I was attracted by Capital Power Corp.’s (CPX) yield of more than 7 per cent, but the dividend payout ratio is 258 per cent. This is clearly unsustainable, yet Capital Power continues to raise its dividend each year. Why do you own shares of a company that is paying out far more than it makes?
I own Capital Power (personally and in my model Yield Hog Dividend Growth Portfolio) because the dividend is actually very sustainable. You just have to measure the payout ratio the correct way.
The bloated payout figure you provided is based on Capital Power’s earnings. I can only assume you got the figure from a financial website that generates payout ratio figures automatically. Problem is, a power producer’s earnings can be depressed by accounting charges such as accelerated depreciation that don’t affect the actual cash flow of the business. That can make the payout ratio (dividends per share divided by earnings per share) look unsustainably high. It can also make the price-to-earnings multiple (share price divided by earnings per share) look dangerously high as well.
That’s why, depending on the sector, companies and analysts often prefer to measure the dividend payout ratio based on cash flow instead of earnings. Instead of relying on financial websites that do not provide any context or explanation for their figures, I always recommend that investors go straight to the source. Most companies make this information available, and it is important for investors to read it.
On Capital Power’s website, you’ll find a PDF of a recent investor presentation. Page 22 has a colourful chart that shows Capital Power’s adjusted funds from operations (or AFFO, a cash flow measure) rising more or less steadily from 2015 through 2020. Note that dividend payments have been less than 50 per cent of AFFO every year. In 2020, the payout ratio is expected to fall to just 40 per cent – below Capital Power’s long-term AFFO payout ratio target of 45 per cent to 55 per cent.
So, in Capital Power’s case, the dividend appears to be quite sustainable. In fact, the company has indicated that it aims to raise the dividend by 7 per cent in both 2020 and 2021, with an increase of 5 per cent projected for 2022. Dividend increases aren’t official until they are declared by the board, but Capital Power – which has hiked its payment for the past six consecutive years – is sending a strong signal that its dividend is not only sustainable, but will likely continue to grow.
Why have Brookfield Infrastructure Corp.’s shares (BIPC) been outperforming Brookfield Infrastructure Partners LP’s units (BIP.UN) by such a wide margin recently? I thought they were expected to trade at similar prices.
That’s what I thought, too. After all, BIPC and BIP.UN are paying the same quarterly dividend/distribution of 48.5 US cents per share/unit. The only difference is how the amounts will be taxed, with BIPC’s dividend qualifying for the dividend tax credit whereas BIP.UN’s distribution has typically included foreign dividend and interest income, capital gains, return of capital and other sources.
In the weeks after the March 31 unit split that created BIPC, the new shares traded closely in line with BIP.UN. But more recently, BIPC has zoomed ahead. BIPC closed Friday at $60.53 on the Toronto Stock Exchange, compared with $56.34 for BIP.UN.
Why the divergence? Well, some investors with non-registered accounts may be selling BIP.UN and buying BIPC to benefit from the dividend tax credit. (Recall that the company is allowing investors to exchange their new BIPC shares for BIP.UN units, but not the other way around.)
Also, some institutional investors that were unable or unwilling to own Limited Partnership units may be acquiring BIPC shares, further pushing up the price. U.S. investors, in particular, are “buying BIPC in a big way,” Frederic Bastien, an analyst with Raymond James, said in an e-mail.
A premium for BIPC is warranted, Mr. Bastien said, citing the dividend tax credit, demand from U.S. institutions and BIPC’s small share float relative to BIP.UN’s. Mr. Bastien is “not sure where the spread [between BIPC and BIP.UN] ultimately settles at, but it is reasonable to assume one will remain,” he said.
It’s worth noting, however, that BIP.UN’s lagging price means that it now offers a higher pretax yield than BIPC. Based on an annual distribution of US$1.94 converted into Canadian dollars at the current exchange rate, BIP.UN now yields 4.79 per cent, compared with BIPC’s yield of 4.46 per cent. Whether that yield premium will be enough to entice more buyers into BIP.UN remains to be seen.
I saw that you sold A&W Revenue Royalties Income Fund (AW.UN) in your model Yield Hog Dividend Growth Portfolio. Did you sell AW.UN in your personal portfolio, too?
Yes, for the same reason that I sold it in my model portfolio: AW.UN has stopped paying distributions and there is no clear timeline as to when the distribution will resume or at what level. I might miss out on a rebound in AW.UN’s units, but I would prefer to put my money into companies that are continuing to pay dividends and whose businesses are facing less uncertainty.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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