I recently wrote about how important it is for dividend investors to act like dividend investors, and not chase trends or hot stocks.
Today, I’m featuring a stock that provides investors with a perfect opportunity to follow that advice. This company is in an industry experiencing a cyclical downturn, and the stock... well, its two-year chart looks like this:
For a momentum investor, that flat-to-declining line screams “stay away!” But as I wrote recently, true dividend investors try to buy low in order to maximize the yield they get on their purchase (yield equals the annual dividend divided by the price you paid for a stock).
This particular chart belongs to Encana Corp. (ECA), a Canadian natural gas producer. Encana was featured as a Spotlight Stock in the November 2011 Dividend Digest, shortly after the stock’s decline pushed its yield close to 4%. At the time, the stock was recommended by both Nathan Slaughter, editor of Scarcity & Real Wealth, and Patrick McKeough, editor of The Successful Investor.
Slaughter touched on the underpriced angle, writing: “Just about every energy producer sells both oil and gas. They each favor one over the other. And most have been tilting toward oil over the past couple years. But Encana Corp. makes no bones about being a natural-gas specialist and is an outspoken industry advocate. Natural gas accounts for fully 96% of the company’s production mix (versus 4% for oil). ... That skewed weighting puts Encana at a disadvantage in the current pricing environment.”
Three months later, natural gas prices are still in the doldrums, and so is Encana. Cold winters make energy prices go up, and this winter has been anything but. Investors who bought ECA with the expectation of rising natural gas prices are still waiting. But for income investors, that means it’s still possible to lock in a 4% yield from ECA!
Which brings me to the reason I’m featuring Encana today: it was recently recommended as a new buy in The Primary Trend, edited by Barry Arnold. Arnold wrote:
“T. Boone Pickens has been the unconventional spokesperson for the natural gas industry, touting the long-term advantages of natural gas for the U.S. and extolling the virtues of those companies whose livelihood is reliant upon ‘clean energy.’ As a long-term proponent of the industry, we agree with Mr. Pickens, but the final arbiter of the success of this industry is price.
“As can be gleaned from the chart at right of the natural gas commodity, prices for natural gas futures have steadily declined throughout 2011 from a high of near $5 per mcf (million cubic feet) to recent trading levels of $2.50/mcf. Remarkably, natural gas traded at nearly $14/mcf in mid-2008 when crude oil traded near $150 per barrel. Times have changed and investors’ opinions have as well, with consensus bulls on natural gas at only 17%—a very lopsided bearish outlook.
“We are bullish on natural gas with what we believe to be limited downside potential, and have purchased Encana Corp. in the Primary Trend Fund and client accounts.
“Encana Corp. is based in Calgary, Alberta, Canada and is a leading North American producer of natural gas. It has prolific shale-gas developments that stretch from British Columbia to Texas and Louisiana. ECA is a simple investment story: l) It is a conservative call option on the price of natural gas shares; when gas was at $14/mcf in 2008, ECA traded above $50; 2) Encana produces 3.5 billion cubic feet of natural gas equivalent per day and its total proved reserves were 14.3 trillion cubic feet as of 12/31/11; 3) ECA pays a hefty $0.80 annual dividend, or 4.0%; and 4) due to the bearishness surrounding the industry, ECA is undervalued based on many metrics and trades at less than its book value of $22 per share.
“Technically, ECA is attempting to form a bottom in the $17-$20 area. We recommend that long-term, value-oriented investors initiate positions in ECA common up to $20, with a total return objective of 50% over the next two years.”
Of course, dividend investors hunting for underpriced stocks do have to be wary of companies that are so beaten-down their dividends are at risk. But that’s not a factor with Encana. As Slaughter wrote in November, “In the meantime, profits aren’t exactly suffering. Last quarter, the company generated $1.2 billion ($1.57 per share) in cash flow, amply covering the $0.20 per share dividend.”
Most likely, someday, natural gas prices will go up. (I wrote the same thing months ago.) But I’m not going to say when. In the meantime, Encana pays its shareholders 80 cents a year in dividends.
If you buy it today at $20, that’s a guaranteed 4% yield per year, regardless of what happens to the stock price (assuming the dividend is maintained.) If you wait to buy until the stock returns to its 2010-early 2011 levels around $30, your yield would be cut to 2.6%.
And who knows, winter might arrive any day now.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of Investment of the Week
