Your first thought should be one of skepticism. A dividend that generates a yield of that magnitude exists for a reason. A dividend cut nearly always looms.
Nearly always, but not always. Exceptions exist. I offer an example.
We found a dividend that generated a legitimate 41% yield on investment.
Warrior Met Coal (NYSE: HCC), a metallurgical coal company, announced in October that it intended to deliver $600 million to its shareholders in a one-off dividend. The amount distilled to $11.21 per share. The dividend generated a 41% yield on Warrior Met Coal’s share price.
Warrior Met Coal’s dividend seemed surreal at first glance. It seemed reckless on second glance.
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The third glance pointed to an opportunity to make serious money.
Warrior Met Coal was a new publicly traded company when it declared its extraordinary dividend.
Warrior Met Coal was no fly-by-night reorganization. It was backed by a roster of blue-chip institutional investors.
Private equity firms Apollo Management Holdings, Blackstone Group, Kohlberg Kravis Roberts, and Blackrock owned large blocks of Warrior Met Coal stock. Mutual fund companies Franklin Resources, Vanguard Group, and Thornburg Investment Management were prominent owners.
These seven firms owned half of Warrior Met Coal’s outstanding shares.
The attraction was obvious. Recent financial performance pointed to a promising future.
Growth in Cash Flow, Revenue, EPS
Warrior Met Coal had generated impressive cash flow growth. The cash account — around $13 million in late 2016 — had ballooned to $260 million last year.
Revenue and earnings have assumed a similar growth trajectory from 2016 to 2017. Revenue grew 43% sequentially; EPS grew 19.4%.
The future is what matters. I want a future that points to adequate earnings growth and wealth creation. The future for Warrior Met Coal’s metallurgical coal business pointed to both.
The regulatory environment for coal had become more accommodating. We had a presidential administration that viewed the coal industry favorably, unlike the previous administration, which viewed it with contempt. Trump’s EPA had repealed the strangling diktats implemented under the Obama EPA.
Warrior Met Coal mines metallurgical coal. This is a special coal that’s burned in blast furnaces to make steel.
Unlike thermal coal, where natural gas is a ready alternative, no ready alternative exists for metallurgical coal. Nearly 75% of the world’s steel is produced using blast furnaces fueled by metallurgical coal. These producers have no alternative fuel source.
As for the outlook on steel, it was positive.
Global steel production was an estimated 1,633 million metric tons in 2016. That’s a 0.4% increase over 2015. Global steel production is expected to have moved higher in 2017.
The outlook for metallurgical coal industry was positive. I believed the outlook for revenue and earnings growth at Warrior Met Coal was positive.
I saw Warrior Met Coal’s special dividend as adding to the value proposition by rewarding investors with an immediate windfall. More important, the special dividend wouldn’t impede growth prospects.
Finding the Right Large Dividends
Warrior Met Coal’s special dividend had all the characteristics of a profitable dividend trade.
And so it was.
We generated a 51.1% holding-period return on Warrior Met Coal. We did it through the $11.21-per-share special dividend and additional share-price appreciation. Our holding period was less than four months.
Warrior Met Coal was no one-off opportunity. We’ve generated large returns on large dividends many times. Warrior Met Coal is the exception for many investors. It wasn’t for us.
The right large dividends, like Warrior Met Coal’s, offer immediate high-yield income. They also set the stage for future share-price appreciation.
But the “right” large dividends are the exception, not the rule. Most large dividends foreshadow failure.
Let me set the stage for investing in these large dividend payments.
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