A Dividend Aristocrat For How Long?

By Chad Henage - August 14, 2012 | Tickers: AEE, EXC, GXP, UGI | 0 Comments

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This year, 14 new dividend aristocrats were named. One of these companies was UGI Corporation (NYSE: UGI), which is both a natural gas and electricity supplier as well as a propane distributor. These businesses traditionally are fairly stable, and I'm certain this stability has led to the company's ability to increase its dividend for at least 25 years. However, there is one glaring weakness in this new dividend aristocrat that makes me question how long the company will retain this new title.

In the last several years, investors have chased dividend yield in certain cases to the point of absurdity. Companies that are slow-growing and used to pay a 6% or 7% dividend, now have been bought up to the point that their yield is in the 3% to 4% range. This doesn't sound like a huge deal until you consider what would potentially happen with higher short-term interest rates. With long-term CDs paying around 2%, or less in some cases, income hungry investors are looking for good yields outside of their traditional comfort zones. The first place many investors look is to utility stocks, as most people think of these companies as safe bets in an uncertain stock market. Though all utilities might appear the same to the uninformed, behind-the-scenes there are significant differences that can expose investors to risk that they may not be aware of. Let's take a look at a few companies in the utilities industry to see what a difference a little bit of extra research can make:

You can see that not only is there a big difference between the four companies yields, but their valuation, growth rate, and free cash flow payout ratios vary widely as well. All of these businesses are considered as electric utilities, but each one focuses on a different area of the country, and in some cases different types of electricity supply.

Traditionally speaking, investors should look for a company that pays a respectable yield, and also has a reasonable free cash flow payout ratio. However, the payout ratio average is a dangerous number to use alone, as this number changes over the years and even quarter-to-quarter. UGI is a perfect example, as the last three years their average payout ratio has been about 76%. However, in 2009 this ratio was just over 48%, but by 2011 this percentage eclipsed 100%. In another example, Great Plains Energy's current ratio is negative, but the company is expected to see over 6% earnings growth in the next few years. This earnings growth should contribute positively to free cash flow, which may cause the dividend yield to go from a dangerous situation to a safe payout ratio. The point is, over time companies and situations change and investors can't assume that all utilities are the same. Knowing a company's payout ratio tells us whether they can afford their current payout. In a similar manner, looking at the company's dividend growth record can give investors an idea of what to expect in the future.

Looking at UGI's dividend growth over the last several years, you can see that aside from one large increase, the company's average dividend increase has been between 3% and just over 4% in the last several years.

With analysts calling for growth in the future of less than one percent, it seems to me that income hungry investors would be better served to look elsewhere. In addition, UGI currently has a payout ratio of over 100%, which does not bode well for future dividend increases. While the company can request rate increases to offset rising costs and help decrease the payout ratio, the company's 3.49% yield is not particularly significant considering the alternatives. UGI may be a dividend aristocrat, but of all the alternatives for income producing stocks, this is not one I would recommend.

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