No Bankruptcy in Retirement, I Hope

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After celebrating my birthday recently, a certain reality hit home: I have to start thinking more seriously about my retirement.  Reading the executive summary for Social Security reveals I’m looking at a 16% cut in my benefits.  Social Security cuts may be off the table during “fiscal cliff” negotiations,  but one thing is clear: I’m not going to do as well as my father when it comes to Social Security benefits received.

So what’s an aging geezer to do?  Invest in securities that pay a decent dividend.

Two venture capital firms with a 10% dividend

Business development companies, or BDCs, pay high dividends by lending money, at favorable terms, to companies seeking financing but unable to get it at banks.

One such BDC is Apollo Investment Corp. (NASDAQ: AINV).  The company provides financing solutions to middle market companies in a wide diversity of industries.  The current yield is about 10%.  In its 2012 annual report, the company stated its intentions of moving away from higher risk subordinated debt (aka mezzanine debt) to senior secured debt and “specialized lending” to take advantage of opportunities presented by recent changes in banking laws.  Apollo has secured a $1.14 billion credit facility at a rate 75 basis points lower than a previous facility.  

However, the investment income paid by Apollo has steadily declined since 2008.  The stock dropped sharply in 2011, but has risen 12% in 2012.  Apollo also began investing more in energy companies, which should bolster returns.  For the first six months of 2013, earnings improved over 2012, but net investment income declined slightly.  Apollo strikes me as a turn-around story, with inherent risks and potential rewards therein.

Another BDC is Prospect Capital Corp. (NASDAQ: PSEC).  This BDC pays a slightly higher dividend (11.5%) than Apollo and poses an interesting situation for investors.  On Nov. 1, the stock sank when the company announced a 35 million share offering, effectively diluting corporate earnings 20%.  Proceeds from this offering will pay off debt and provide capital for future investment.  

The interesting part is that no indication was given regarding just how much cash was going into which activity.  Prospect announced earlier this month a 77% increase in net investment income over the fiscal quarter 2011.  Perhaps Prospect’s focus on first liened loans had something to do with it.  Increased loan repayments didn’t hurt either.  The company claims that none of its loans over the past five years have gone to non-accrual status.  The float dilution issue aside, Prospect looks like the clear winner over Apollo.

Both Apollo and Prospect face uncertainties and vulnerabilities in the tight credit market.  So far, they seem to have avoided any significant problems with their business, but as European and American debt problems remain unresolved, liquidity is a dark cloud to keep an eye on.

A likely safer source of income

BDCs provide high returns and levels of excitement retirement accounts might not want.  A safer source of dividends is pipeline companies.  Oil and natural gas production in the US has soared with no end in sight. That energy has to go from Point A to Point B and pipeline companies make money off every barrel or cubic foot moved.  

Plains All American (NYSE: PAA) offers both income and capital gains.  The current yield is 4.7% and the stock has grown from $32 per share to $46 over the past year.  The future bodes well.  Plains purchased natural gas and liquefied natural gas operations from British Petroleum (NYSE: BP), a move that gives Plains access to Canadian shale gas.  Plains expansion plans in the Eagle Ford and Permian Basin fields should pay off as oil production there continues to climb.  I foresee continued earnings and dividend growth from these developments.  The company boasts a ROE of 16.4%, earnings that generally beat expectations and a dividend growth rate that exceeds the industry average.

El Paso Pipeline Partners, LP (NYSE: EPB), owned by Kinder Morgan (NYSE: KMI), operates natural gas pipelines in the western and southeastern US.  El Paso has generally improving earnings on an annual basis over the past three years.  Also, The Street reports El Paso sales and earnings grew faster than the average competitor over the past year.  

Others have noticed this revenue/earnings growth as the stock trades at a little under 18 times earnings.  However, El Paso’s five-year net profit margin comes in at an industry leading 36% and dividends have grown from $0.15 per share in 2008 to $0.58 per share in the latest quarter of 2012.  Current dividend yield is 6.49%.  One dark cloud for El Paso is an investigation into price overcharging by the US Federal Regulatory Commission launched Nov. 15.  Time will tell how this resolves.

One last benefit of these pipeline companies:  They are both master limited partnerships and thus, tax wise, do not pay dividends, but rather distributions.  That is, the income you receive is not taxed like a dividend - an important detail as Congress bickers over raising taxes to avoid the country's "fiscal cliff."


Foolish bottom line

With Social Security cuts looming for younger Americans and Medicare facing bankruptcy in the future, self-sufficiency becomes more important.  Risk and reward go hand in hand, and dividend plays are no exception.  

BDCs offer high yields, but these tend to be newer, riskier investments requiring attention.  The pipeline plays offer the security of an infrastructure play on America’s growing shale oil and gas production.  Pipelines pay lower dividends, but considering most retirees have enough gray hair as it is, the security trade-off may be worthwhile.


dylan588 owns shares of Prospect Capital and BP. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend El Paso Pipeline Partners LP. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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