However, that’s the combined average 2012 dividend income increase from these five of some of the strongest dividend payers around. And considering they offer an average dividend yield of over 3%, that’s not so bad.

These five businesses have fairly strong balance sheets, are some of the largest players in their industries, and have 25 or more years of consecutive annual dividend growth. Many of the bluest of blue chips can potentially have their dividend growth taken for granted since it occurs like clockwork, so it’s good to observe and recognize raises from some of the strongest dividend payers.

The Coca Cola Company (KO)

Topping this particular list with 8.5% annual dividend growth this year is Coca Cola. Sporting only a 2.67% dividend yield, it’s a little light for current income (it is, after all, supporting a P/E of around 20), but the company has strong finances, among the widest of moats thanks to its distribution system and brand strength, and very consistent dividend growth for about five decades.

The dividend income is well-covered by earnings, with a dividend payout ratio from earnings of around 55%. The balance sheet has been a bit strained from the bottler acquisition from not too long ago, but it holds well enough, with a strong interest coverage ratio of over 25.

A key thing to take into account, in my view, about Coke, is that while their reach extends quite so far, it’s still doesn’t have near the market penetration in some of the world’s most populous nations as it does in North America.

From the last Coca Cola Analysis:

Although the Coca Cola Company already has worldwide distribution, their potential in emerging markets is substantial. The average per-capita annual consumption of Coca Cola products is 89 servings according to their own information. The nation with the highest annual consumption is Mexico, with 675 annual 8 ounce servings per capita. The United States is fourth on the list, with 394. The consumption in China and India is only 34 and 11 respectfully, and these are the two most populous countries in the world. Other high population areas such as Nigeria, Pakistan, and Indonesia only consume 28, 15, and 13 servings per year.

So from a health perspective, this probably isn’t good news. But from a financial standpoint, it looks like Coca Cola’s year-after-year growth shows little sign of stopping. That being said, with their valuation where it is now, I’d look for dips before putting more capital towards their shares.

3M Company (MMM)

One might not expect it, but some of the companies with the longest streaks of dividend increases are semi-cyclical engineering businesses- companies like Emerson Electric, Dover Corporation, Illinois Tool Works, Leggett and Platt, and 3M Company. 3M offers a 2.77% dividend yield, with 7.3% annual dividend growth for 2012.

The company’s six business segments are:
Industrial and Transportation
Health Care
Consumer and Office
Displays and Graphics
Safety, Security, and Protection
Electro and Communications

To get more specific, from the 2012 3M Analysis, here are some of their targeted growth areas:

-Water purification
-Environmental protection, sustainability, renewable energy
-Health care in both developed and developing countries
-Automotive OEM growth
-International/Emerging consumer products
-Increased and sustained unemployment in the developed world
-A long term increase in petty crime resulting from economic problems, and 3M’s corresponding safety, security, and protection businesses
-A trend towards worker protection in emerging markets
-The continued trend toward electronic and software interaction, robotics, communication, and globalization

Overall, 3M also offers one of the strongest balance sheets on this list, with total debt/equity under 30%, and an interest coverage ratio of over 30. I’d look for a price dip of 10% or more before committing to a position, however. With Eurozone uncertainty, we may get a bigger broader dip than that.

Johnson and Johnson (JNJ)

Johnson and Johnson offers the highest dividend yield on this list, at 3.83%. I’ve been looking towards health care as a fairly decent area for long-term investment, and yet since the recession, their stock prices have been relatively flat. But flat stock prices and sustainable continued dividend growth means bigger yields, and if JNJ boosts the dividend next year by the same rate as this year, and the stock price is still the same, it’ll breach a 4% yield.

Although many investors have not been impressed by company management over the last few years, at least their drug pipeline is strong, and their areas of operation remain as diverse as ever in pharmaceuticals, medical devices, and consumer products.

From the 2011 JNJ Analysis:

Johnson and Johnson has a strong presence in emerging markets, including the BRIC countries of Brazil, Russia, India, and China. Double digit emerging market growth helps to offset lackluster performance in developed countries, and over the long-term, many developed countries have an aging population that will continue to require large amounts of medical treatment.

As far as comparing balance sheets, Johnson and Johnson is the one on this list that has an AAA rating, and based on balance sheet metrics such as interest coverage, debt/equity, and overall diversification, it looks deserved.

Procter and Gamble (PG)

Much like Johnson and Johnson, PG’s performance over the last few years has been lackluster. The 50+ years of consecutive dividend growth are appreciated, but it’s the future that matters. Can this $180 billion company showcase another half-century of dividend increases going forward, or is it running out of steam?

The company currently offers a 3.50% dividend yield and 7% recent dividend growth for 2012. The dividend certainly looks safe for now, since less than 2/3rds of earnings are being paid out as dividends and the balance sheet is respectable enough, with interest being covered more than 15 times over by operating income, and with a very manageable total debt/equity situation.

From the 2011 PG Analysis:

At it’s core, Procter and Gamble is a brand management company. Their products are often the best around, but their brands just as important. The company owns 23 billion-dollar brands and 20 half-billion-dollar brands.

Developing markets are playing a larger and larger role in the growth of the company, accounting for 29% of sales in 2007 and 32% of sales in 2009. The company has over 4.2 billion customers, and targets 5 billion by 2015.

I view PG as being reasonably valued at the current time, but am not particularly excited about its long-term prospects compared to some smaller businesses, or some higher-yielding businesses. Procter and Gamble is currently undergoing multi-billion-dollar restructuring, including several divestitures, in order to reignite EPS growth. Both JNJ and PG face the need to continue EPS growth if they hope to continue dividend growth.

