Income stocks have not been keeping well lately as rising interest rates have ballooned their cost of debt. Several mid- and small-sized companies even slashed their dividends to have sufficient cash to service debt. If a company defaults on debt, its credit score is affected for a long time. It will find it harder to get debt at favourable terms. Hence, debt takes precedence over dividends. High debt expense stresses a company’s profitability and pulls down the stock price.
A once-in-a-decade chance to get rich from income stocks
Judging a dividend stock by its current profits and cash flows is misguided, as these companies build a project keeping future cash flows in mind. A value investor looks at the future cash flows of a company and uses dividend cuts as an opportunity to buy such income stocks at a heavy discount.
Higher expenses and interest is reducing the profits of telecom and pipeline companies. For telecom, recent regulations on streaming operations forced telcos to slash jobs. As for pipeline companies, the cooling of oil and gas prices and rising interest rates negatively affected their profits.
But interest rates won’t remain high for a long time. As inflation slows, the central banks could cut interest rates. But this will take some time, probably next year. Until then, companies have to stay focused on preserving fundamentals. Here are two such income stocks that are at their 52-week lows. They have the fundamentals to sustain their dividend per share, if not grow it, and give you capital appreciation of 5–10% as things stabilize.
BCE stock
Second-quarter earnings were not quite impressive for telcos. BCE’s (TSX:BCE) net profit fell 39% year over year while revenue continued to grow 3.5%. Higher expenses like interest on debt, severance pay for jobs slashed, and depreciation on the 5G infrastructure pulled down profits. But these expenses are one-off and will reduce with time. Moreover, BCE also incurred a $377 million non-cash loss on the repurchase of a minority interest in one of its joint venture equity investments.
The company is bullish on the second half as the costs incurred in the first half bear fruit. BCE has maintained its full-year free cash flow (FCF) growth guidance of 2–10%. Assuming a 5% growth rate, the 2023 FCF should be $3.2 billion. Given that BCE’s first-half FCF was only $1.1 billion due to huge capital spending, the telco is confident it can double its second-half FCF to $2.1 billion and achieve the full-year guidance. BCE’s long-term FCF from 5G subscriptions remains intact.
BCE stock is trading at the December 2021 level while paying a higher dividend per share of $3.87 ($3.5 in 2021). It means you can lock in a 6.8% dividend yield. And if the stock returns to its average trading price of $60–$61, you can get 8% capital appreciation.
A $2,000 investment today could earn you $270 in a year ($135 in dividends and $135 in capital appreciation). And when you compound this, the amount could grow severalfold and make you rich.
Pembina Pipeline
Pembina Pipeline (TSX:PPL) reported weak revenue (-33%) and earnings (-13%) in the second quarter as oil and gas prices fell compared to last year. If you recollect, oil and gas prices peaked in June 2022 due to the supply shock from the Russia-Ukraine war. So the earnings dip is a sign of business returning to normal.
Pembina Pipeline earns 80% of its operating profit from the contracted transmission and the remaining from open market prices. But it pays dividends from the fee collected from contracts.
Apart from weaker prices, the pipeline company saw lower volumes (-5%) due to a Northern Pipeline system outage, wildfires, and third-party outages. But its cash flows remain strong, and its dividend-paying capacity is intact. The company has grown dividends in 12 of the last 13 years. So far, there are no signs of dividend cuts. And its pipelines will continue to earn cash flows for years to come.
Now is a good time to buy the stock while it trades closer to its 52-week low and lock in a 6.35% yield.
By buying these income stocks while they face difficult times, you can create value for your portfolio. Better still, these dividends could compound your returns through reinvestment.
