For the Love of Dividends!!

One thing that the MoneySaver demographic generally loves is dividends. As do I, to be sure. Indeed there are companies known as “Dividend Aristocrats”, which have increased their payouts for 25 straight years or more. Currently there are around 100 of these enterprises in the United States and if the past is indicative of the future, these could be good plays for those seeking some certainty of ongoing payouts. Of course, past performance is not necessarily indicative of future performance, as many investors found out during the recent recession, when a myriad to blueblood companies not only cut their dividends, but eliminated them.

One company in the President’s Portfolio that I manage at Contra is Capstone Infrastructure. It was acquired in 2014 at $3.58 a share and a primary reason was for the quarterly dividend of $0.075. That worked out to about 8.4 percent. One has to be wary though when purchasing dividend payers. Back in 2009 the company paid $0.0875. A month! The plan was to keep the rate at that level and hopefully increase it. But plans can change when results are desultory at best and CSE did not live up to its billing.

A key question when I bought into the company was, “Is the dividend sustainable?” Management insists that it is, but they have been terribly wrong before. As the outfit had to renegotiate a contract at its Cardinal co-generation plant with Ontario Power Generation, a facility that was running full time is now effectively on a standby basis. That greatly reduces cash flow and profitability.

Unfortunately, that has not been the only headwind facing Capstone. Their Bristol Water plant in England has seen the regulator chop rates for this year. The following four years will also see a further reduction. That again will hurt cash flow and negatively impact the bottom line. CSE is appealing the decision, hoping that rates will be boosted somewhat.

Those two problems were major factors in revenue dropping in the first quarter to $90 million from $114 million a year ago. The bottom line did remain black
though, but net income dropped from almost $20 million to the $5 million range.

The combo of these events means that the payout ratio last quarter was 112.5 percent, a number that is obviously unsustainable. The year before it was around 36 percent. Capstone expects it to drop to about the mid-level between those numbers over the next few years, a necessity for the dividend to remain at the current rate.

The company is working on a number of other projects. Recently the Saint-Philemon wind facility in Quebec was commissioned, while progress continued on the Goulais wind farm in Algoma. Meanwhile approvals were received for a number of other wind projects. Cash will be necessary to feed the mill to develop these projects and Capstone’s balance sheet is not what one would call“clean”.

Infrastructure is a pretty hot area right now and there is some consolidation going on in the industry. It would not surprise to see one of the larger players make a play for CSE at a significant premium. That ultimately could be the best chance to sell the position at a significant profit.

So is Capstone a good buy? Insiders have been bulking up recently, which is a good sign. But certainly this position is not without risk, while remaining on our Buy list with an Initial Sell Target of $8.34. Hopefully the dividend will not be cut once again and will be paid out while waiting for a higher share price. If the
payout continues, that in itself is a lovely return on investment.
by Benj Gallander