With the stock market tumbling at the end of 2018, finding stocks with dividend yields above 5% has become quite a bit easier. But it's important to remember that all dividends aren't created equal. A high yield today doesn't mean much if the stock later tumbles and the dividend gets slashed.
Three of our Motley Fool contributors think Magellan Midstream Partners (NYSE: MMP), AT&T (NYSE: T), and Alliance Resource Partners (NASDAQ: ARLP) offer both high yields and relative safety. Here's what investors need to know.
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A solid business trading at a recession-level yield
Tyler Crowe (Magellan Midstream Partners): Magellan Midstream Partners is one of those stocks that rarely goes on sale. It has a reputation in the oil and gas transportation and logistics industry as being one of the most stable, conservatively managed companies businesses. Ever since its IPO in 2001, management has grown the business while maintaining an investment-grade credit rating (a rarity among pipeline companies) and one of the most conservative balance sheets in the business. Its reputation for growing its payout through the ups and downs of the oil market has historically meant investors were willing to pay a premium for its stock.
Recently, though, that premium has been wiped out. Wall Street has soured on the stock because management elected to allocate more capital toward growing the business than to increase its payout to investors. So instead of the 8%-10% distribution growth investors became accustomed to over the past few years, management has elected instead to slow payout growth to around 5%. That, plus a broader sell-off of everything oil, has led to Magellan's stock sporting a distribution yield of 6.7%, the highest it has been since the recession.
A yield this high might lead you to think there are some holes in Magellan's business, but its most recent earnings suggest otherwise. The company has raised guidance for distributable cash flow every quarter in 2018, and it's retaining more cash to redeploy into a plethora of growth projects over the next few years. From a business perspective, Magellan looks stronger than ever.
What has Wall Street so scared of Magellan's stock today doesn't seem to line up with the company's business prospects. For investors looking for a high-yield investment, this looks like an incredibly opportune time to take a look at Magellan's stock.
A hated dividend stock
Tim Green (AT&T): Not only is telecom giant AT&T's dividend yield over 5%, it's now nearly 7% after a multi-year slump for the stock and a recent dividend increase. The market has grown more pessimistic on the debt-ridden company over the past few years, which has opened the door for dividend investors to snag shares at a discounted price.
AT&T has made two very expensive bets that have driven up the debt on its balance sheet. The acquisition of DirecTV in 2015 and of Time Warner last year have transformed the company into a media conglomerate. The wireless business is still the company's cash cow, but these acquisitions are meant to be its growth engine. The $183 billion of debt on the balance sheet, up $75 billion over the past four years, is what investors are worried about.
The good news is that AT&T generates a lot of free cash flow. The company expects free cash flow to be roughly $26 billion in 2019, and it plans on reducing its debt by around $20 billion this year. The stock trades for just eight times that expected free cash flow, a multiple that reflects the market's concerns about AT&T's debt.
The excessive debt on AT&T's balance sheet makes the company more fragile and the stock riskier. But with such a beaten-down valuation and a sky-high dividend yield, I think the stock is worth that risk, at least as a small position in a diversified dividend portfolio.
A diamond in the rough
Sean Williams (Alliance Resource Partners): With the stock market in meltdown mode, high-yield dividend stocks with staying power will be more attractive than ever. If you're looking for a relatively secure income stream, consider coal giant Alliance Resource Partners. And, no, you didn't read that incorrectly -- I did say "coal."
Generally speaking, coal has been a nightmare of an investment for about a decade. Lower natural gas prices have encouraged a number of electric utilities to make the switch from coal to natural gas when generating electricity. This led to an oversupply of coal that weakened prices and sent debt-riddled producers into bankruptcy. Most of the industry is still struggling... but not Alliance Resource Partners.
To begin with, this is a company that's been managed somewhat conservatively. Its management team resisted loading up on debt to acquire new properties, which, when the bottom fell out on coal prices, hit competitors very hard. Right now, Alliance Resource Partners has around $415 million in net debt, but generated $679 million in operating cash flow over the trailing-12-month period. In other words, there are zero liquidity issues here.
Alliance Resource Partners has also done an excellent job of locking in future sales. The company's most recent quarterly report highlights secured volume and price commitments of 32.9 million tons, 17.7 million tons, and 7.9 million tons in 2019, 2020, and 2021, respectively. For context, the company produces around 40 million to 41 million tons per year. These commitments ensure that a majority of its production won't be exposed to wholesale price fluctuations, thereby leading to predictable cash flow.
Finally, Alliance Resource Partners has been relying on exports to foreign markets (ahem, China) to curb any domestic weakness. More than a quarter of its current-year sales should come from exports, up from a low single-digit percentage just a couple years earlier.
Sporting a nearly 12% dividend yield, most investors would be skeptical of Alliance Resource Partners. But from what I can surmise, this is a diamond in the rough.
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Sean Williams owns shares of AT&T. Timothy Green owns shares of AT&T. Tyler Crowe owns shares of Magellan Midstream Partners. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.