Colgate Palmolive (CL)

Colgate Palmolive is a leaner competitor to Procter and Gamble. They have the lowest dividend yield and 2012 dividend growth on this list, at 2.45% and 6.9% respectively. The company has been paying consecutively growing dividends since the 1960′s, and currently has a market capitalization of approximately one third of what Procter and Gamble has.

In addition, although Procter and Gamble’s global diversification is impressive, in terms of international sales as a percentage of total sales, Colgate Palmolive actually leads Procter and Gamble. From the 2012 Colgate Report:

Colgate-Palmolive is a very high-quality and diverse international company. Approximately 75% of sales come from outside of North America, and the company defines approximately half of their sales as coming from emerging markets.

The fact that most of the sales of this company come from abroad allows North American investors to participate in the faster growth of some foreign markets. Even among blue-chip American companies that as a group have rather large global exposure, Colgate-Palmolive is ahead of the curve. The company markets their products in over 200 countries and territories, and the Colgate brand has been in Asia for over 50 years and Latin America for over 75 years.

Unfortunately for value investors, Colgate has completely defied the latest market decrease, and went ahead and breached $100 to get a new all-time high. I’d look elsewhere until the stock is a bit less heated.

For a more actionable current investment, this week’s analysis of Philip Morris presents an argument as to why the company is a solid buy at the current price.

Full Disclosure: As of this writing, I am long KO, JNJ, PG, LEG, and EMR.
You can see my dividend portfolio here.

Get the Dividend Newsletter:
Sign up for the free monthly dividend investing newsletter to get market updates, attractively priced stock ideas, resources, and investing tips:

For the 2009-2011 period:
-Revenue Growth Rate: 11.4%
-EPS Growth Rate: 22.3%
-Dividend Growth Rate: 12.2%
-Current Dividend Yield: 3.58%
-Balance Sheet: Significant debt, but very stable

Based on the past growth rate and the long-term growth estimates provided by company management, I calculate that the stock is fairly valued at the current price in the mid-$80′s. Due to the diversified and defensive nature of the business, and compared to the value of the markets as a whole, I believe the stock currently represents a decent buy.

Overview

The company’s history stretches back into the 1800′s, but Philip Morris International (NYSE: PM) is fairly new as an independent publicly traded company. The business was spun off from what is now called Altria in 2008, to focus on international growth and expansion. PM uses Altria’s brands, and is based in the U.S., but does 100% of its business outside of the U.S.

With 78,000 employees and 56 manufacturing facilities, the company operates 7 of the top 15 global cigarette brands, including the number one brand Marlboro. Their top ten brands by volume are Marlboro, L&M, Fortune, Bond Street, Parliament, Philip Morris, Chesterfield, Sampoerna, Lark, and Dji Sam Soe. According to the company, Marlboro has been the top global cigarette brand for 40 years, and they sold over 300 billion Marlboro cigarettes in 2011, which exceeds the next two largest international cigarette brands combined. Overall, the number of cigarettes sold by Philip Morris International per year is approaching 1 trillion.

In 2011, Philip Morris International reported $9.2 billion in net revenue from the European Union, $7.9 billion in net revenue from the Middle East, $10.7 billion in net revenue from Asia, and $3.3 billion in net revenue from Latin America and Canada. Revenue and income increased in 2011 compared to 2010 for all four of these geographic segments, with Asia leading the pack in terms of growth. Volume, however, has been more mixed. All of the geographic segments besides Asia saw mild declines in volume in 2011 compared to two years ago in 2009, while Asia has seen large volume increases. Total volume is mildly up.

Ratios

Price to Earnings: 17
Price to Free Cash Flow: 16
Price to Book: very high*
Return on Equity: very high*

*due to near-zero equity

Revenue and Free Cash Flow

(Chart Source: DividendMonk.com)

I prefer to review and provide a longer operating history, but the first full year for the company as an independently publicly traded business was in 2009. Over this two year period, Philip Morris International has grown revenue at an annualized 11.4% pace, which based on their large size, should be lower than this over a longer period. The company targets 4-6% long-term annual revenue growth, according to a recent presentation. Excise taxes, which total over $40 billion annually, are not included in the revenue chart because those represent an artificial price increase that goes to governments and are not representative of true profit margins and other ratios.

The company, like many tobacco businesses, generates tremendous free cash flows that exceed net income. Selling an addictive product that is mostly based on brand preference, profit margins can be quite high, there is only modest research and development to do, and capital expenditures are very small compared to operating cash flows.

Earnings and Dividends

(Chart Source: DividendMonk.com)

EPS has grown by over 22% annually over this period, but this must come down over a longer period. The company targets 10-12% annual EPS growth over the long-term, according to a recent presentation. The dividend grew by a more modest, but still substantial, 12%.

The current dividend yield is 3.58%, and the payout ratio from earnings is currently around 60%.

How PM Spends its Cash

During 2009, 2010, and 2011, Philip Morris International generated about $25.5 billion in free cash flows, and also issued a bit more debt than it repaid. Over this period, they spent about $13.5 billion in dividends, and about $15.5 billion in net share repurchases (repurchases minus issuance of shares). Only a bit over half a billion was spent on net acquisitions over these three years. Overall, it would be preferable from a dividend investor standpoint to spend a bit more on dividends and a bit less on repurchases, but overall, PM handles its cash fairly well in my view. The free cash flow finds its way to investors in the form of dividend income or greater company ownership.

