An attractive yield plus strong dividend growth is the holy grail for income-focused investors. High-yield stocks usually come with little or no dividend growth. Stocks with solid dividend growth tend to be priced for much lower, even unattractive, yields. On occasion, however, the market will get it wrong, allowing investors to grab shares that will pay a high current yield with strong dividend growth.

That’s what’s happening right now. Let me show you…

Pipeline on a field
Investing for dividend growth is a powerful, long-term wealth-building strategy. With a stock that steadily increases its dividend rate, an investor will earn a growing income stream and share price appreciation driven by the larger dividends.

Mathematically, for a stock’s yield to stay at the same level after a dividend increase, the share price must rise by a percentage equal to the amount of the dividend boost. Over the long term, the compound annual total returns from a dividend growth stock will end up very close to the average yield plus the average dividend growth.

Recently, the CEO of energy midstream company Plains All American Pipelines LP (PAA), Willie Chiang, participated in a fireside chat series hosted by Morgan Stanley and VettaFi/ETFTrends. Investors should get excited about CEO Chiang’s comments concerning Plains’ distribution growth plans.

Plains is a publicly traded master limited partnership (MLP) with a network of crude oil and NGL pipelines and storage assets. According to its website, the company owns and operates 18,300 miles of crude oil and NGL pipelines, 140 million barrels of storage capacity, 2,100 trucks and trailers, and 6,000 crude oil and NGL railcars.

As an MLP, PAA investors are limited partner unit holders and receive a Schedule K-1 for tax reporting. Unique in the MLP space, Plains GP Holdings (PAGP) shares report on Forms 1099. Each PAGP share is backed by one PAA unit and the PAA distribution tax characteristic pass-through.

Plains is a large and profitable midstream company. For 2022, it reported an adjusted EBITDA of $2.51 billion, which generated $1.61 billion of free cash flow. The company forecasts similar EBITDA and cash flow for 2023.

The $1.60 billion of free cash flow provides 273% coverage of the current $1.07 annual dividend. During the fireside chat, CEO Chiang stated that Plains plans to increase distributions to investors by $0.15 per share each year until the cash flow distribution coverage reaches 160%.

This means the PAA distribution will grow by 14% next year and by high single digits until the dividend rate has doubled. Going from 273% coverage to 160% coverage means distributions will grow by the difference of 113%.

The projected dividend growth doesn’t include any organic increase in EBITDA or cash flow, which is unlikely.

PAA/PAGP currently yield just under 8%. Combine that with the projected distribution growth, and investors who get in now will be very happy for the next decade.

— Tim Plaehn

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Source: Investors Alley