One of the reasons why I love investing in dividend growth companies is that management has many tolls at their disposal to generate value for their shareholders.   The easiest manner is to announce a share buyback program or a dividend increase, which have minimal impact on the operations of the companies.  However, if management is looking for a larger splash, they can always spin-off a business unit, merge two companies out of no-where (See Kraft) or even sell the company to the highest bidder.   All of these scenarios have different impacts for us dividend growth investors.  Today, I wanted to take a look at one of the rumors that has been floating around for the last couple of weeks and analyze how the move would impact my forward dividend income.  Let’s dove into these Norfolk Southern (NSC) buyout rumors.

The Situation & Offer

My journey and plunge into ownership began in the spring of 2015 after Lanny performed a stock analysis over the company, indicating the company was undervalued at the time.   I had some extra capital to spend and I initiated a position in the company.  What’s funny is the stock continued to fall in price as the market and commodities became less stable and I ended up buying the stock four different times, lowering my cost basis along the way.  In total, I own 27.64 shares of Norfolk Southern, which produces $65 in projected dividend income annually.   Just quickly, some of the things that drew me to NSC were the history of dividend increases, the high barriers of entry to the railroad industry, and the company continued to trade at a discount among its peers.  I’m still a little shocked that the company’s stock price fell below $75/shares this year and it seemed to take a larger beating than others in the industry.  However, I was fortunate to DRIP a few dividends at a lower price for an extended period of time.

A few weeks ago I checked my investing app and saw that NSC’s stock price shot up nearly 10%.  I was excited and thought that NSC had finally announced their annual dividend increase!   Wishful thinking, right?  As it turns out, several articles were published indicating Canadian Pacific’s interest in purchasing NSC.  So just like that I saw my long-term stream of dividend income turn into a short-term gain (if the merger is completed as discussed).  Over the last week, details have emerged regarding the current offer on the table.  From an article in Bloomberg this week,

“Canadian Pacific on Wednesday released the contents of its letter, confirming Norfolk Southern’s statement that the bid was $46.72 in cash and a fixed exchange ratio of 0.348 Canadian Pacific share based on Friday’s closing price. That indicates an offer of $94.02 a share for Norfolk Southern, 5.7 percent higher than its closing price on Friday. The bid amounts to about $28 billion, based on Norfolk Southern’s shares outstanding and the terms that Canadian Pacific laid out.”

The bid in its current form is a nearly 50/50 split between cash and CP stock.  There have even been grumblings that NSC has rejected the current bid and considered this a “low ball offer,” so I am sure there will be subsequent negotiations aim to increase the premium received by NSC shareholders.  I’m sure there will be plenty of news about this topic over the next month or so as talks progress and new details emerge 

Impact of Norfolk Southern Acquisition

Selfishly, I wanted to take at this acquisition and see how it would impact my portfolio and forward dividend income.   After all, owning 27 shares of Norfolk Southern represents a decent percentage of my portfolio and this acquisition could have major implications going forward.  Assuming the facts of the current offer, if accepted, I would receive $1,290 in cash and 9.619 shares of CP’s stock.  Currently, CP has an annual dividend of $1.07/share and the new position would net me $10.29 in annual forward dividend income annually.  I’m not exactly sure how I feel about this though.  On one hand, it would be nice to receive the cash without having to pay a trade fee and have the freedom to invest in other great dividend stocks.  There are plenty of great discounts available in the market right now such as HCP, which Lanny purchased recently, or some of the other stocks on our last watch list.  Unfortunately though, I wouldn’t receive the cash until the merger closes and due to the sizes of the companies, I don’t see this acquisition closing any time soon.

The second thought that popped into my head was “Do I even want to own shares of CP? Does it even fit my investment strategy?”  Answering this question is also key because I am losing one great dividend growth stock in my portfolio and would like to replace it with another.   Let’s take a quick look at CP’s dividend information and run the company through our stock screener.  CP’s yield is way below the average yield of the S&P 500, CP has a payout ratio of <20% and has a paid a dividend since 2001.  What concerns me about the company is that the dividend growth rate has been less than stellar over the last few years as the 3 and 5 year average dividend growth rate’s are 2.56% and 6.37%.  I understand a low growth rate with a higher yield, but I expect larger dividend increases from a company with that low of a yield.  This stock definitely would not classify as one of our Top 5 low dividend yield, high dividend growth rate stocks.

Based on my quick analysis, it does not seem like CP fits my investing strategy.    So where do I go from here?  If you recall, Lanny went through a similar dilemma when Lorillard  (LO) was purchased by Reynolds-American (RAI).  Ultimately, Lanny decided that RAI was not the best tobacco stock for his portfolio considering the loss of income that resulted from the acquisition and instead decided to sell before the merger was complete, take his gains, and invest the full amount in a different tobacco company he liked better…Philip Morris.  In hindsight, the move has worked out perfectly for him and he reminds me of this transaction on what feels like a daily basis.   His experience taught me a great lesson and I think I will deploy a similar strategy once a final agreement is reached and the full terms of the transaction are disclosed.  As I brainstorm quickly, here are the three courses of action I will most likely take.

1. Buy a Different Railroad Stock- Clearly I enjoy owning a railroad company because of the high barrier of entries in the industry.  Otherwise I would never have bought NSC in the first place.  There are a few other names that offer a better dividend yield and dividend growth rate than CP, such as Union Pacific (UNP), CSX (CSX), or Kansas City Southern (KSC).  This strategy would be nice because I would not lose my industry allocation.
2. Buy One of My 5 “Always Buy” Stocks – Earlier in the year I create a list of 5 stocks that I am always looking to buy.  These stocks were identified because of their strong dividend histories, economic moats, and successes over a long period of time.  If I am ever unsure of a purchase and need to make a quick investment decision, I turn to this list.  I wouldn’t mind buying another massive stake in a company like 3M or Johnson & Johnson with the funds from this acquisition.
3. Buy Realty Income – Last week I performed a stock analysis over Realty Income and loved what I saw.  The company is a monthly dividend machine and is well diversified in the industry it operates.  I still can’t believe I don’t own this stock already.  Even though it may not be trading at a discount now or when the acquisition closes, I may use this transaction as an excuse to initiate a position and forget about the stock!

Summary

As I said earlier, we still have a long way to go in this as management as the two sides appear to be digging in their heels.  Who knows if the transaction will go materialize?  But if the transaction does occur and the structure of the deal is similar to the one disclosed above, I know what move I will make.  Look for a Sell article and a Buy article as I will sell my stake in Norfolk Southern prior to the merger, capture the gain, and re-deploy my capital elsewhere.  There are plenty of other great dividend paying companies out there!

What would you do if you were me?  Would you hold on to a stake in CP?  Or do you prefer a different railroad company?  Have you experienced a situation before where a company has been acquired and you do not want to own the new acquiring company’s stock?  How have you handled it?

-Bert