Balance Sheet

Most tobacco companies, including Philip Morris International, have a great deal of debt on their balance sheets. With an addicted customer base, low input costs, and fairly recession-resistant products, they can safely take on substantial leverage.

Strong balance sheets are a pillar of my investment approach, but strong is relative to the industry. The company has certain lousy debt metrics, such as a total debt/equity ratio of nearly 200 (off the charts, basically), which is due to having close to zero book value and substantial debt levels. The near-zero book value includes nearly $10 billion in goodwill, so the tangible book value is actually negative. But total debt/income is far more reasonable at under 2.5, and the interest coverage ratio is over 15, which is extremely solid. So while the company has substantial debt levels, their overall financial position is quite solid.

Investment Thesis

Philip Morris International has an envious position. They’re based in the U.S., but their business operates strictly outside of the U.S. So while tobacco companies that operate wholly in the United States, such as Altria, face consolidated regulatory risks, Philip Morris international, with its highly diversified geographic position, is buffered from strong regulatory or litigation risks from any specific region. Advertising limitations, excise taxes, and government relationships with their company, are diverse rather than consolidated, and they have full exposure to international and emerging market growth.

In addition, Philip Morris International focuses on premium brands, and so their profit margins are substantial. 7 of the top 15 international cigarette brands are operated by the company, including the world’s flagship cigarette brand Marlboro.

Their free cash flow is enormous due to low amounts of required input costs, and they use this free cash flow basically entirely for dividends and share repurchases.

The company targets 1% long-term volume growth, 4-6% long term annual revenue growth, and 10-12% long term EPS growth. Combined with a 3+% dividend yield, long-term investment returns have solid potential.

Risks

In addition to the usual currency risks and commodity price risks, two key risks for tobacco companies are: reduction in interest in their products, and increases in regulations. In some areas, smoking is on the decline, which of course directly affects the volume of product sales. Regulators can reduce advertising allowance for, increase taxes on, and otherwise impede tobacco companies. In some ways, decreasing advertising can “lock in” the key brands by keeping competition away, but it also makes it difficult to continually establish top brands.

For Philip Morris International, the risks are reduced. With global operations in almost every country outside of the U.S., the regulators from any one country only pose a mild threat. When smoking volume falls in one country, it may rise in another. Having such a broad reach reduces each individual risk.

Conclusion and Valuation

The long-term growth targets for the company are appealing. 10-12% annual EPS growth combined with a 3+% dividend yield is ambitious. Only 4-6% annual revenue growth and 1% annual volume growth are estimated to be necessary to produce this result. This highlights the importance of returning cash to shareholders- much of this total return will come from taking the free cash flow and using it to pay dividends or buy back shares, and all of it is based on fairly mild volume growth and moderate price increases on that volume in emerging markets.

The performance of the company since the spin off has been excellent, the long-term goals are stated, and analysts currently predict a mean of approximately 10% annual EPS growth for 2012 and 2013.

In order to justify the current valuation with discounted cash flow analysis, a 4% long-term free cash flow growth rate and 10% discount rate is sufficient. Using the dividend discount model, sustained dividend growth of 8% per year is necessary to justify the current valuation even with a 12% discount rate. Considering that the company looks for 4-6% revenue growth and 10-12% EPS growth, it appears that the current valuation is therefore tuned to the low end, or slightly below the low-end, of the goals, implying a mild margin of safety on a solid international company.

PM has enjoyed a nice stock run-up over the last few years, but this run-up has been supported by solid performance and growth. Considering that by broad metrics like Capitalization/GDP and Shiller P/E, the market is a bit heated currently in terms of valuation, I think PM represents one of the stronger dividend growth investments out there. The valuation at the current price in the mid-$80′s, based on the above-described methods of calculation, is currently fair.

Full Disclosure: As of this writing, I have no position in PM.
You can see my dividend portfolio here.

Dividend Stock Newsletter:
Sign up for the free dividend investing newsletter to get market updates, attractively priced stock ideas, resources, investing tips, and exclusive investing strategies:

Becton Dickinson Analysis
D4L Analyzed Becton Dickinson and concluded it was a 4-star strong stock.

Four Dividend Paying Companies With Long Term Growth Plans
Dividend Growth Investor provides info on some of the stronger dividend stocks.

Three Stocks to Buy on Weakness
Dividend Mantra points out three very strong companies that are a bit pricey, and would be great at lower prices. All of three of them are extremely robust, which is why the market is paying up for them, currently.

TSX Dividend Stocks
The Dividend Guy is a good source for Canadian dividend stocks.

Telecoms
Defensiven has been loading up on telecom stocks. It’s now his portfolio’s largest sector. Personally, I think that if you’re looking for high yields currently, telecoms and MLPs are the way to go. Regular utilities (in aggregate, not every single one), on the other hand, are generally expensive. Scan through some of Defensiven’s recent posts for info on good European telecom stocks.

5 Stock Portfolio
A Road Paved with Dividends lists his portfolio, and it currently consists of five holdings. All of them have at least 3% dividend yields as of the current writing. Check out which five companies he let into his portfolio.

Railway Battle
The Passive Income Earner compared Canadian National Railway, to Canadian Pacific.

-Seven Year Annualized Revenue Growth Rate: 4.1%
-Seven Year Annualized EPS Growth Rate: 6.7%
-Seven Year Annualized Dividend Growth Rate: <1%
-Current Dividend Yield: 4.08%
-Balance Sheet: Fairly Strong for a Utility

I calculate that Consolidated Edison is somewhat overvalued currently. Utilities in aggregate aren't particularly value investments at the current time, though there are a few fair ones. MLPs and telecoms are currently more attractive areas for high yields in my opinion, with blue-chip tech, health care, and industrial/engineering firms being attractive areas for dividend growth.

