2 Dividend Stocks to Stay Away From — and 1 Worth Buying
One of the best parts of investing is getting paid simply to own a stock. However, that doesn't mean dividend stocks require less research from individual investors. If anything, they might require more to ensure the yields are sustainable and that the total returns (stock performance plus dividends distributed) still result in long-term gains. Unfortunately, that's not always the case.
Digging deeper into two seemingly healthy dividend yields proves this point. Investors may discover that coal producer Alliance Resource Partners LP (NASDAQ: ARLP) and gold miner Gold Fields (NYSE: GFI) are two dividend stocks to avoid. Meanwhile, the high yield of Brazilian chemical manufacturer Braskem (NYSE: BAK) passes the test — and could even grow stronger in the near future.
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These are two dividend stocks to avoid
Investors are likely drawn to Alliance Resource Partners for its 10.2% dividend yield. While well above average, the business pumps out enough cash flow to make the distribution sustainable. For now, anyway. That's because that business is selling coal, and although coal markets were strong in the first half of 2018, there were multiple asterisks. In other words, this may not last.
Alliance Resource Partners reported strong growth in the first six months of 2018. The volume of coal sold jumped 10% from the year-ago period, which helped to push revenue and operating income 13% and 44% higher, respectively, in that span. So what's there to worry about?
The catalysts driving the business are likely to be temporary. Heat waves in Asia caused Australian thermal coal prices to surge, which helped quite a bit, considering the company's reliance on international sales jumped from just 4.5% of total revenue in 2016 to an expected contribution of over 27% this year. But coal selling prices crashed at the end of July. Worse, while weather might be unpredictable, the swelling volumes of American liquified natural gas exports to Asia is much more certain — and those cargoes will steal increasing market share from coal in the next few years.
Similarly worrisome is coal's performance domestically. The United States consumed 4.5% more electricity in the first half of 2018 compared with last year (a relatively giant leap), but coal-fired power plants generated 6% less electricity in that span. That trend is not the friend of Alliance Resource Partners, and it's possible that rapid shifts both internationally and domestically accelerate coal's decline within the next several years. What appears to be a growth spurt this summer may only be a blip on the radar.
Gold Fields stock has also encountered recent turbulence from international sources. In recent years, and especially in the last several quarters, many mining companies have initiated plans to modernize and improve the efficiency of their operations in South Africa. But improving safety with more machines and automation goes hand in hand with reduced labor. As a result, an estimated 50,000 mining jobs have been eliminated in the last several years.
That creates a delicate situation in a country already dealing with high rates of poverty and inequality where the mining industry is a top employer. It reached a tipping point in August, when Gold Fields announced its turnaround plan for the South Deep mining complex, which included cutting 1,560 jobs. The very next day the African National Congress (ANC), the leading political party in South Africa, issued a warning to the mining industry against further job cuts. Many South African gold mining stocks suffered significant losses on the announcement.
The rising tensions have pushed stock valuations lower and dividend yields higher, with Gold Fields stock sporting its highest dividend yield since 2014 at around 3%. However, investors may want to think twice before declaring the unfolding situation in South Africa a buying opportunity. If mining companies are required to employ more miners than are needed, then it could sap operating margins and keep certain assets in the country in the red. The South Deep complex has lost $282 million in the last five years. Wall Street is right to worry about the fallout, and individual investors shouldn't overlook the risks.
An under-the-radar chemical manufacturer
In contrast to Alliance Resource Partners and Gold Fields, Brazilian chemical manufacturer Braskem is turning international relations into a competitive advantage. Although distributions are unpredictable in timing and amount, shares have sported the equivalent of a roughly 5% dividend yield on an annual basis for the last five or so years.
Already the largest petrochemical producer in South America and one of the world's leading manufacturers of polyethylene (ranking seventh) and polypropylene (ranking third), the company has aggressively expanded in recent years with a goal of generating half of sales and profits outside of Brazil. The business is well on its way.
In the first half of 2018, roughly 40% of adjusted EBITDA was generated outside of Brazil, up from just 12% in 2015. A massive polyethylene complex in Mexico (completed in 2016) contributed 20% of adjusted EBITDA in the second quarter of this year — and it operated at only 72% of capacity. That will soon be joined by a new polypropylene facility along the Gulf Coast of the United States, which will be the first such plant built in North America since 2005. It will be the company's sixth such facility operating in the United States.
Braskem's push north is also driven by the desire to gain access to cheap feedstocks, namely natural gas liquids such as ethane and propane, created by the American shale revolution. In 2009 naphtha represented nearly 80% of all feedstocks consumed by the company's chemical manufacturing fleet. But after expanding internationally — and even shipping cheap ethane from the American Gulf Coast to Brazil — the company now boasts a well-diversified input stream comprising 37% naphtha, 35% propylene, 22% natural gas liquids (NGLs), and 3% ethanol, and some wiggle room to switch between naphtha and NGLs.
While the international expansion of the last decade positions Braskem for its next phase of growth, it soon may be able to accelerate that strategy. Global petrochemical manufacturer LyondellBasell Industries is exploring an acquisition of a majority stake in the Brazilian chemical leader.
Any deal would have to go through Brazilian construction conglomerate Odebrecht (50.1% of voting capital) and Brazilian petroleum leader Petrobras (47% of voting capital), but diversifying ownership with a financially stable European parent company would ease credit concerns and improve access to capital. While Petrobras may retain its stake, Odebrecht is seriously considering unloading its equity. Any transaction would be great for Braskem shareholders and would unlock considerable value in the long run.
Not all dividend stocks belong in your portfolio
While dividend stocks pay you just for owning them, the regular income can be sullied by a stagnant or falling stock price over time. That's why it's a good idea to compare a dividend stock's total return versus that of the S&P 500 over time. That simple analysis (provided in the chart above) demonstrates quite clearly that Alliance Resource Partners and Gold Fields haven't been great investments, while Braskem has held its own against the index. Of course, due diligence is still required to evaluate the opportunity ahead, but the Brazilian chemical manufacturer easily comes out ahead of the coal producer and South African gold miner.
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Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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