Williams Companies Inc Is A Good Dividend Play

Williams Companies Inc (NYSE:WMB) is a midstream energy infrastructure company that owns and operates natural gas pipeline systems in Texas and in many of America’s other natural gas-producing areas. Because U.S natural gas production has increased substantially in recent years due to advances in shale technology, the company’s dividend has grown to $0.64 in September 2015 from $0.125 in August 2010, giving the dividend an astonishing compound annual growth rate of 38.63% over the last five years.

In late September, Energy Transfer Equity LP (NYSE:ETE) acquired Williams Companies Inc (NYSE:WMB) in a deal that should yield $2 billion in annual EBITDA synergies by 2020. Under the terms of the merger, Williams Companies Inc (NYSE:WMB) shareholders are entitled to 1.8716 Energy Transfer Equity LP (NYSE:ETE) shares for each share of Williams that they own. Williams Companies shareholders can also elect to get cash, but on a prorated basis of $6.05 billion. Once the $6.05 billion of cash is out, Williams Companies shareholders can only receive Energy Transfer Equity LP shares. Because the deal has a limited cash component, the combined company will have an acceptable debt/cash flow ratio. Credit agencies agree, as the S&P gives Energy Transfer Equity LP a decent credit rating of ‘BB’.

Although the synergies of the ETE/WMB deal will improve cash flow in the future, they won’t do much for the companies now. Fortunately, Williams Companies’ latest quarterly results show its EBITDA is rising. Because of new pipelines and processing plants coming online, Williams Companies’ primary cash cow, Williams Partners, enjoyed an adjusted EBITDA increase of 21% year-over-year to $1.1 billion in the third quarter. Distributable cash flow more than doubled to $754 million for the quarter, up from $367 million in the third quarter of 2014. Because of the increase in cash flow, the company has a cash distribution coverage ratio of 1.04x, more than enough to cover the dividend payout.

For long-term investors, Williams Companies and Energy Transfer Equity LP make for a good bet. The combined company will be the largest energy infrastructure company in the United States, with a network of over 100,000 liquid and natural gas pipelines. Their strong cash flows at a time when natural gas and crude prices are low mean their dividend is secure . As members of OPEC cut production and as the U.S begins exporting its natural gas over the next few years, natural gas and crude prices will jump, and the volume of oil and gas flowing through Williams Companies’ and Energy Transfer Equity LP’s pipes will increase further, providing more cash flow to increase the dividend yield over time. Hedge funds were bullish on Williams prior to the merger announcement. Of the 730 elite funds that we track, 86 funds owned $10.64 billion of Williams Companies Inc (NYSE:WMB)’s shares, accounting for 24.80% of the float on June 30.

Most investors don’t understand hedge funds and indicators that are based on hedge funds’ activities. They ignore hedge funds because of their recent poor performance in the bull market. Our research indicates that hedge funds underperformed because they aren’t 100% long. Hedge fund fees are also very large compared to the returns generated and they reduce the net returns experienced by investors. We uncovered that hedge funds’ long positions actually outperformed the market. For instance the 15 most popular small-cap stocks among funds beat the S&P 500 Index by 53 percentage points since the end of August 2012. These stocks returned a cumulative of 102% vs. a 48.6% gain for the S&P 500 Index (see the details here). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).

Disclosure: None