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Cranking out returns: Companies are using dividends to attract investors

January 9, 2016

The sleepy dividend is making a comeback.

What has for decades been the unglamorous province of retirees and buy-and-hold investors is now a major strategy by Indiana’s biggest companies to attract shareholders.

Cummins Inc., Duke Realty Corp., Eli Lilly and Co., Simon Property Group Inc. and Vectren Corp. are among the prominent Indiana companies boosting their dividends in recent months. For a few companies, it’s the first increase in years.

Some of these dividends—particularly if reinvested—are downright scintillating relative to prevailing interest rates and a 2 percent decline in the Dow index in 2015.

focus-dividends-charts.gifFor example, Cummins’ dividend yield—a ratio of how much paid in dividends relative to share price—is now 4.4 percent. Or there’s Indianapolis-based oil refiner Calumet Specialty Products, with an eye-popping dividend yield of nearly 14 percent.

Not bad compared with the current average five-year CD paying less than 1 percent.

For many companies, “their goal is to attract shareholders with a healthy dividend. Anything over 3 percent is good in this market,” said George Farra, a principal of Woodley Farra Manion Portfolio Management, in Indianapolis.

But experts say choosing a suitable dividend-paying stock is not without challenges and could be complicated by changing market conditions.

For one, it’s not like there are lots of undiscovered dividend-paying stocks out there whose stock prices haven’t been bid up already.

In fact, one could argue that “everybody bought the decent dividend-paying stocks that are safe,” said Don Woodley, of Woodley Farra. A solid dividend growth record is, in fact, a requirement for stocks the 20-year-old investment firm considers for its portfolio.

Also clouding the dividend scene is that many of the dividend darlings aren’t performing so well lately. For example, the iShares Select Dividend Fund, which tracks high-dividend-paying U.S. equities, was down 2.03 percent in 2015.

And believe it or not, dividend-paying stocks might be getting some competition from traditional interest-paying instruments such as certificates of deposit.

At first blush, this seems preposterous. After all, interest rates have been at rock bottom for a decade. But in December, the Federal Reserve raised rates for the first time in nine years, by 0.25 percent. A pittance, yes, but more hikes are likely if the economy picks up.

And if interest rates rise, dividend investors may be tempted to chase even higher-dividend-yielding stocks that can carry higher risks. Some investors have been infatuated by high-dividend-yield stocks like Warner Brothers cartoon character Pepé Le Pew is with the felines of Paris.

“If it’s an extremely high dividend, then they’re probably not paying a high-dividend yield because it’s [necessarily] safe,” said Juli Erhart-Graves, president of Worley Erhart-Graves Financial Advisors, in Indianapolis.

“I encourage people to be very cautious about just searching for yield. [Clients] will say, ‘Look at this yield; it’s 5 percent!’ I say, ‘Ah ... there’s probably something going on here.’”

Long-term record

Oftentimes, there is.

Cummins’ attractive dividend yield belies challenges of late for the Columbus-based engine maker.

Its stock price ended 2015 down almost 40 percent. Blunting sales prospects has been a stronger dollar, which hurts its export business. An important slice of its revenue comes from China, where the economy has slowed.

On the other hand, Cummins is a solid and fairly straightforward company. While its industry is particularly cyclical, Cummins’ dividends have surged higher over the past five years. Its $3.51 per-share annual dividend in 2015 compares with just 88 cents per share in 2010.

Cummins recently raised its quarterly dividend to 97.5 cents a share from 78 cents.

“When you see a high yield, you have to do your homework,” said Farra. “If a company has a high yield because its business has stumbled, you have to ask, ‘Is it a one-time decline in earnings or is this a longer-term trend?’”

The Indiana company with the best track record in that regard is Evansville-based Vectren.

For years, the gas and electric utility holding company has been named among the nation’s “dividend kings” on any number of investing websites.

“We’ve increased the dividend for 56 straight years,” said Chief Financial Officer and Senior Vice President Susan Hardwick.

In late 2015, its dividend was raised 5.5 percent—to 40 cents a share from 38 cents. That puts its dividend yield at about 3.8 percent.

In 2014, Vectren announced long-term financial targets of 5 percent to 7 percent per year, and said dividends would grow at the same pace. Vectren’s stock price ended the year down 6 percent.

