5 Top Dividend Holdings of Seth Klarman: PDLI, BBEP, ITRN, BP, MSFT

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Sep 19, 2011
Seth Klarman is the portfolio manager of The Baupost Group. Founded in 1983, The Baupost Group now manages several billion dollars. His holdings are generally value picks, ranging from obscure companies to large-cap household names. His portfolio has a quarter-over-quarter turnover of 19%.

Although many of his 20 picks do not pay a significant dividend, there are five that do. All of them are value plays, and three are high yielding, lesser known companies, while the other two are well-known companies that pay a moderately sized dividend.

PDL Biopharma Inc. (PDLI, Financial)

PDL is a smallcap pharmaceutical company that developed humanized antibodies, and receives royalties based on the usage of their patents in other drugs. They receive royalties from a diverse set of health care areas, including cancer treatment, treatment for symptoms of multiple sclerosis, macular degeneration, and asthma. The company spun off or sold significant portions of its business in 2008.

The premise behind humanized antibodies is that, unlike antibodies from other animals, the human body's immune system does not reject them. So PDL developed antibodies that are mostly originating from humans, which are more effective but more difficult to produce.

Currently, the company pays a large dividend that is covered by earnings. In addition, the patent revenues are increasing each year. However, the patents expire in 2014. The company paid out very large special dividends when it spun off businesses, but now pays out a regular dividend that doesn't have a long track record. For these reasons, I view PDL's dividend as being extremely unreliable for the long term, and is likely not suitable for a casual dividend investor. The dividends basically have an expiration date, but should be enormous before that date. Klarman traded in, out, and back in his position in PDL, which currently makes up a bit over 2% of his equity portfolio.

Dividend Yield: 10.42%

Most Recent Year Dividend Growth: n/a

Earnings Payout Ratio: 85%

BreitBurn Energy Partners L.P. (BBEP, Financial)

Breitburn is an independent developer and producer of oil and natural gas in the United States. The partnership has operations in several states, including Michigan, California, Wyoming, Florida, Indiana and Kentucky, and total proved reserves are 119 million barrels of oil equivalent. Michigan is the primary location, as it consists of 58% of the partnership's operations output, and 68% of the partnership's proved reserves.

Natural gas is 54% of the partnership's output, while the other 46% is oil. Proved reserves consist of 65% natural gas and 35% oil.

The distribution paid by the partnership was suspended throughout 2009 due to a number of factors including decreased energy prices, risks related to the credit agreement, and principally, costs of litigation with Quicksilver Resources. In 2010, the partnership announced a settlement of all claims with Quicksilver, and the distribution resumed, albeit at a lower figure than in 2008.

Going forward, I believe the distribution is only moderately safe. The total liabilities/equity ratio is approximately 50%, and interest payments are manageable, so by those standards, it looks fine. However, income from operations is erratic, and the relatively small size of the partnership increases the risks since operations are less diversified and single events can cause considerable monetary damage. It's a value play in this regard — smaller and likely riskier than many other partnerships, but offering a higher yield. Klarman has been decreasing his position, and it now consists of 2% of the equity portfolio. The partnership is currently trading for only 90% of its book value.

Distribution Yield: 9.07%

Most Recent Year Distribution Growth: 10.4%

Earnings Payout Ratio: Erratic

Ituran Location and Control Ltd. (ITRN, Financial)

Ituran is a very small (sub $300 million market cap) company that provides products and services related to vehicle theft. The company operates in the U.S., Argentina, Brazil and Israel, and also licenses products for China and South Korea. The principle operation of the business is to operate call centers and enforcement teams (consisting of demobilized soldiers) to track down stolen vehicles via a real time transmitter installed on the vehicle. Much of this revenue is subscription-based. The company also provides electronic RF and GPS devices, fleet management solutions, one-touch emergency buttons, and more. Revenue has more than tripled over the last decade, and cash flow is particularly strong.

