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Time to Warm Up to Cold-Weather Dividend-Payers

Josh Peters, CFA
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We've had a warm start to this winter. I'm here with Josh Peters--he is the director of equity-income strategy and also the editor of Morningstar DividendInvestor newsletter--to see what impact that could have on some of his portfolio holdings.

Josh, thanks for joining me.

Josh Peters: Good to be here.

Glaser: You've said in the past that you have kind of a cold-weather bias in your portfolio in some ways. How do you think about short-term trends like this for businesses that might be dependent on weather for demand?

Peters: I think you want to see it as a variable for certain kinds of companies in your portfolio. If you think about a warm winter for a large swath of the country, especially the areas that consume a lot of heating fuels like the Northeast and the Midwest, that might be kind of tough short term for some utilities. One name that comes to mind that's got some exposure there that I still like is AmeriGas Partners (APU). They are a little bit different from a utility in that they are not price regulated. They are delivering propane that gets used for heating and other appliances in the home, but they have the benefit of not being regulated. It doesn't cap their profitability, but it also means that they don't have regulatory support. They can't book a regulatory asset to level out and weather-normalize the business. They either sold the propane or--if it was too warm--they didn't. So, there is some variability in the business there.

Another business I own and like a lot is Compass Minerals (CMP). I actually bought this stock back after having had a great experience with it earlier in our 11-year run because I thought the stock had gotten cheap. But their biggest product is highway de-icing salt. And here, if it's kind of warm but really wet, maybe you still get a lot of wet snow and some ice storms and stuff. That's not, on balance, so bad for them, but warm and dry--or even cold and dry--is kind of bad for them. So, from year to year, weather is going to have a big impact on the business. For that reason, you may think that maybe you don't want to max out your exposure all the time in names like this. If there is a warm winter, maybe I want to have the ability to take my exposure up opportunistically if investors are overreacting to one bad winter season for these companies. But the bigger question for the long run is are they adequately protected? Is there enough excess coverage for the dividends--or in AmeriGas' case, partnership distribution--that they can survive a warm winter or two without that threatening my income as an investor?

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Glaser: But even if there isn't a cut on the horizon, can a bad season impact dividend growth? Could you see that rising at a much slower rate than maybe you anticipated?

Peters: I think that that is a possibility for AmeriGas at this point. For a number of years, they have been targeting a 5% distribution growth rate, and they've met or, in one year, exceeded that. But it's not a very fast-growing business. In fact, propane consumption nationally is declining for the reason that homes are getting more efficient. Appliances are getting more efficient. It's the same thing that's happening in natural gas. But again, not being a regulated utility where they are recovering operating costs and a fair return on capital, it's up to the individual propane distributors to recover that through pricing, which AmeriGas has done a good job of. But this may be more of a 3% or 4% type of growth story going forward as opposed to 5%.

What you have right now, though, is the stock has gotten hammered mercilessly, and I think the weather maybe is playing into a few people's decisions. If you have a really short time horizon, you might say, "Oh, warm winter--I don't want to have anything to do with AmeriGas or other propane distributors." But the bigger problem is that they are a master limited partnership. They are in some of the MLP indexes. Those have been sold down for reasons that have really nothing to do with AmeriGas or propane but rather all the trouble that's going on in the real midstream energy industry because of low oil and natural gas prices. But for AmeriGas, low propane prices are actually a plus. They just pass along the cost of propane--that's just a pass-through to their customers. But when propane is cheap, the total bill for their customers is less; people might be incentivized to turn up the thermostat. There is actually some price elasticity involved even in energy commodities. So, that's actually a net plus for them if propane is cheap longer term, too, because it will reduce the temptation to switch to natural gas, which has been cheap for a while.

The only reservation I have about AmeriGas is that their distribution coverage has slipped a little bit. But on a weather-normalized basis, it looks like they still cover about 1.15 times. Over a series of years, they are going to have some warm years; they are also going to have some cold years. It's going to even out. I think that provides for adequate distribution coverage as well as some growth.

Glaser: And then would you buy Compass today?

Peters: Compass is a name I'm hoping to buy more of--and honestly, I'm hoping to have some volatility in the share price. I think it's a good time to start a position. I would love to bulk up on the stock if it slips, say, into the mid-70s or lower. The stock historically has tended to react to changes in the weather. It also tends to massively overreact to events in the fertilizer market. They have a much smaller piece of their business that produces specialty fertilizer. The agriculture industry is under a lot of pressure, and potash prices are down a lot. Prices for Compass' products haven't come down so much, but there could be a bad news development there. But the fact is that in our fair value estimate, which I think is in the $95 area, we're not assuming that the fertilizer business is going to contribute anywhere near the earnings that management is expecting. Instead, we're looking at the salt side of their business, which has the yearly weather variability, but that evens out over the long run. They are reducing costs; they are expanding capacity. They already have very low-cost mines. This is an opportunity for them to generate a couple of years of good earnings growth on a weather-normalized basis without needing the weather to necessarily cooperate. So, I'm at around a 2% position right now. I'd love to take it up to 4%. I'm going to try to let volatility, over time, give me the opportunity to do that.

Glaser: Josh, thanks for your thoughts today.

Peters: Thank you, too, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.