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photo by Russel Metals
photo by Russel Metals

Yield Hog

Economy will test Russel's dividend mettle Add to ...

High-yielding Russel Metals Inc. has gone on a dividend-raising binge before, only to cut its payment when times got tough.

Will this time be any different?

Buoyed by the recovering economy and solid demand for steel, particularly from the oil patch, the Mississauga-based metals processor and distributor has raised its dividend three times in the past 15 months. That includes a 17-per-cent increase announced on May 3, the same day Russel posted first-quarter results that topped expectations.

The stock, which closed Tuesday at $26.05, now yields an enticing 5.4 per cent based on the new dividend rate of 35 cents a quarter – or $1.40 annually.

A rocky history

When a yield gets that high, investors need to start asking about the sustainability of the dividend. That’s especially true with a cyclical company like Russel, which chopped its dividend before when the global economy went into the tank.

After a string of increases during the good times, the company slashed its payment by 44 per cent in 2009, dropping it to 25 cents a quarter from 45 cents. The share price also took a massive hit.

“We felt strongly about our dividend, but unfortunately we did have to cut it … and that was partly because our banking had to be redone because there were certain covenants we knew we weren’t going to meet,” said Marion Britton, Russel’s chief financial officer.

“In the end could I have got it done without cutting my dividend? Probably. But it was the right thing to do … we cut management salaries by 10 per cent, we cut the dividend, everybody took a haircut because it was a serious event.”

The 2008-09 downturn was serious indeed for Russel. The company suffered a 40-per-cent drop in shipments and took a huge inventory writeoff, Ms. Britton said. Normally, demand doesn’t rise or fall more than about 5 per cent, unless something unusual happens such as the loss of a major customer, she said.

More cautious this time

The dividend is still well below its pre-recession levels, and for now, there are no plans to increase it again. The company aims for a payout ratio of about 80 per cent of average after-tax earnings over a cycle lasting four to five years. Based on 2012 earnings estimates, the current payout is about 71 per cent.

“They are the type of firm that now, more than ever, are very cautious about the way they manage the business,” said Raymond James analyst Frederic Bastien, who has an “outperform” rating and $29 target price on the stock.

The economy would have to suffer another shock like the 2008-09 downturn before Russel would contemplate another cut, he said. But the company should have no trouble maintaining the dividend through the normal ups and downs of the business cycle, he said.

Silver lining

The 2008-09 slump actually had a silver lining for Russel, Mr. Bastien added. To limit their inventory risk, more customers started purchasing steel in smaller quantities from Russel’s metal service centres, instead of buying in bulk directly from steel mills. Metal service centres carry products in a wide range of sizes and shapes tailored to the customer’s specific needs.

During the last downturn “a lot of end users were stuck with very high-priced inventory of steel,” he said. As a result, they are now more cautious and have adopted just-in-time inventory strategies.

The risks

That said, steel is still a cyclical business tied to the ups and downs of industries such as equipment manufacturing, construction, shipbuilding and energy.

Given the risks, some analysts are more cautious about the stock.

Scotia Capital analyst Anthony Zicha has a “sector perform” and “high risk” rating, citing economic uncertainty, lower energy prices and expectations of higher steel supplies in 2012, both from North American mills and imports.

The verdict

Barring a severe recession, Russel’s dividend is probably safe. The company is a mature business with low capital requirements, so it’s able to throw off lots of cash and pay out a hefty chunk to shareholders.

“We’re relatively comfortable” with the dividend, Ms. Britton said. There are no guarantees, but “we’re increasing it to a level we feel is sustainable over the cycle.”

The share price, however, could provide more excitement than some investors want. In the past year, it has swung between $18.90 and $27.95, making it about 37 per cent more volatile than the S&P/TSX composite index. If the economy takes a dive, expect the shares to follow, but Russel’s rich dividend will at least blunt some of the pain.

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  • Russel Metals Inc
  • Updated January 22 4:00 PM EST. Delayed by at least 15 minutes.

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