Overview

Consolidated Edison Inc. (NYSE: ED) traces its founding back to 1823. This large utility company serves New York, including New York City, and some parts of northern New Jersey and Pennsylvania with electricity, gas, and steam. It also provides energy infrastructure development services.

The regulated businesses are Consolidated Edison Company of New York (CECONY), and Orange and Rockland utilities (O&R). CECONY serves 3.3 million customers electricity, 1.1 million customers gas, and 1,700 customers with steam, mostly in New York City. O&R serves an additional 300,000 customers with electricity in areas surrounding New York, and over 100,000 customers with gas.

In addition to the regulated businesses, ConEd’s less regulated businesses include Con Edison Solutions, Con Edison Development, and Con Edison Energy. These groups participate in the development of energy infrastructure and the wholesale and trading of energy.

Ratios

Price to Earnings: 16.6
Price to Free Cash Flow: Highly Erratic
Price to Book: 1.5
Return on Equity: 9%

Revenue and Free Cash Flow

(Chart Source: DividendMonk.com)

Revenue growth averaged 6.7% per year over this period, while FCF was erratic and often negative.

Utilities have large capital expenditures that are required to maintain and expand equipment, which can keep FCF on the lower side.

The revenue number is solid, except that the trend has been downward since the middle of the reporting period. This is due primarily to a broad mild reduction in annual energy transmission.

-Total kWh’s of electricity delivered by CECONY were approximately 1% lower in 2011 than they were back in 2007.
-Total sales and transportation of gas by CECONY in terms of mdth were approximately 1% lower in 2011 than they were back in 2007.
-Total steam delivered by CECONY was down over 13% in 2011 from 2007.
-Total kWh’s of electricity delivered by O&R were approximately 2% lower in 2011 than they were back in 2007.
-Total sales and transportation of gas by O&R in terms of mdth were approximately 23% lower in 2011 than they were back in 2007.
-Sales of electric volume (kWh) by Con Edison solutions was up over 28% in 2011 compared to 2007.
-Wholesale of electric energy was way down in 2011 to only about a fourth of what it was in 2007.
-Construction expenditures by Con Edison Development has been mildly down.

These reductions in energy volume, mostly across the board, have had a mildly negative affect on ConEd’s revenue, partially offset by rate increases. Modest revenue increases are currently expected by analysts for 2012 and 2013.

Earnings and Dividends

(Chart Source: DividendMonk.com)

EPS had been mildly erratic, and has averaged 6.7% annualized growth over this period. The chart shows a sharp recovery in EPS from the recession, compared to the previously described revenue figures which were in a sustained downward trend.

Although the consecutive years of dividend increases approaches four decades, the dividend has grown at a tiny pace of less than 1% per year over this 7-year period. Each year here, the company has increased the quarterly dividend by half a cent per share. Fortunately, I believe the numbers show that this pace can modestly quicken over time. Back in 2004, the dividend payout was only one penny less than EPS, resulting in a nearly 100% dividend payout ratio from earnings. As EPS has grown, the dividend has grown more slowly, which has now resulted in a dividend payout ratio from earnings of under 70%. This gap doesn’t have to increase forever, and eventually the dividend can sustainably grow at the same rate as EPS, on average.

Balance Sheet

ConEd’s balance sheet is fairly robust for a utility. Utilities, which are asset-heavy and require substantial investment, need to utilize debt to get a decent return on equity. But this debt is generally reasonably conservative because the cash flows generated by a utility are pretty reliable.

The company’s total debt/equity ratio is a bit over 0.9. For a utility to be under 1 with this ratio is fairly conservative. The interest coverage ratio is over 3, and closer to 4, which is comfortable for a utility. Goodwill is rather negligible. Debt maturities from 2012 to 2016 are reasonably smooth.

Overall, the company is in very good shape here.

Investment Thesis

Consolidated Edison has a rather diversified assortment of products and services in a strong economic area, geographically speaking. The dividend growth has a very long and consistent record, but recently, the dividend growth has not even kept up with inflation. Revenue declines have occurred due to decreases in energy volume, which were partially offset by increases in rates.

Utilities in aggregate aren’t particularly attractively valued at the current time. As they historically have been solid places for dividends, and bond rates have been very low, it’s natural to shift towards dividend paying stocks. But with too many interested investors, comes unappealing valuations.

Risks

As a utility, ConEd has rather reliable operating cash flows and stability, but they do have a number of risks. They are highly regulated, and rely on reasonable regulations to maintain profitability. When their costs rise year to year, they need rate increases to avoid massive decreases in margins. Their operations are at risk to damage from weather, although their areas of operation tend to have fairly mild weather, overall. In addition, economic health affects energy usage. And of course, increases in interest rates affect a company’s ability to roll debt into new debt with similar interest payments, and so for a company that uses substantial leverage, potential interest rate increases can have an impact.

Conclusion and Valuation

I previously analyzed ED back in 2010, and reported that it was a fair investment for a decent income stream but not too great on growth. But since then, the stock has increased somewhat substantially in terms of valuation, and the yield has decreased to only a bit over 4%. The sum of dividend yield and and dividend growth, at only around 5%, isn’t particularly appealing.

