Yield-hungry investors have been pushing up prices for bonds and overpaying for mature dividend-paying stocks such as telcos and utilities. A wiser strategy might be to hunt for companies that pay modest dividends today, but are likely to increase them substantially.
To that end, take a look at Stella-Jones Inc. Despite its racy-sounding name, Stella-Jones operates in a dull industry. It sells treated wood products, mainly rail ties and utility poles. For dividend lovers, however, Stella may soon become the next hot thing.
Under CEO Brian McManus, the Montreal-based company has achieved 11 years of growing profits, and its strong third-quarter earnings released Friday point to a 12th year in the making. About 90 per cent of the demand for its products stems from maintenance needs – replacing old ties and poles – the kind of capital expenditure that is the last to be cut, even during recessions. Stella is the only serious consolidator in the business, and has taken a disciplined, focused approach to acquisitions.
Today, Stella pays a modest 64-cent annual dividend. The payout is up eightfold since 2004, but still amounts to a yield of less than 1 per cent. That will soon change, substantially.
Mr. McManus has long maintained that once Stella-Jones hits the brakes on acquisitions it will start cranking up the dividends. With the company's announcement of its largest-ever acquisition last week – a $230-million (U.S.) deal for McFarland Cascade Holdings, Inc. of Washington state – that time is now on the horizon.
Once the integration is complete, probably within 18 months, there won't be any large acquisitions left to make in North America, and Stella will be ready to start raising dividends, probably in two years, Mr. McManus said in an interview. "I'm a firm believer in [the idea that] if we don't have a use for it, pay it out."
Stella's dividend-paying capabilities are already considerable. Last year, dividends paid out amounted to less than 20 per cent of its profit. Without acquisitions, Mr. McManus figures he could afford to pay between 60 and 80 per cent. "That's a fair target" for a post-acquisition phase, he said.
It's not difficult to forecast Stella's post-acquisition dividend-paying power. Consider that Stella earned $55.7-million (Canadian) in profit last year on sales of $640-million. McFarland earned $255-million (U.S.) in revenue last year. Assuming Stella-Jones could derive 7-per-cent profit out of the acquired operation (a reasonable guess given post-acquisition performance of past U.S. targets), a combined Stella-McFarland would have earned about $74-million in 2011; if it paid out, say, just 60 per cent of that in dividends, shareholders would have received roughly $2.80 a share. Even after a 75-per-cent spike in Stella's stock price this year, that would represent a yield of just under 4 per cent at current prices.
And remember, that's based off last year's revenues; both companies have increased revenues by 10 per cent this year. Best of all? There's no digital alternative to railway ties or utility poles.
Sean Silcoff