$21 Billion Hedge Fund Loves These Dividend-Paying Stocks

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Billionaire Tom Steyer founded Farallon Capital Management, LLC, an investment firm, in 1986. At the end of last year, he stepped down as a co-senior managing partner of the firm, leaving his partner, Andrew Spokes, at the company’s helm. Over the twenty-seven years at Farallon, Steyer managed to deliver a net annualized return of 13.4%, outperforming the broader market indices. Despite his retirement, Steyer still keeps a large share of his wealth under Spoke’s management (see the firm’s entire equity portfolio).

Farallon, a multi-strategy firm that bases its bets on the fundamental, bottom-up analysis, and based on its portfolio of holdings at the end of the fourth quarter 2012, Farallon’s largest positions included Hudson Pacific Properties, an office property REIT, and Nexen, which was acquired by CNOOC. In the quarter, the $18.6 billion firm also initiated several new positions, including stakes in a few dividend-paying stocks.

Here is a closer look at five of Farallon’s bullish positions yielding above 2.0%. These picks represent either growth or value plays that boast some upside potential. Much like Insider Monkey’s market-beating strategy, it’s always important to pay attention to the smart money, and this time is no different.

Rockwell Collins (NYSE: COL), a communications and aviation electronics company serving both commercial and government customers, has a dividend yield of 2.0%, a payout ratio of 26%, and a five-year annualized dividend growth of 9.9%. Given its exposure to the defense sector, from which it derives half of its revenues, the company has been bracing for the adverse impact of the sequestration on sales. Still, as a testament to its resilience in the face of adversity, the company raised its full-year 2013 guidance in early January, after topping analyst estimates of first-quarter EPS.

Seeing 2013 as a “year of transition,” the company projects lower 2013 revenues and higher EPS. The strength of the high-end of the business jet market and the firm’s international government systems should support overall growth. Yes, U.S.-specific government systems revenue is expected to fall 10% this year, but analysts still see Rockwell’s long-term EPS CAGR coming in above 7%.

In terms of valuation, shares of this company are trading at 12.8 times forward earnings, below the aerospace industry’s average multiple of 14.0x. Last quarter, Farallon hiked its position by 21% to $134 million.

Fidelity National Information Services (NYSE: FIS), the world’s largest provider of banking and payments technology, was another one of Farallon’s bullish bets at the end of 2012. The company has a dividend yield of 2.3%, a payout ratio of 28%, and a five-year annualized dividend growth of 21.9%. Fidelity National is attractive given its leading position in a stable industry with high barriers to entry. A substantial portion of its revenues is recurring, derived from secure, long-term contracts.

Given the company’s dominant role in its sector, in particular in emerging markets—e.g. it is the largest payments processor in Russia and China—Fidelity National looks well positioned to deliver on its objective of growing organic revenues by 4%-to-7% annually and adjusted EPS by 12%-to-15% annually through 2015. The company generates high free cash flow, with a conversion rate of 1.6x, and given its growth prospects, Fidelity National is undervalued trading at 13.4 times forward earnings and 1.7 times its book value—both below industry metrics. Last quarter, Farallon boosted its stake by 47% to nearly $129 million.

United Technologies (NYSE: UTX), meanwhile, is another defense and commercial aircraft sector play in Farallon’s portfolio. This aerospace and building systems conglomerate has a dividend yield of 2.3%, a payout ratio of 35%, and a five-year annualized dividend growth of 21.7%. Like Rockwell Collins, this company may be attractive to Farallon because of its expansion into the commercial aircraft business through the recent acquisition of Goodrich. That acquisition will produce cost synergies and integration of products for use in both Boeing and Airbus aircrafts.

The company beat analysts’ EPS estimates in the fourth quarter of 2012 and on the year as a whole. Especially notable improvements in orders have been reported for large commercial engine spares and North American residential HVAC new equipment. Based on improved order trends, the company expects its 2013 revenue to be up 11%-to-13% and its EPS to be up 9%-to-15% from last year. EPS growth will also be buttressed by $1.0 billion worth of share buybacks planned for 2013.

In February, the company authorized a share repurchase program for up to 60 million shares, worth $5.4 billion. In terms of valuation, United Technologies is trading at 15.0 times forward earnings, a little above its industry’s average multiple. Last quarter, Farallon hiked its stake in United Technologies by 16% to nearly $72 million.

BP (NYSE: BP), an integrated oil and natural gas giant, pays a dividend yield of 5.3% on a payout ratio of 43%. Total dividends paid in 2012 were up 18% from 2011. Last quarter, Farallon raised its BP stake by 14% to more than $40 million.

Obviously, the company has been heavily hit by the Deepwater Horizon disaster in 2010, for which the price tag should swell well above the initially estimated $7.7 billion cost, and it has been divesting assets, including the sale of a TNK-BP stake to Russia’s Rosneft, in order to cover expenses associated with the oil spill. The overall divestment program is worth $38 billion.

Despite these woes, the company is looking forward to expanding production capacity and output. It plans to increase upstream reinvestments to drive growth in higher-margin areas, such as Angola, Azerbaijan, the Gulf of Mexico, and the North Sea. With increasing output from 15 high-margin upstream projects, BP expects to grow operating cash flow some 50% by 2014, and it remains committed to “a progressive dividend policy.”

BP shares are down 13% over the past year, trading at only 8.3 times forward earnings, below the industry multiple of 9.5x. Its mere 10% premium to book value—well below industry metrics—and a miniscule price-to-sales multiple make the stock look particularly appealing to value investors, and we can see why Farallon is bullish.

Copa Holdings (NYSE: CPA), lastly, is a leading Latin American company engaged in air transportation of passengers, cargo, and mail, and has a dividend yield of 2.1%, a payout ratio of 24%, and a five-year annualized dividend growth of 48.7%. The company has seen robust EPS growth over the past five years, with its bottom line expanding at an annualized rate of 20.5%. Analysts expect Copa to maintain growth at a rate of 18.7% per year for the next half decade.

While the company has been a real outperformer, it failed to deliver on both revenue and adjusted earnings expectations last quarter, despite growing these two financial metrics from the year-earlier period. The airliner expects continued consolidated capacity expansion in 2013, as well as lower unit costs excluding fuel—by 3%—and marginally higher unit revenues—by 1%. Its operating margin should also improve by up to 2%.

Moreover, Copa’s system-wide passenger traffic is rising at double-digit rates, driven by international growth. Despite its attractive prospects, the stock is considered overvalued by some, as it is trading at 15.5 times trailing earnings versus the stock’s five-year average multiple of 10.9x. Still, the stock was a new position for Farallon in the previous quarter, valued at $14.5 million.

We choose to track 450 of the 8,000-strong hedge fund industry’s best players, and by focusing on this upper-tier, ardent investors can benefit. Farallon Capital is a perfect example of a fund that flies under the radar of most market participants, but its track record indicates that we should pay attention to its moves, particularly how it was preparing itself for 2013 and beyond. This “fab five” of dividend-paying companies is a good place to start.

This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. 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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