Several telecoms and MLPs provide both a higher yield and a higher growth of the income stream . ConEd’s dividend growth may mildly accelerate, but still, I wouldn’t expect much in the way of total returns compared to some of the alternatives out there. Using the dividend discount model, and assuming 2% future dividend growth, the stock is only fairly valued at a discount rate of below 6%, which is rather low. Even various other estimates for dividend growth rates (such as 3% or 4%) don’t provide very robust outcomes for a decent target rate of return, generally resting in the mid single digits. At the current time, I’d look elsewhere for dividend income, unless the stock dips back to the mid-$40′s, where it would more readily provide a mid-high single digit rate of return.

Full Disclosure: As of this writing, I have no position in ED.
You can see my dividend portfolio here.

Dividend Stock Newsletter:
Sign up for the free dividend investing newsletter to get market updates, attractively priced stock ideas, resources, investing tips, and exclusive investing strategies:

One of the primary aspects of an MLP is the Incentive Distribution Rights (IDRs) payout that the partnership pays to the General Partner (GP). The thing that makes MLPs particularly appealing for dividend investors, is that the whole structure is centered around the distribution payout, rather than allowing the payout to be an optional use of cash like in a typical corporation. Put simply, IDRs are structured as follows: the general partner is entitled to a percentage of the total cash flow of the partnership, and this percentage is based on the current size of their quarterly distribution payout to limited partners. So if management does a good job of growing the per-unit value of the partnership (and correspondingly the per-unit distribution to limited partners) over time, then the holders of the general partner benefit even more, but everyone should be pleased with substantial returns.

A potential problem arises, however, if those incentive distribution payouts get too large. Many MLPs IDR agreements allow the payout to the general partner to approach 50% of total cash flow. If the payout gets quite high, it typically means that both the limited partners and the holders of the general partner have done quite nicely in terms of returns up to this point (since these payouts were explicitly determined based on quarterly distribution growth), but going forward, the general partner has a lot more value to look forward to than the limited partners.

This is because the effective cost of capital becomes so high. Since the partnership has to issue new units and debt in order to make acquisitions or grow organically, and upwards of 30+% or more of the free operating cash can go to the general partner due to IDRs at later stages, it ends up leaving little money for distribution growth for limited partners. The general partner still benefits, however, because their payouts grow both when they raise the quarterly distribution to limited partners and when they increase the total number of partnership units (and more specifically, the total size of the partnership cash flows). In the early stage of a partnership, it doesn’t directly benefit the GP to increase the number of units, because they get only at small percentage of total cash flow anyway. But once they are entitled to such a large percentage of the total cash flow of the partnership, then their cash flow can grow primarily from increasing the number of units and correspondingly, the total cash flows of the partnership. Limited partner unit distribution growth can slow or stall.

There are, however, several ways to invest in MLPs and avoid this problem. Presented below is a solid but non-exhaustive list of seven partnership investments that put investors on the right side of the IDRs.

Energy Transfer Equity (ETE)

The most straightforward way of avoiding problematic IDRs is to be on the receiving side of them rather than the paying side of them, which means owning a stake in a General Partner. This list, therefore, begins with 4 different publicly traded general partners, starting with Energy Transfer Equity. Energy Transfer Equity (ETE) owns the general partners and IDRs of both Energy Transfer Partners (ETP) and Regency Energy Partners (RGP). As a whole, ETE and its partnerships constitute one of the largest partnerships in the U.S., and they own natural gas pipeline systems across much of the United States.

Energy Transfer Equity also represents a good example of a partnership that has run into issues due to IDRs. ETP has been unable to grow its quarterly distribution for a few years now, while the general partner, ETE, has been able to grow its own quarterly distribution. The downside to general partners is that their distribution yields are not typically as high as those of limited partners, but the total yield + growth tends to be higher. ETE currently has a 6.23% yield.

My analysis of ETE is a bit dated and could use an update, but if you’re interested in learning more about general partners or IDRs, this ETE analysis provides a far more quantitative overview of how general partners benefit disproportionally after a certain point: Energy Transfer Equity Analysis

Brookfield Asset Management (BAM)

Brookfield Asset Management owns IDRs to a few partnerships, with exposure to real estate, renewable energy, and global infrastructure assets. Further, their payments from IDRs are set to max out at 25% rather than 50%, so they should never run into the issue of being weighed down in heavy cost of capital due to IDR payouts, and they’re on the appealing side of the IDRs anyway (the receiving side). They also receive lucrative management fees that scale in a similar fashion to their IDRs. BAM unfortunately offers the lowest yield on this list, at under 2%, but I believe that perhaps due in part to the highly complex structure of the partnership, they’re currently attractively priced.

Kinder Morgan Inc. (KMI)

Kinder Morgan Inc is the general partner of Kinder Morgan Energy Partners (KMP). It’s structured as a corporation, so investors can get MLP exposure without the associated tax complexity that typically comes with owning an MLP. The yield is modest, at only around 3.5%, but the dividend growth rate should exceed the growth rate of KMP. KMP, however, is a solid counter-example of a partnership that despite reaching high levels of IDR payouts, continues to be able to modestly increase the distribution to the limited partners.

Oneok, Inc. (OKE)

Oneok holds numerous investments, and one of them is a stake in the Oneok Partners LP (OKS). The business gathers, processes, stores, transports, and distributes natural gas and natural gas liquids around the country. Interestingly, Oneok provides some diversification alongside other partnerships, because while partnerships tend to be centralized around the Gulf of Mexico, Oneok’s primary infrastructure hub is farther north in Oklahoma and Kansas, and stretches around the country from the Gulf, to the Great Lakes, to Canada. While OKS provides a 4.56% yield, OKE currently provides only a 2.89% yield, albeit with greater growth.