The company's dividend has been large, but erratic. It pays an annual dividend, which was $0.205 in 2007, $1.34 in 2008, $0.17 in 2009, $1.50 in 2010, and $1.00 in 2011. The dividend paid out has exceeded EPS in most years. However, cash flow from operations covers the dividend, and free cash flow covers it in some years. Overall, due to Ituran's small size and very high payout ratio, I'd classify the dividend as rather risky, but this is somewhat offset by the solid balance sheet and good growth prospects. The company can probably provide erratic income but not consistent dividend streams. Klarman holds ITRN as about 1% of his equity portfolio.

Dividend Yield: 8.01%

Most Recent Dividend Growth: n/a

Earnings Payout Ratio: 145%

BP PLC (BP, Financial)

BP is one of the world's largest oil companies, and is infamous for the Deepwater Horizon oil spill. The company is obligated to pay $20 billion into a trust, and has continued litigation directed at it. In addition, the company has considerable political risk, both in Russia and the U.S.

Before the oil spill, BP was paying out $0.84 in dividends per ADR per quarter. The spill resulted in a suspension of the dividend, which was then reinstated in 2011 at half of the original value ($0.42). This results in a dividend yield of well over 4%, and the dividend is covered nearly 4 times by earnings. The balance sheet is moderately strong as well, with a debt/equity ratio of around 0.50.

I consider the dividend to be somewhat risky, although not as risky as the previous companies' on this list. The dividend is very comfortably covered by earnings, but after the spill, free cash flow has been negative. There is uncertainty about political risk, and oil prices affect the profitability and potentially the dividend of the company. For example, BP held the dividend static rather than growing for two years even before the oil spill, as oil prices fell. Still, with a P/E of less than 6.5, and a dividend that is at least easily covered by EPS, this may not be a bad time to get into BP stock, and it certainly seems to be a value play in line with Klarman's investing philosophy. Klarman recently started a position in BP with approximately 10% of his equity portfolio.

Dividend Yield: 4.23%

Most Recent Dividend Growth: n/a

Earnings Payout Ratio: 27%

Microsoft Corporation (MSFT, Financial)

Klarman also recently began a large position in Microsoft, which now consists of over 12% of his portfolio. The last portfolio I covered, of Arnold Van Den Berg, also included a large position in Microsoft.

Microsoft's stock valuation has been decreasing over this past decade, even as revenue, EPS, cash flow, and the dividend has increased, with the result being a fairly static stock price. But I believe at approximately 10 times earnings, Microsoft may be getting to a point where there is a solid floor for the stock price, and probable eventual stock price appreciation.

The company has a strong and diversified tech portfolio, including Windows 7, Office, Xbox, Xbox Live, Windows Phone, Bing, MSN, and now after a recent acquisition deal, Skype. The company has devoted a considerable portion of its development towards "cloud" computing and some of the more traditional businesses like Windows should continue to pull in huge cash flows. Windows 8 has been shown to run on both traditional processors as well as ARM architecture, which is dominant in the high power efficiency world of mobile computing. In addition, Windows 8 has many visual similarities to Windows Phone, such as the "tiles" approach, and has plans to include an app store. Windows Phone is also integrated with Xbox Live. These factors, combined with the company's presence in cloud computing and voice over IP, shows an integrated and continually consolidating software giant with a lot of pieces falling into place.

I consider Microsoft's dividend to be very safe. The company has rather consistently grown the dividend since 2005, and the payout ratio of both earnings and free cash flow is low. The yield is only moderate in size, but the dividend has grown at a double-digit rate, and should continue to do so.

Microsoft's low valuation of only 10 times earnings means the stock can have both a reasonable yield and a very low payout ratio. With total debt/equity of only 0.21, an interest coverage ratio of over 90, one of the few AAA credit ratings, and over $50 billion in cash and cash equivalents, Microsoft's balance sheet is superb. There is however significant and persistent long term risk inherent in technology — Microsoft must continually keep its products competitive, which means the server and tools division of Microsoft is probably going to have to produce a bigger chunk of the growth going forward as computing becomes more server-based.

Dividend Yield: 2.36%

Most Recent Dividend Growth: 23%

Earnings Payout Ratio: 24%

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. Microsoft is on my watch list for possible eventual purchase. Any investment decisions should be performed knowledgeably or with the assistance of a professional.