John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
I love dividend growth. It's the core of my investing philosophy.
But there's one thing I love even more: growth of dividend growth.
Let me explain. Lots of companies raise their dividends at a fairly consistent rate of, say, 5 or 10 per cent every year. That's great. Lately, however, fuelled by burgeoning free cash flow and investors' growing appetite for income, more companies are announcing plans to increase the rate at which they boost their dividends annually.
It's like your boss giving you a raise … on your raise.
This is a bullish sign because it speaks to the confidence companies have in their revenue cash flow outlooks. No company wants to raise its dividend only to throttle it back when times get tough. That would damage management's credibility and hurt the stock. So companies don't typically make such promises unless they're fairly certain they can deliver.
Consider Brookfield Renewable Energy Partners LP (BEP.UN). In September, the power producer raised its distribution growth target to a range of 5- to 9-per-cent annually, up from 3 to 5 per cent. The operator of hydro, wind and thermal generating facilities cited factors including "strong organic growth prospects" and a "robust development pipeline of projects" for the decision.
In recent weeks, other companies have also raised their dividend growth projections or strongly hinted that such increases are coming.
Enbridge Inc. (ENB), for example, has said its dividend would rise in line with projected earnings per share growth of about 10 to 12 per cent annually through 2018. However, with free-cash flow poised to rise at roughly double that pace thanks to new projects and lower maintenance capital spending, "there may be an opportunity to accelerate dividend growth," chief executive officer Al Monaco said on Enbridge's recent third-quarter conference call.
"After 2018 we could see significant surplus free cash, enabling us to further elevate dividend growth," Mr. Monaco said. "That will depend on the size and quality of our capital investment opportunities."
Some observers are speculating that the pipeline company could deliver a bigger-than-usual dividend increase as early as Dec. 4 – the date of its annual guidance conference call, when it typically announces a dividend hike.
"I suspect that the company may have heard the message from investors that a higher payout ratio would be well received by the investment community," said Robert Cable, director of wealth management with ScotiaMcLeod, who owns Enbridge personally and in client accounts.
Fellow pipeline operator TransCanada (TRP) was even more explicit. Even as its Keystone XL and Energy East projects face an uncertain future, the company intends to double its dividend growth rate to 8 to 10 per cent annually through 2017, up from less than 5 per cent previously. The fatter increases are being driven by the completion of about $13-billion of small- and medium-sized projects over the next several years.
For 2018 and beyond, the potential completion of larger-scale projects could drive even bigger growth in TransCanada's dividend, the company said at a recent investor conference.
Even before TransCanada announced its higher dividend-growth targets, some analysts were predicting such a move. "We believe a turning point is fast approaching," Credit Suisse analysts said in a note. "TRP may achieve double-digit dividend growth with the successful building of many projects in the near future."
Based on an analysis using the dividend discount model (DDM) – which values a stock based on its expected future dividend payments – Credit Suisse recently raised its ratings on both TransCanada and Enbridge to "outperform" from "neutral." It also hiked its price targets substantially, to $68 from $58 for TransCanada (current price: $55.50) and to $70 from $52 for Enbridge (current price: $52.85).
Credit Suisse also upgraded Brookfield Infrastructure Partners LP (BIP.UN) and Fortis Inc. (FTS) to "outperform" from "neutral" and reiterated an "outperform" rating on Emera Inc. (EMA), citing strong expected dividend growth that is not fully reflected in the share price. Another factor in Credit Suisse's rating changes was a reduction the expected yield of the 10-year Government of Canada bond, to 2.5 per cent from 2.75 per cent (compared with about 2 per cent currently).
Dividend growth is good. Growth of dividend growth is even better, and I suspect we'll see similar announcements from other companies in the future.
Disclosure: The author personally owns shares of BEP.UN, ENB, TRP, BIP.UN, FTS and EMA, and holds ENB, TRP and FTS in his Strategy Lab model dividend portfolio.
John Heinzl