Brookfield Infrastructure Partners (BIP)

Owning general partners isn’t the only way around the IDR problem. Brookfield Asset Management, which was previously described, is structured slightly differently than many other partnerships. Most relevant for this discussion is that their total allowance of the cash flows from IDRs maxes out at 25% rather than 50%. This means in practice, their payout will not exceed the upper-teens or the low-20s in terms of total percentage of partnership cash flows, rather than the 30+% that MLPs can get to. BAM receives IDRs from multiple partnerships, and one of those is Brookfield Infrastructure Partners (BIP). The partnership owns a diversified set of assets on multiple continents, including coal terminals and railroads in Australia, timberlands in North America, shipping ports in Europe, electric transmission lines in Chile, and a number of other assets around the world including natural gas pipelines. Personally, I’d look for dips below $30 to snag units with a 5+% yield.

My full analysis of the partnership is available here: Brookfield Infrastructure Partners Analysis

Buckeye Partners (BPL)

The third way here to avoid being on the wrong side of high IDR payouts is to own partnerships that no longer have to pay IDRs. Buckeye bought out its general partner a couple of years ago, and no longer has any IDR payouts to pay. This lowers the effective cost of capital for the limited partners, and allows distributions to grow more quickly. Buckeye currently offers the highest yield on this list, with a 7.35% yield, and was able to raise distributions every quarter straight through the financial crisis and recession, but currently doesn’t cover the distributions as strongly with cash flow as many others on this list.

Enterprise Products Partners (EPD)

Enterprise Products Partners is another large partnership that bought out its general partner and cancelled its IDRs. No longer burdened by these payments, EPD can give more cash to unitholders. The partnership currently offers a 4.86% distribution yield, and has raised the distribution for more than 30 consecutive quarters. EPD has 21,000+ miles of natural gas pipelines, 17,000+ miles of NGL and petrochemical pipelines, 6,000+ miles of crude oil pipelines, 190 million barrels worth of liquids storage capacity, 14 billion cubic feet of natural gas storage capacity, 24 natural gas processing plants, 20 NGL and propylene fractionation facilities, and 6 offshore hub platforms.

I published a report on EPD earlier this week, and it can be found here: Enterprise Products Partners Analysis

Full Disclosure: I am long ETE and BIP at the time of this writing.
You can see my portfolio here.

Dividend Stock Newsletter:
Sign up for the free monthly dividend investing newsletter to get market updates, attractively priced stock ideas, resources, and exclusive investing strategies:

-Seven Year Annual Revenue Growth Rate: 27%
-Seven Year Annual Distribution Growth Rate: 6.9%
-Distribution Yield: 4.82%
-Balance Sheet: Fair

EPD is in a position to potentially offer high single-digit returns over the long-term, but at the current time, I’d look for dips to the mid-$40s before purchasing.

Overview

EPD had its IPO in 1998, and has grown considerably since that point. Assets have grown from around $0.7 billion to over $34 billion, which represents nearly 35% average annual growth of their asset base over more than a decade. Master Limited Partnerships are suited towards growth due to their attractive tax structure and reliable cash flows, which together, allow them to constantly issue new units and get returns on this capital that benefits the whole partnership.

The partnership has:
21,000+ miles of natural gas pipelines
17,000+ miles of NGL and petrochemical pipelines
6,000+ miles of crude oil pipelines
190 million barrels worth of liquids storage capacity
14 billion cubic feet of natural gas storage capacity
24 natural gas processing plants
20 NGL and propylene fractionation facilities
6 offshore hub platforms

Revenue

(Chart Source: DividendMonk.com)

This represents 27% annualized revenue growth. EPD, like many MLPs, has accelerated the growth of its revenue and asset base by issuing new units to fund acquisitions and organic growth projects. This way, they can pay out most of their cash flows as distributions, and yet still grow. The number of units outstanding has increased more than fourfold since 2002. Still, unitholder returns over this period have been rather substantial. When MLPs issue new units, as long as the numbers of the deal allow for continued distribution growth per share, it’s usually favorable.

Distributions

(Chart Source: DividendMonk.com)

EPD has increased the distribution for over 30 consecutive quarters. Over the last 7 years, the average annual distribution growth has been 6.9%. The current distribution yield is 4.82%.

Balance Sheet

Like most MLPs, Enterprise Products Partners uses a substantial amount of leverage. The situation is currently stable, with the interest coverage ratio of well over 3. For most dividend stocks, much higher interest coverage ratios are preferable, but for asset-heavy infrastructure businesses, what passes for a good balance sheet is different.

Debt maturities over the next several years are as follows: $500 million in 2012, $1,200 million in 2013, $1,150 million in 2014, $650 million in 2015, $750 million in 2016, and $8,500 million in cumulative years after that. In comparison, EPD brought in $3,300 million in cash flows in 2011. The partnership, therefore, appears financially solid.

A risk, though, would be an increase in interest rates. If the business has to roll its debt over into higher interest debt over time, it could squeeze profitability a bit. Interest rates only have one direction to go, and that’s up. But with a comfortable-enough coverage ratio, and a fairly long successful operating history for an MLP, EPD seems well-prepared for any realistic changes.

Investment Thesis

The MLP has raised quarterly distributions for over 30 consecutive quarters. The partnership is well-diversified in terms of commodity types and geography. Their assets center around Texas and Louisiana, but stretch across the U.S. from the Gulf of Mexico to the Marcellus Shale to the Eagle Ford Shale to the Permian Basin, and so forth. Practically all major domestic gas energy deposits are serviced by EPD.

