Whenever you find a stock with a 15%
, remember the adage: "It's too good to be true."
This kind of ultra-high
invariably means that most investors anticipate a major cut in the
. Otherwise, it would attract so much buying interest that the
yield would get pushed sharply lower anyway.
But some of these high-yielders can present real bargains if you're
willing to do some math. I've been looking at a pair of high-yield
stocks that are actually undervalued, despite the likelihood of a
Here they are...
1. Inergy L.P. (Nasdaq:
Current yield : 17.4%
This propane distributor, which is structured as a
master limited partnership (
, fell into a classic trap. Management grew addicted to a steady
annual boost in the dividend, aiming to attract investors and
provide them with extra income even as the company's operating
fundamentals were deteriorating.
The slump in
can be chalked up to four factors. First, Inergy invested in a
natural gas storage depot, known as Tres Palacios, where early
returns have been weak because a glut of gas reduced profitability
for storage facilities. (Many gas producers are selling on the
or lining up
contracts because it doesn't pay to simply store gas.) Tres
Palacios is currently at 71% of capacity, well below management's
Second, Inergy has been forced to maintain or reduce pricing in
certain propane markets due to heavy competition. Third, Inergy has
been suffering because of a remarkably mild winter in the United
States. In the last quarter of 2011, for instance, propane demand
was reduced by almost 17% compared with the same period in 2010
(and this was before the record warmth of January and February).
The continuing warm spell will extend the company's recent
slump into fiscal (September) 2012. Lastly, Inergy spun off a 25%
interest in its natural gas pipeline division,
Inergy Midstream L.P. (Nasdaq:
, in December 2011. This new convoluted shareholder structure
turned off some investors.
Despite all of these challenges, Inergy is likely to still generate
in coming years. Analysts project
of roughly $400 million in fiscal 2012, $420 million in fiscal 2013
and $440 million in fiscal 2014. These numbers could move up if
Inergy's propane and natural gas markets start improve. Frankly, a
more normal temperature range next winter would have a profound
impact on Inergy's volumes and profits. (As I write this, my
hometown in upstate New York is a balmy 70 degrees -- in March.)
Still, this would not be quite enough for Inergy to maintain its
current dividend. The company announced an imminent dividend cut in
late January, and analysts now forecast it to be about $1.80 a
share in the current
and just $1.50 in fiscal 2013. Even using the lower $1.50 figure,
that yield would be roughly 9.4% ($1.50 dividend / $15.82 stock
price = 9.4%), which is still much higher than most other gas
and propane MLPs. For example, rival
AmeriGas Partners (NYSE:
sports a 6.7% yield, while the
Alerian MLP ETF (Nasdaq:
carries a 5.9% yield.
But let's assume Inergy would eventually trade at a 7% yield when
all of the current noise has abated. This means buyers would likely
bid up the stock until the yield dropped from 9.4% to 7.0%. That's
a 25.5% gain. Throw in the pro forma 9.4% yield, and you're looking
at a 35% gain in the near-term, and a nearly double-digit yield in
2. Two Harbors Investments (Nasdaq:
This is a
real estate investment trust (REIT)
that buys and sells residential mortgage-backed securities. Yup,
these are the same
into big trouble a few years ago.
But it's actually a far safer
these days. First, these bonds trade at a discount to
, reflecting the chance that some of the mortgages in the bonds
could fail. And though the housing market is still unhealthy, the
pace of new
activity appears to have markedly slowed. This gives this firm the
chance to buy relatively safe bonds that sport ultra high yields.
The juicy 15.5% yield may well be maintained for a while to come,
but will have to come down eventually. Conditions are favorable
right now, but ultimately as the housing market rebounds, the
market will no longer be quite so skittish, and this firm's
investment managers won't find such high-yield bargains.
Two Harbors boosted its dividend from $1.48 a share in 2010 to
$1.60 in 2011, and it could stay at this level during this year and
next. Assume that reduced bond yield pushes the dividend figure
down to $1 a share by 2014, and the stock would still sport a yield
of nearly 10%. As is the case with Inergy, Two Harbors'
may also modestly appreciate as the 10% "safer" yield attracts
Risks to Consider:
As the U.S.
continues to rebound, interest rates are bound to move up. This
could affect the relative appeal of income-producing stocks as
bondsoffer ever-higher yields.
Action to Take -->
A double-digit yield often means there's something amiss. But it
doesn't necessarilymean the stock is in trouble. Do the math to see
what the yield will look like after current or future challenges
have been taken into consideration. The two stocks mentioned above
have such high yields that even if they cut dividends, investors
would still benefit from generous high yields of 9% or more.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.