Wednesday, April 29, 2009

High-Yield Canadian Royalty Trusts vs Dividend Growth Stocks

Dividend growth stocks typically leave themselves some wiggle room in order to lessen the probability of a dividend cut due to earnings volatility. That’s why normal recessions don’t stop them from increasing distributions. They do pay out lower yields, but the dividend payments are stable, growing and you know that the cash, which the company generates, is also reinvested into the business. The balanced approach of rewarding shareholders while also growing the business is very appealing to income investors who are looking for an inflation proof form of dividend income. Investors who selectively purchase from the dividend aristocrats, dividend champions or dividend achievers lists are true visionaries who do not chase high current yield but look for stable, wide moat businesses which could generate enough earnings in order to support long term earnings and dividend growth in addition to expansion of the business. Nobody ever bought Wal-Mart (WMT) for its yield – yet it has been one of the best performing dividend growth stocks over the past 3 decades.

High Yield Canadian Royalty Trusts on the other hand pay all of their cashflows out as dividends. They grow by selling more units and diluting your stake. There is also some uncertainty about the tax structure of the income trusts after 2011. Currently there are imposed limits on the amount of units Canroys could sell in order to maintain their current status by 2011.

Many investors believe that CanRoys are the only solution that generates enough income for them to supplement Social Security. Actually you shouldn’t spend more than 4% of your portfolio every year. If you do, you are risking spending it all before you die, which is not a good solution for most retirees.

It’s great to receive a 12% yield on cost, but you have to ask yourself how sustainable is that payment? What if the dividend is cut by 50%? Then you are only making a 6% yield on cost. If you are a retiree who is living off their portfolio, spending up to 4% of your portfolio would leave some unused balances to be reinvested and provide some buffer in bad years. If you need an income trust yielding 20% in order to retire, then you don’t have enough money to stop working.

Dividend Growth investors tend to purchase the aristocrats and the achievers primarily for their smoothly growing dividend payments. Stock prices are volatile enough to stomach, thus a dependable and a growing stream of dividends is providing a safety cushion even during the worst bear markets over the past 70 years. If you also have volatility in dividends, then retirees can’t safely live off their investments.

An income investor should not concentrate only in the sectors, which are traditionally the best yielding ones. For example dividend investors have traditionally bought utilities and financials for their stable yields. The 2007-2009 financial crisis has pretty much left financials out of the income investor’s radar screen.
Canadian Income Trusts were very popular among income investors up until 2006 when Canada decided to gradually phase out the Income trust structure by 2011. Since then trusts have cut dividends across the board as their stock prices have collapsed.

Pengrowth Energy Trust (PGH), which engages in the acquisition, ownership, and operation of working interests and royalty interests in oil and natural gas properties in Canada, currently yields 15.80%. The current monthly distribution of $0.081/share is 63% lower than last year’s payment.

Penn West Energy Trust (PWE), which engages in acquiring, developing, exploiting, and holding interests in petroleum and natural gas properties and assets, yields 21% at the moment. The most recent monthly distribution of $0.187/share is 44% lower than last year’s payment.

Advantage Energy Trust (AAV), which operates as an oil and natural gas exploration and development company, has discontinued distributions according to its most recent March 20 press release.

Harvest Energy Trust (H T E), which engages in the exploitation and development of petroleum and natural gas properties in western Canada, has reduced its monthly distributions by 87% over the past year to $0.039/unit. The trust currently yields 11.50%.

The lesson to learn is not to put all your investments in one basket, such as one sector for example.

Remember the story of the tortoise and the hare – the slow and steady wins over time, not the hit or miss approach.

There are many dividend aristocrats whose dividends are safe and would be growing over the next several years. A sample list of dividend aristocrats, which have been growing payments for over 25 years include:

Mcdonald’s (MCD), which franchises and operates McDonald’s restaurants in the food service industry worldwide, has been a consistent dividend grower for 32 consecutive years, currently yielding 3.50%. (analysis)

Pepsi Co (PEP), which manufactures and sells various snacks, carbonated and non-carbonated beverages, and foods worldwide, has rewarded shareholders with dividend increases for 36 consecutive years. The stock currently yields 3.30% ( analysis)

Johnson & Johnson (JNJ), which engages in the research and development, manufacture, and sale of various products in the health care field, has increased dividends for 46 consecutive years. The stock currently yields 3.60%. (analysis)

Full Disclosure: Long JNJ, PEP, MCD and WMT

This article was included in the Carnival of Personal Finance: Birthdays Edition Weakonomi¢s

Relevant Articles:

- High yield Canadian Royalty Trusts
- Dividend Aristocrats List for 2009
- The Dividend Edge
- Yield on Cost Matters


  1. Sure sounds like a pyramid scheme to me. At best it sounds too good to be true.

  2. How do you feel about limited partnerships such as Kinder Morgan Energy Partners (KMP) which trades on the NYSE and has a yield of 8.6% today?

  3. I sold my KMP, just recently. I didn't like the owner, Mr. Kinder, taking KME (the operating partner)private in 2008. Sets up a natural conflict. I made a good profit on KME, and KMP, but decided to liquidate KMP for this reason.

    Take a look at BPL, SXL, and OKS.

  4. Nice, but your analysis ignores a couple things. First, the likely future of the energy crisis we're in the middle of. The dividend cuts of the income trusts are already priced in and based on $45 oil or so, and there's a real floor to the field, because people cannot give up heating their houses in the winter and commuting to their jobs. The steadily increasing dividend yield of the Aristocrats is great, but how much of the increase comes from nothing more than the maintenance of market share in a world with steadily increasing population?

  5. Do you think that strict dividend investing is too limited? If you are truly interested in building an income stream for the future, why wouldn't you invest in the best opportunities that you could find, regardless of dividend state. Then down the road, harvest your gains and roll the proceeds into dividend stocks at that time, or even an annuity. I have a post on the downsides of dividends here:
    I'd be interested in your thoughts.

  6. Has anyone ever considered SJT. Paying 8.91 percent as of this date. Located in the southwest US so no split with the canucks.


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