Some higher-yielding dividend stocks are cheap for a reason: Investors don't believe that the company can sustain its payout due to deteriorating financials. That said, other times the market gets a stock completely wrong, which seems to be the case with Kinder Morgan (NYSE: KMI), Medical Properties Trust (NYSE: MPW), and Summit Midstream Partners (NYSE: SMLP). All three companies trade at embarrassingly cheap valuations these days, which means investors can pick up their compelling yields at bargain-basement prices.
Continue Reading Below
A ridiculously cheap cash flow stream
While pipeline giant Kinder Morgan's 2.6% yield might not catch the eye of some income investors, its low valuation should grab the attention of bargain hunters. Thanks to the stable stream of cash flow that the company's pipelines and storage terminals generate, Kinder Morgan expects to produce $4.46 billion of distributable cash flow (DCF) this year, which works out to $1.99 per share. At its current stock price of around $19 per share, that works out to a price-to-DCF multiple of just 9.5. Put another way, the company has a free cash flow yield of 10.5%, which is what the stock would yield if Kinder Morgan paid out 100% of its cash flow. For a company that has traditionally traded at a mid-teens DCF multiple along with the rest of its pipeline peers, the stock is ridiculously cheap right now.
Meanwhile, income investors will love to hear that Kinder Morgan's dividend should increase substantially over the next year. The company currently only pays out a quarter of its cash flow in dividends, which is well below the 50% to 90%-plus that most other pipeline companies pay out. However, after spending the past two years shoring up its balance sheet and lining up financing for growth projects, Kinder Morgan is likely to use a significant portion of future excess cash flow for dividends starting next year. That looming dividend increase, along with visible cash flow growth from upcoming expansion projects, suggests it could be a gold mine for income investors, especially considering its cheap valuation these days.
A healthy dividend for a rock-bottom price
Hospital-property-owning REIT Medical Properties Trust will appeal to income-hungry investors given its current yield of 7.4%. Normally when a yield gets that high, it's a warning sign. However, that's not the case at Medical Properties Trust. The company has a top-notch balance sheet because it has one of the lowest leverage ratios in its peer group. Furthermore, rental contracts and mortgage agreements underpin its properties and support the company's forecast that it will produce $1.35 to $1.40 per share in funds from operations (FFO) this year, which more than adequately covers its current dividend run rate of $0.96 per share.
Continue Reading Below
Instead of weak financials, the driving force behind the company's eye-popping yield is its dirt-cheap valuation. At its recent share price of around $12, the company trades at just 9.0 times the midpoint of its FFO guidance, which conversely works out to a FFO yield of 11%. For comparison's sake, leading healthcare REIT Welltower (NYSE: HCN) trades at 18 times expected 2017 FFO, or a FFO yield of just 5.5%. That's despite the fact that Welltower had a higher leverage ratio of 5.26 debt to EBITDA (earnings before interest, taxes, depreciation, and amortization), while Medical Properties' leverage was a historically low 4.5 last quarter. Meanwhile, with that low leverage and healthy coverage ratio, Medical Properties Trust has the financial firepower to buy more properties and grow its FFO and dividend.
Weighed down by the unknown
Pipeline and processing company MLP Summit Midstream Partners offers the highest yield in this group at 9.7%. When a yield gets that high, it's typically a warning sign from the market that it doesn't expect the current payout rate to last. That said, in Summit Midstream Partners' case, its payout appears to be on solid ground. The company expects to produce between $2.65 and $2.88 per unit in distributable cash flow this year, which would more than adequately cover its current annual payout of $2.30 per unit. Meanwhile, with several expansion projects underway, the company estimates that it could potentially resume distribution growth by year-end. Providing further support to that view are the facts that 98% of its cash flow comes from long-term fee-based contracts, and the company has a relatively low leverage ratio for an MLP, at 4.35 debt to EBITDA.
Given those metrics, Summit Midstream Partners appears to be seriously cheap right now, trading at just 8.4 times the midpoint of its 2017 DCF guidance, or a DCF yield of 11.9%. If there is one concern, it's that the company owes its parent a deferred payment in 2020 to finance the balance of a large drop-down transaction it completed last year. At the moment, the company expects that payment to be between $800 million and $900 million. While the company doesn't have that kind of cash lying around, it does have until 2020 to raise that capital it needs, so it can wait for a more opportune time than the present. That said, the suspense of how it will pay for the deal weighs heavily on Summit Midstream Partners' unit price, which is providing the opportunity for risk-tolerant investors to buy this high-yield stock for an unbelievably low price.
The market is making a big mistake with these stocks by having them sell for valuations that would imply their dividends aren't on solid ground. Quite the opposite is true, since all three generate stable cash flow supported by long-term contracts, and have solid balance sheets and healthy coverage ratios. Because of those strong metrics, and the visible growth prospects these companies have on the horizon, their dividends are likely going to head higher in the years ahead. This suggests that investors who buy at today's cheap prices could do very well once the market realizes its mistake.
Find out why Kinder Morgan is one of the 10 best stocks to buy now
Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)
Tom and David just revealed their ten top stock picks for investors to buy right now. Kinder Morgan is on the list -- but there are nine others you may be overlooking.
*Stock Advisor returns as of July 6, 2017
Matt DiLallo owns shares of Kinder Morgan and Medical Properties Trust and has the following options: short January 2018 $30 puts on Kinder Morgan, long January 2018 $30 calls on Kinder Morgan, and short December 2017 $19 puts on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Welltower. The Motley Fool has a disclosure policy.