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Choosing Stocks over Bonds

December 13, 2013 | About:
Fede Zaldua

Fede Zaldua

In the search for yield, activist hedge fund managers have successfully pushed managements towards increasing dividends and buybacks. The results are clear: Many high quality companies are paying cash dividend yields that closely resemble what those companies pay for their 10 year bonds. This does not surprise me when I see 10 year US treasury yields trading at almost the exact same level as the MSCI world dividend yield index. Still, the average payout ratio of US companies is 10% off its long run median. Let's take a look at two companies. The first one not only does pay a high cash dividend yield but also should keep on increasing its current payout ratio. The second company is a highly leveraged play which pays a dividend yield that surpasses the yield US high yield bonds are currently paying.

On the Road Toward Recovery

British Petroleum (BP), held by Baupost's Seth Klarman, is now recovering from the 2010 platform explosion in the Gulf of Mexico that shed over $40 billion from the company's market capitalization. Nowadays, the company expects cash margins from its major new projects to be twice the average of it current portfolio while the company also expects its stake in Russia's Rosneft to start paying back much higher dividends. In October this year the company decided to cement a trend which is here to stay: British Petroleum decided to increase its quarterly dividend by 5.6% and use $10 billion from additional asset sales to buyback shares. The company now pays a 4.9% cash yield, which is lower than Royal Dutch Shell's (RDS.A) 5.3% cash yield. That said, I believe British Petroleum, in terms of cash dividend payments, will be able to catch up with its peer - which is also increasing its payout - in the coming two to three years.

Risky Business and Huge Dividend Yield

Despite its earnings miss, Seadrill (SDRL), the oil driller contractor held by James Barrow, decided to press the dividend 4% higher quarter over quarter. The company's current divided yield stands at the outstanding level of 9.4%, which is higher than what the average US high yield bond pays. Clearly, such huge yield means that the market is seeing huge risks involved to the sustainability of the dividend. Indeed, the company remains the most leveraged play to the offshore drilling cycle. As a matter of fact, Seadrill has the most aggressive order book of all the drillers and its net debt stands at almost 4 times the company's 2014 EBITDA. Nevertheless, Seadrill's upcoming contracts give the company the very much needed visibility in terms of revenues. For example, a tentative agreement with Mexico's Pemex would assure Seadrill a revenue potential of well over $1.8 billion. If you can bear the risks involved to a leveraged play into a risky business such as offshore drilling and you are looking for yield, Seadrill looks like a compelling option.

Bottom Line

With interest rates still near the zero lower bound, companies that pay high cash dividend yields are increasingly compelling. Today's market offers hundreds of options. You may find many strong companies like The Coca Cola Company (KO) - which pays a 2.8% dividend yield - that will forever keep increasing their cash payouts to its shareholders. All those companies look like a much safer place to keep your money from losing value than bonds with low coupons trading well above parity, which is pretty much the norm right now.

Rating: 2.3/5 (3 votes)


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