Generally, the regulated utility industry has been seen as a secure investment, given its captive ratepayer base and ability to recover from those ratepayers the cost of capital expenditures.

One advantage to the company of offering a consistently growing dividend is that it helps attract investors, Hardwick said. That ability to raise capital can help a company rely less on debt, the cost of which is rising as interest rates nudge higher.

“People like the certainty that comes with utility earnings and a dividend,” Hardwick said.

Dividends awake

Meanwhile, two of Indiana’s corporate titans that have had consistent dividends in recent years—consistently flat, that is—are finally putting a log on the dividend fire.

Eli Lilly’s dividend was unchanged from 2009 to 2013, in a long spell marked by the expiration of patents on blockbuster drugs and resulting decline in sales. In late 2014, it boosted its dividend for the first time in 24 quarters—by a penny. It added another penny in December, bringing the annual dividend per share to $2.04.

A penny or so more in quarterly dividend might not sound like much. But as CEO John Lechleiter said in 2014: “The increase in our dividend signals continued confidence in Lilly’s future and confirms our commitment to return additional cash to shareholders.”

Lilly has increased the annual dividend more than 40-fold since 1972. Until impending patent expirations caused the company to forgo a dividend increase in 2010, it had announced dividend increases for 42 consecutive years.

Lilly’s stock ended 2015 up over 20 percent. Its dividend yield is about 2.4 percent, which isn’t screaming but is better than the pharmaceutical industry average.

Another large Indianapolis company whose dividend had been asleep for years, Duke Realty, increased its dividend by 1 cent, or 5.9 percent, in November.

The following month, Duke paid a special dividend of 20 cents a share, mostly due to selling $1.7 billion in assets in 2015. Duke shares closed the year up 4 percent, and its dividend yield is about 3.4 percent.

Not to be outdone, of course, is the city’s other big real estate investment trust, Simon Property Group. The shopping center king in October said it would hike its quarterly dividend by a nickel, to $1.60 or 23 percent. Simon’s dividend yield is at 3.3 percent.

While one can slice and dice numbers of dividend-paying companies, the general rule of thumb is, “What you want to see is companies generating good, strong free-cash flow,” said Mark Foster, chief investment officer at Kirr Marbach and Co. in Columbus.

Though cash-flow measures can vary from industry to industry, it’s essentially how much cash a business generates after all its operating expenditures, but before accounting charges such as interest, taxes and depreciation and before major equipment purchases or construction projects.

The more cash flow, the more—in theory—a business can pay in dividends.

Much yield, many questions

That’s easier said than done with some companies, such as Indianapolis-based Calumet Specialty Products.

Investors received dividends of $2.74 a share in 2015, and its dividend yield comes out to nearly 14 percent.

Calumet’s industry isn’t well-known to many investors around this part of the country, however. It produces and refines specialty hydrocarbon products in places such as Louisiana and Texas. Calumet turns crude oil into such products as solvents, waxes, asphalt and motor oil. Its branded products are unknown to most, except perhaps for its Royal Purple synthetic motor oil brand found in most auto-parts stores.

During the third quarter, Calumet reported a net loss of $48.9 million, which included special items such as a $33.8 million non-cash goodwill impairment charge in its oilfield-services segment. Calumet stated that, without special items, its earnings would have been a record $131.7 million, up almost 20 percent from a year earlier.

What does have some followers of Calumet upbeat is that, odd as it sounds, refining margins often increase as oil prices decline, and oil prices have been falling.

Last fall, Calumet’s then-interim CEO, Bill Hatch, hinted that a rise in dividend might be on the way. Hatch said the company was finishing up its final three growth initiatives, which would free up cash flow. That could include “paced growth” in the “quarterly cash distribution.”

“With our organic growth campaign reaching conclusion at the end of this year, we intend to evaluate a potential increase in the quarterly cash distribution in 2016,” Hatch told shareholders.

Such promises are attractive, but Farra cautioned investors to not attach the same confidence to dividends as they do to interest rates paid on bonds and bank deposits.

A dividend “is not the U.S. Treasury, where you know you’re going to get paid,” Farra said. The stocks paying the most dazzling dividends, he added, “usually, those are the stocks most at risk of reducing their dividends.”•

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