Brian Rogers is the portfolio manager of the T. Rowe Price Equity Income Fund, and he has been in this position since the inception of the fund in 1985. He focuses on dividend payers, but does have a quarter-over-quarter turnover rate of 33%. His 10-year cumulative return is 52.5% compared to the S&P 500's cumulative return of 16.4% over the same period.
His portfolio consists of numerous dividend-paying companies, and is heavily focused on telecoms (he owns all three top U.S. ones, as well as Telefonica), and utilities. This article will select five of his holdings, representing multiple industries, to discuss.
Behind AT&T (T) and Verizon (VZ), CenturyLink is the third largest telecommunications company in the United States, and the company offers the largest dividend in the portfolio. CenturyLink acquired Embarq in 2009, Qwest in 2010 and Savvis in 2011, and all of these were multi-billion dollar mergers/acquisitions.
The company currently provides broadband, voice and wireless services, and with the acquisition of Savvis, now offers enterprise cloud infrastructure and IT solutions. It's an interesting mix of old and new business: their landline phone segment is losing customers, while their cloud solutions are poised to bring in new customers and already holds a significant amount of the Fortune 100 as customers. Due to the complexity and scale of all these recent mergers, comparisions and predictions are difficult, and I wouldn't consider it to be nearly as conservative as the typical telco.
As far as the dividend is concerned, the payout ratio is high, and growth is inconsistent. The yield, however, is quite large. The company paid $0.725 per quarter throughout 2010 and 2011 (no raise between the years), and paid $0.70 per quarter before that. Prior to that period, the company structure was much different, and the quarterly dividend was a tenth of the amount. Currently, the earnings payout ratio is approximately 140%, and the free cash flow payout ratio is approximately 60%. Operating cash flow significantly exceeds net income for CenturyLink due to the large depreciation reductions. I'd suggest that the earnings payout ratio presents a misleadingly high figure, and the free cash flow payout represents a misleadingly low figure. In my view, while the dividend is not necessarily immediately at risk, the very high payout ratio is a significant concern, and I wouldn't classify the dividend as particularly safe or likely to grow at a solid rate.
AT&T traces its history back to 1877 as the Bell Telephone company, but its recent history extends back only to the 1980's, when AT&T was split into seven companies. Since that time, the companies have once again consolidated into what is today AT&T, Verizon, and CenturyLink. AT&T is one of the largest companies in the world, with a market capitalization of nearly $170 billion despite trading for under 10x earnings.
Currently, AT&T along with Verizon is dominant in wireless services in the United States, and AT&T owns its entire wireless subsidiary. The company still derives significant revenue from landlines, however, and no longer has exclusivity on the iPhone. The company also requires significant network upgrades to deal with the ever-increasing data consumption of smartphones and other devices. AT&T's decision to acquire T-Mobile has been blocked by the U.S. Department of Justice, and if unsuccessful, will result in a $6 billion loss for the company.
Compared to CenturyLink, I believe AT&T's dividend is much safer. While the yield isn't as high, the earnings payout ratio is a more sustainable 50%. The free cash flow payout ratio is around 75%. The growth rate of the dividend is rather slow, but the company has raised its dividend every year in recent times, so there is a significant amount of consistency. Overall, I'd consider AT&T a solid hold for those seeking current dividend income.
Sun Life Financial (SLF)
Sun Life Financial, a Toronto-based financial company, is involved with the insurance, investment, and retirement services. With a market capitalization of over $14 billion despite having a low earnings multiple of well under 10, the company is a rather large insurer. The company is well-capitalized, and to its credit remained fairly strong throughout the extremely difficult conditions of the financial crisis, but the dividend has been held steady with no growth in the fourth straight year now. Earnings have been pretty volatile, and if a deep recession were to occur, the company would likely not be able to maintain the dividend unless it accepted very high payout ratios again. During the 2008-2009 period, SLF was only able to maintain the dividend by temporarily accepting a payout ratio of over 100%.
Overall, while I'm not convinced SFL is a great business for growth, it does offer substantial current yield, and the low valuation provides some downside protection. Modest EPS growth is expected by the analysts going forward over the near term, and despite such a significant dividend yield, the dividend payout ratio is very reasonable.
Exelon Corporation (EXC)
Exelon is a large utility company, and the largest operator of nuclear generators in the United States, with 17 active reactors. The company also has considerable investments in other fairly clean energy areas, including their announcement last to week to acquire First Solar's 230 MW California solar farm. This will be among the largest solar fields in the world. The company also owns regulated transmission assets. There's also the ongoing proposition to acquire Constellation Energy, which would make Exelon the largest energy utility in the country.
The company is at an appealing valuation at only 10 times earnings, but the downside is the static dividend which has not grown for 12 consecutive quarters. This is due to many factors, including decreased revenue during the recession, large obligations to employment retirement plans, and the low prices of natural gas. Exelon's moat has always been that, once built, nuclear energy is extremely cheap to operate. But with natural gas prices so low, they have begun to compete on cost and threaten Exelon's profits.
Overall, I think Exelon would make a solid investment choice for current income, although there is some risk. The earnings payout ratio is very reasonable. The free cash flow generated by the company is erratic due to both volatile operating cash flow and big differences in yearly capital expenditure. My confidence in the company is strong, but while I believe their dividend is secure, I wouldn't allocate a large percentage of my dividend income to Exelon if I couldn't afford the prospect of a dividend cut.
Merck & Co. (MRK)
The New Jersey based Merck and Co. is one of the largest pharmaceutical companies in the world. The company merged with Schering-Plough in 2009, and is currently in a period of integration and cost-cutting. As the company plans to eliminate thousands of jobs through 2015, EPS is expected to rise. Unfortunately, the company's leading drug, Singulair, goes off patent in 2012. The company will have to offset this with continued development and sales of newer drugs. The merger provided substantial pipeline strength to Merck.
The company has a fair balance sheet, with a total debt/equity ratio of under 0.30, and an interest coverage ratio of over 6. The primary downside for shareholders is that the company has held its dividend static for an astounding 29 consecutive quarters. The company has had erratic earnings and cash flow numbers, but based on the payout ratios, I believe the dividend is reasonably safe. There may be some dividend growth available as the company streamlines, but with the inconsistent dividend record, it's difficult to predict.
Full Disclosure and Disclaimer: At the time of this writing, I do not own any of the companies mentioned, and my portfolio can be seen here. Any investment decisions should be performed knowledgeably or with the assistance of a professional.
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