No IDRs to Pay
A key advantage to EPD is that they no longer have to pay any Incentive Distribution Rights, thanks to a merger with their general partner, Enterprise GP Holdings, in 2010. Most MLPs have to pay IDRs, which means they pay out a growing percentage of their cash flows to the general partner as they grow their distributions to the limited partners.

This is fine at first, because it gives management a huge incentive to raise distributions and grow the whole partnership. But after a while, when the percentage of payments increases to the upper thresholds of the agreement, it can be an anchor on distribution growth for the limited partner. When these upper thresholds are reached, the general partner often still does fine, because at that point, they benefit both when limited partnership distributions are increased and when the number of limited partner units (and more particularly, the asset-base and overall cash flows) grows. Limited partners, however, don’t directly benefit from the increased number of units unless it allows the partnership to grow their distributions.

So for example, Energy Transfer Equity (ETE), the GP of Energy Transfer Partners (ETP), was able to grow its own distribution to unitholders even though ETP has not been able to do the same for its own unitholders. ETE even had to temporarily waive IDR agreements for ETP on a piece of their new acquisition for the deal to benefit everyone involved.

Enterprise Products Partners, by merging with its GP, has now avoided this problem.

Recent Developments
EPD is not at a loss of growth opportunities or places to invest capital.

-Enterprise Products Partners and Enbridge are set to expand the Seaway Pipeline to 850,000 barrels per day by 2014. This is will add a 500 mile, 30-inch pipeline.

-Enterprise Products Partners agreed to a joint program with Anadarko Petroleum and DCP Midstream. This will be a 435 mile pipeline from Colorado to Texas, expected to begin service in late 2013.

Risks

The three key risks for EPD are:
-Interest Rate Risk
-Catastrophe Risk (including Hurricane Risk along the Gulf)
-Commodity Price Risk

In addition, as an MLP, investors have additional tax filing complexity. Adding onto this, with budget deficits and tax reforms, it’s always possible that the tax advantages of the MLP structure could change.

Conclusion and Valuation

Overall, I view EPD as a solid business, but the key question always is whether the valuation is reasonable or not. For an MLP, a distribution yield of under 5% is fairly low. Over the last seven years, the distribution has grown by slightly under 7% per year.

If the dividend discount model is used, and 6% distribution growth is assumed for the next 5 years followed by 5% distribution growth thereafter, and a 10% discount rate is utilized, then the fair value is calculated to be around $48/unit. At the current price of $52, while I don’t think it’s a bad investment by any stretch, I’d hold off and look elsewhere, or for price dips. Acceptable discount rates and estimates on long-term distribution growth vary enough to provide a range of acceptable values. If one is willing to accept returns in the high single digits with little margin of safety other than the strength of the business, however, the current price is fairly easily justified.

Personally, I’d be more interested in the units in the mid-$40′s.

Previous Analysis: Canadian National Railway (CNI)

Full Disclosure: As of this writing, I have no position in EPD. I am long ETE.
You can see my dividend portfolio here.

Dividend Stock Newsletter:
Sign up for the free dividend investing newsletter to get market updates, attractively priced stock ideas, resources, investing tips, and exclusive investing strategies:

It has a lot of information for new investors, but there’s some more specific content there for more established investors as well. For example, there’s a sub-section on MLPs, and by “sub-section” I mean multi-page specific overview of master limited partnerships. Also, there’s an overview of stock valuation which discusses discounted cash flow and the dividend discount model.

Microsoft Analysis
D4L analyzed Microsoft and his system rates it a 4-star strong stock. I hold MSFT, and here’s my most recent analysis.

Five Awesome Things You Can Do When You’re Financially Free
Dividend Mantra’s goal is to retire by 40. Here he discusses things you can do when you have a freer lifestyle.

Start Making Passive Income
A blog with a similar focus and a more direct name, “Retire by 40″, discussed passive income.

When To Sell a Dividend Paying Stock
My Own Advisor discusses when to sell a dividend stock.

Your Guide to the Perfect Business Lunch
I love the Art of Manliness. It’s a site I read consistently. It’s a very popular online magazine for men that has a humorous vintage theme and a lot of “how to” posts.

Previous Weekend Reading
Articles from last week.

-Seven Year Revenue Growth Rate: 4.7%
-Seven Year EPS Growth Rate: 14%
-Dividend Yield: 1.87%
-Balance Sheet: Quite Strong

The quantitative and qualitative factors for Canadian National Railway all look strong. As far as price is concerned, I view the stock as approximately 20% overvalued, and would look for $65 as the threshold for where I’d consider the stock to be a good buy.

Overview

Founded in 1918, Canadian National Railway is the largest railway in Canada and has significant operations in the United States. The rail network extends from the Atlantic Ocean to the Pacific Ocean through Canada, and also extends southward to the Gulf of Mexico through the United States. The total mileage of track exceeds 20,000.

The company is divided into seven commodity groups:
-Petroleum and Chemicals
-Metals and Minerals
-Forest Products
-Coal
-Grain and Fertilizers
-Intermodal
-Automotive

Stock Metrics

Price to Earnings: 15
Price to Free Cash Flow: 26
Price to Book: 3.4
Return on Equity: 22%

Revenue and Free Cash Flow

Canadian National Railway grew revenue by an average of 4.7% per year over this period, and grew FCF by only 3.4% annually over the same period.

