffer, even suffer more than they already have.

I’ll be watching this one around earnings — I’m curious to see what their comments are about the performance of their loan portfolio, in particular, and their confidence in the viability of the dividend. Not sure I’m interested in buying, but I like this sector more than traditional banks and investment banks, since the lack of leverage and the diversification allow for some downside protection, and I am starting to get a little bit tempted. We’ll see.

Didn’t mean to throw out that much speechifying about Mahlon and his ACAS gang … will squeeze the next one in quick:

“Dividend Superstar #3 15.4% Yield from Fleet of Profit-Gushing Oil Tankers That Generate Up To $4.4 Million Each Day”

“Oil companies are geysers of cash. No secret there. But an even steadier business is the massive container ships that transport the oil[8]. These companies churn out fat profits whether oil prices are up or down.

“If you own those ships, you stand to rake in a constant stream of cash, and that’s especially true of my favorite dividend superstar in this sector.

“Take a guess how much it charges to use one of its ships! In the first quarter of 2008, the average rate for one of its Very Large Crude Carriers (VLCCs) was $82,400. And according to early numbers, it was getting an average of $112,000 in the second quarter.

“Once you realize that the company boasts dozens of ships, you’ll get a sense of just how much money it can make in a single day. Take the average day rate from early 2008 and multiply it by 54 — that’s $4.4 million in 24 hours.

Has paid out dividends that are pretty remarkable:

“In 2005, it handed investors dividends of $8.10 per share.

“In 2006, it paid out dividends worth $7.55 a share.

“And in 2007, it paid dividends of $8.25 per share.

What else does our friend at Dividend Superstars tell us?

“Looking ahead, whether oil is up or down, I certainly don’t see less oil being shipped anytime soon. And I should also note that this company is involved in transporting other hot commodities like coal[9] and iron, too. If anything, rising worldwide demand for natural resources argues for even bigger profits ahead for this shipper.”

Well, time escapes me but I’ll just tell you that this is almost certainly …

Frontline (FRO)[10]

He’s got the dividend payments understated, as far as I can see — I think they paid more like $11 in dividends in 2007, but perhaps we’re using different calculators. No other VLCC owner pays out nearly as much in dividends as Frontline, the massive oil tanker owner (well, now operator more than owner) controlled by modern-day viking John Fredriksen.

I’ve written about FRO several times before — it has been picked, quite successfully, by other newsletters in the past and is one of the top-performing picks here in Gumshoedom, though it’s also a stock that gives analysts fits, especially when compared to more conservative US tanker companies. I also owned the shares for a couple years and enjoyed a couple years of very nice dividends as they started their huge leveraging process to take advantage of high tanker rates, the phaseout of single-hulled tankers following a raft of spills, and low interest rates — they essentially sold their whole fleet to a subsidiary (Ship Finance Limited), then spun off that subsidiary to shareholders and as an IPO, and leased back all the tankers at a fixed (cheap) long term rate with a bit of profit sharing thrown in. That was the source of a lot of those dividends in 2005 and 2006, the capital gains from selling the tankers, but generally high tanker rates have also allowed them to continue to pay out huge dividends, a hallmark of a Fredriksen company (he usually owns about 30% of the equity of his companies, and likes to return capital to shareholders, himself included, through dividends that come as quickly and as generously as possible).

If you’re curious about my previous notes on Frontline, there was one back in January when it was also teased as a high yielder[11] — it certainly is a high yielder, around 17% at the moment (one-time special dividends[12] plump up that number), but also quite volatile and in a very competitve supply/demand business, so keep an eye on tanker rates and newbuilds if you want to see how Frontline is likely to perform in any given quarter, they’ve had some tough dips in the last few years since I’ve owned them, as well as some nice runs up and some fantastic dividends … and they have a lot of very loyal individual shareholders who loooove those dividends, so take care not to be standing in front of the exits if the divdiend policy were to change signfiicantly, or the dividend get cut dramatically, in the months ahead.

It might also help to think about where oil is coming from and going to — that’s what really matters for the day rates for oil tankers, which for companies like Frontline that don’t fix many long term charters (they tend to charter at much more volatile day rates for single voyages, as opposed to leasing a ship for several years to an oil company). If we get much of our oil from Venezuela, Canada[13], Mexico[14] and Nigeria, then the ships have to travel less far to deliver their huge loads of crude to Louisiana. If Venezuela stops selling to us, or Nigeria cuts production, then the marginal barrels of oils that the US needs have to come from the Middle East[15] or other, farther away locales, that means longer trips on tankers, especially if they’re the biggest, most efficient VLCCs that have to go around the Horn of Africa[16], and therefore more demand for the ships and higher rates. It’s a complex business, with many folks following it very closely, though the shares also often move in sympathy with oil prices even if that doesn’t necessarily make sense.

Fredriksen is also an M&A junkie who believes that many companies could benefit from his aggressive financial strategies, so he’ll be taking runs at other companies that could bring movements in either direction to the share price — most recently he’s been sniffing around Overseas Shipholding Group (OSG), a much more staid US company that has a very similar business in shipping oil and petroleum products.

And finally, there have also been a few decent articles on FRO over at SeekingAlpha[17] in recent months, and there was a good chat about it at the Gumshoe forum[18] just recently, so there’s plenty of opportunity to do some learnifyin’ if you so desire.

For full disclosure, my personal largest holding, Seadrill, is also a Fredriksen company that is implementing this same sale/leaseback leveraging strategy for a fleet of deepwater drilling rigs as FRO did for tankers, but I no longer own Frontline and I do not own shares of American Capital Strategies (I do still hold shares of CapitalSource, which was briefly mentioned above).

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