Does This Dividend Aristocrat Give You Gas?

By Chad Henage - August 14, 2012 | Tickers: BKH, CNP, MDU, STR | 0 Comments

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I've read several articles suggesting that stocks that pay dividends are so much in favor, that there might be a dividend bubble much like the famous dot.com bubble of the year 2000. However, not all dividend paying companies are created equally, and this year 14 new names were added to the dividend aristocrat list. One of the new names that was added this year was MDU Resources Group (NYSE: MDU). The company is an oil and natural gas exploration company, construction materials company, and a diversified electric and natural gas distributor all rolled into one. Many investors assume that utilities all basically work the same and look for higher yield as the defining factor between which stock to buy. However, for a company to be a good long-term investment we need to look not only at yield, but also payout ratio and dividend growth.

For MDU Resources, analysts are calling for EPS growth of 8% over the next several years. For investors that followed the utility sector, a company growing earnings at 8% is somewhat unusual. This is largely because while MDU does operate a utilities division, their largest sources of revenue and income is from exploration and construction. To put MDU in perspective, let's quickly take a look at some of their competition to get an idea of how the company is valued relative to other similar investments.

Each of these four companies has a different focus, which accounts for the different growth rates. MDU as we mentioned is an exploration company, but in their utility business they generate twice the revenue from natural gas as they do from electric. In addition, MDU is also involved in mining and selling construction aggregate, liquid asphalt mix, and multiple other ventures. By contrast, both CenterPoint Energy and Questar are more traditional utilities. Black Hills Corporation is probably the closest competitor to MDU, as the company not only operates as utility but also is heavily involved in exploration as well.

Taking all this into consideration, investors looking for a true pure play utility would be selecting from the final two companies in the above table, versus MDU and Black Hills which represent more diversified plays. On a valuation basis, MDU has the second lowest relative value based on their earnings projections. Assuming the companies are all valued reasonably, investors should be able to have confidence that MDU is not significantly overvalued. The next step in determining if this could be a good investment is looking at the company's payout ratio.

In the last 3 years, MDU's payout ratio has jumped significantly from under 29% in 2009, to over 95% as of last year. The payout ratio further increased in the first quarter of 2012 to over 100% of free cash flow. While it's not unusual for an exploration company to show significant changes in free cash flow because of expenses related to future growth, investors should keep a close eye on the company's balance sheet. Traditionally speaking, a company paying the majority of their free cash flow out in dividends is in a difficult situation. All things being equal, if the company's earnings were to drop a little bit, or costs increase, the company's payout ratio could rise over 100% which is what happened in the first quarter of this year. At this point, MDU shareholders should feel reassured by the fact that the company has cut its long-term debt each of the last four quarters. This shows that management understands that investing for the future is important, but maintaining a strong balance sheet is equally important. Assuming the company can continue its current payout, the next question is, what type of dividend growth can investors expect?

You can see over the last several years how the company has handled its dividend increases:

Prior to 2009, the company's average dividend increase was just about 7%. However, as the Great Recession came about, the company significantly changed its dividend growth policy. In part because of high payout ratios in the last two years, the company's dividend increases have averaged around 3%. While this is still positive, it is of course less than half of what investors were used to prior to this economic turmoil. With analysts calling for earnings growth of 8% going forward, if the company is able to meet this goal, MDU should be able to return to a better dividend growth percentage. However, depending on future expenses, management may choose to lower the payout ratio to avoid potential issues in the future. Given these concerns, I would suggest investors could expect dividend growth of between 3% and 5% going forward. With the company paying a current yield of about 3%, MDU may not be the most exciting company, but their diversification and potential for growth make the stock more attractive than one might first think.

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