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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 (HTE), 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

Dividend Growth Investor

www.dividendgrowthinvestor.com


Rating: 2.8/5 (15 votes)

Comments

DUFFTOM
DUFFTOM - 5 years ago
I agree that there are some who, lacking better ideas, promote Canadian royalty trust as the solution to the need for cash flow. The concerns expressed are valid, but the potential for an income stream to disappear in january 2011 or at any other time is not limited to Canadian royalty trusts.

I have no wish to denigrate any company, but we have seen, in the past year, companies with a long term history of stable or growing dividend payments cut their dividend payments. I have, at this time, particular concern over certain drug companies, frequently promoted as income stocks, whose performance in research and innovation is weak but who seem to believe that they can succeed through sales and marketing. Their day may be over. In my view the future of health care does not lie in pills.

Any income investment requres consideration, not only of the yield, but of the security of that yield, and of the value in the absence of that yield; remember that many of these Canadian royalty trusts have valuable properties. Yield is not the only source of gain.

Investors should also remember that not all Canadian trusts are royalty trusts; some are closet growth companies, which find that the structure works for them, until, in 2001 they convert to some other workable structure.

I am not in the business of telling people how to manage their money; they have to do their own homework. Ideas are always worth considerating but only you are commited to your own best interests.
value_barbarossa
Value_barbarossa - 5 years ago
I think that certain domestic MLP's may be superior alternatives to CanRoys.

If you're looking for the potential for long term double digit dividend yields I believe these can be acquired right now by purchasing units in certain MLP's with quality assets that have reduced or eliminated distributions in order to pay down debt.

Two examples that I hold are EROC and BBEP. Both of these are as strong or stronger financially than the typical royalty trust; they don't constantly dilute stakeholders (although it's always a possibility if they can't pay down debt fast enough). The debt is not obscene on these, but with crazy low NG prices many of these MLP's will struggle to remain in compliance with their loan covenants.

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