Revenue growth was fairly consistent with the major exception of the financial crisis which disrupted most companies. Free cash flow, however, grew rather erratically and slowly. This was mainly because operating cash flow was itself rather erratic, while capital expenditures grew rather smoothly and consistently. Capital expenditures actually grew by a compound rate of 6.2% over this period, which outpaced both revenue and operating cash flow, and therefore had a negative impact on FCF. Management expects this continued capital expenditure growth to continue into 2012 as well.

Earnings and Dividends

EPS grew by almost 14% annually over this same seven year period, and the dividend grew by over 18.7% annually. The dividend yield is low, at only 1.87%, so the company can benefit from accelerated dividend growth for a while. Eventually, dividend growth must be capped by EPS growth for the payout ratio to stop rising. The dividend payout ratio from earnings is currently under 40% and therefore has plenty of room. The most recent quarterly increase, between 2011 and 2012, was over 15%.

The amount of cash spent on acquisitions over this seven year period was rather low, so most of the free cash was truly free, and able to be given to shareholders. Only about a third of it was paid out in dividends, while the rest went to share repurchases. These share repurchases were a decent value, considering that they accelerated EPS growth to 14% per year compared to only 10% per year for company-wide net income, but as is typical among share repurchases, they weren’t timed very well. The company purchased the fewest shares in 2009 when prices were lowest. The company would do well by shareholders to increase the dividend and decrease the share repurchases.

Balance Sheet

Total debt/equity is only around 60%, and the interest coverage ratio is over 9. These are very strong numbers. Further, total debt/income is under 3.

Overall, the company has a very strong balance sheet.

Investment Thesis

Railroads serve a critical part in world transportation. They remain the most energy efficient way of transporting large amounts of material far distances. From an investing point of view, railways also have among the very strongest of economic moats, in that they are established businesses where new competitors are scarce. Obstacles to starting up a new railway business are obvious, because once track is put down to serve an area, duplicate track would be a poor investment.

The company has several strong indicators:
-None of the seven commodity groups account for more than 20% of revenue, which is solid diversification.
-Further in terms of diversification, 18% of revenue comes from U.S. domestic traffic, 22% comes from Canadian domestic traffic, 28% comes from trans-border traffic, and 32% comes from international traffic.
-Compared to 2009, the ratio of injuries and accidents to person-hours and transportation-miles in 2011, respectively, have decreased.
-The total number of employees is up by 8% at year end of 2011 compared to year end of 2009.
-Recovery since 2009 has been broad, with 6 out of 7 of their commodity groups experiencing increased carloads per year in both 2010 vs 2009 and 2011 vs 2010. The only exception to this was coal, which saw an increase in carloads in 2010 but a decrease in 2011.

Overall, I view Canadian National Railway as a fundamentally solid, albeit cyclical, business. The revenue growth is consistent, free cash flow is fairly strong, and the balance sheet is healthy. The business portfolio has satisfactory diversification and breadth in terms of geography and commodity group. Railways have natural moats surrounding their businesses. A simultaneous pro/con is that capital expenditure is very regular and increasing. It shows management is on top of their priorities for long-term sustainable growth, efficiency, and safety, but when this outpaces revenue growth, there is of course a cost.

Risks

The company is fairly safe from competitors in my view, so the risks are mainly associated with macroeconomic conditions. The company held up well during the recession but was still materially impacted by it, and this will likely be the case during the next recession as well, whenever it occurs. The company has good safety metrics and as previously mentioned, spends considerable sums on capital expenditures, so catastrophic incidents should be rare. My view is that the company is cyclical, but fundamentally solid on all observable quantitative and qualitative matters.

Conclusion and Valuation

In conclusion, I view the company as strong. The next question, then, is what about the valuation?

Based on an assumed free cash flow growth rate of 4% and a discount rate of 9%, I calculate that the stock is overvalued by about 20-25%. In order to justify the current valuation at around $80/share, the long-term FCF growth rate would have to be 5%, with a discount rate of 9%. Based on this, I’d hold off on buying unless the stock drops to about $65, at which time I’d consider it a reasonable value.

Previous Analysis:
Becton Dickinson (BDX)

Full Disclosure: As of this writing, I have no position in Canadian National Railway.
You can see my dividend portfolio here.

Dividend Stock Newsletter:
Sign up for the free dividend investing newsletter to get market updates, attractively priced stock ideas, resources, investing tips, and exclusive investing strategies:

Dividend Stocks: The Essential Guide

Feel free to use it as a resource, and any sharing of it would be appreciated.

Also, I found this article particularly interesting:
50 Amazing Numbers about Today’s Economy

Recent Buy: Bank of Montreal
See why Dividend Ninja bought this particular bank.

7 Small Cap High Yield Dividend Stocks
Not all good dividend payers are large, so D4L provided 7 smaller dividend picks.

Abbott Laboratories is Cheaper Than You Think
Dividend Growth Investor explained why Abbott is a good value currently.

Ross Stores Stock Analysis
In retail, you never want to be in the middle. Either luxury or discount, not average. Ross is discount, and Sigma Swan reviewed the company.

Start Making Passive Income
Retire By 40 offers ways to build passive income.

Spring Clean Your Portfolio
Christine Benz from Morningstar discusses how to straighten up your portfolio a bit. She mentions some dividend sectors that are a bit expensive, and I agree.

Marquee Energy: Undervalued Oil Junior with Strong Production Growth Ahead
Beating the Index produces great content on the energy sector.

Dividend Stocks 101: The Essential Guide
If you’re new to the site, check out this key resource.

Dividend Stock Newsletter:
Sign up for the free dividend investing newsletter to get market updates, attractively priced stock ideas, resources, and exclusive investing strategies: