Icahn Enterprises (IEP) Offers a 12% Yield and Trades at a Four-Year Low, But Is It Safe?

One investing school of thought is that you should find an amazing investor and ride his or her coat tails to fun and profit.

 

This certainly worked out well for those who bet on history’s greatest investor, Warren Buffett, by investing in Berkshire Hathaway (BRK.A, BRK.B). You can view Buffett’s high dividend stock portfolio here.

 

After all, if you invested $10,000 in Berkshire in 1965, your position would be worth a staggering $88 million today.

 

Of course, the odds that Buffett can recreate that kind of success in the coming years is all but impossible due to the massive size of Berkshire; something he himself freely admits.

 

However, there are still ways for investors to invest alongside legendary investors, including private equity and hedge fund legends such as Carl Icahn, who is the 38th richest person on earth with a net worth of $19.4 billion.

 

Icahn runs his empire via a master limited partnership (MLP) called Icahn Enterprises (IEP).

 

While Icahn Enterprises offers regular investors the opportunity to invest alongside one of the most well-known investors in history and enjoy a 12% yield to boot, this MLP comes with plenty of risks.

 

Let’s take a closer look to see if the risks make it unsuitable for most dividend growth investors, especially those needing steady income in retirement.

 

Business Overview

Unlike most MLPs, which generally are involved with energy gathering, transportation, and processing, Icahn Enterprises is a diversified conglomerate that Icahn uses to help raise investor capital for his activist investing empire.

 

Icahn’s empire owns stakes in 11 different industries (he recently sold his position in Trump Entertainment to avoid conflicts of interest to join the administration) including: auto parts makers, energy companies, casinos, miners, food packaging companies, industrial companies, and real estate.

 

Unlike most MLPs, Icahn Enterprises has no general partner or incentive distribution rights.

 

That’s because, while 99% of the MLP is owned by limited partners, Icahn himself, via Icahn Associates, owns just over 90% of the MLP’s units (and chooses to be paid in new units instead of cash).

 

This structure helps to ensure that Icahn’s stake will rise over time and will always grant him absolute control over the MLP.

 

 

In other words, any investor in Icahn Enterprises is basically agreeing to have no say in the management of the partnership but is trusting that one of history’s greatest activist investors can continue growing his empire, and thus, their wealth over time.

 

Finally, it’s important to realize that while Icahn Enterprises is highly diversified in the number of industries it invests in, the vast majority of revenue, and Adjusted EBITDA comes from its automotive, energy, and railcar holdings.

 

Meanwhile its investment arm generates highly volatile revenues and earnings, which is par for the course in the hedge fund and private equity world.

 

Business Segment	2016 Revenue	2016 Adjusted EBITDA	% of Revenue	% of Adjusted EBITDA
Investment	-$1.2 billion	-$528 million	-7.5%	-62.7%
Automotive	$9.9 billion	$697 million	60.7%	82.8%
Energy	$4.8 billion	$156 million	29.1%	18.5%
Metals	$269 million	-$15 million	1.6%	-1.8%
Railcar	$962 million	$379 million	5.9%	45.0%
Gaming	$948 million	$73 million	5.8%	8.7%
Mining	$63 million	$1 million	0.4%	0.1%
Food Packaging	$332 million	$40 million	2.0%	4.8%
Real Estate	$88 million	$41 million	0.5%	4.9%
Home Fashion	$196 million	-$1 million	1.2%	-0.1%
Holding Company	$21 million	-$1 million	0.1%	-0.1%
Total	$16.4 billion	$842 million	100%	100%

Source: Icahn Enterprises 8-K Filing

 

Business Analysis

The unique nature of IEP’s business model (essentially a publicly traded hedge and private equity fund) means that Icahn Enterprises’ sales, earnings, and free cash flow are incredibly volatile. The same is true for its margins and returns on capital.

 

 

The company’s volatile fundamentals are largely due to the cyclical nature of many of its biggest business segments, such as energy.

 

In addition, because the investment arm of the MLP operates as an asset manager, its annual contributions to profitability are highly cyclical and lumpy, based on the timing and success of Icahn’s sales of his investments.

 

While Icahn’s overall track record is amazing, the last three years have been highly disappointing, with Icahn’s returns becoming increasingly negative during one of the market’s strongest bull markets.

 

Icahn’s lackluster performance is mostly due to his enormous investments into CVR Refining and CVR Partners.

 

However, that doesn’t necessarily mean that Icahn has lost his touch. After all, the man is famous for being patient and investing for the long-term.

 

In fact, Icahn and his team of about 20 managers (who are presumably some of the most talented and experienced asset managers in the world) will often build stakes in cash rich companies, and then turn them around over several years before selling for a large profit.

 

 

However, while Icahn and his team of Wall Street veterans certainly have an impressive track record, that doesn’t mean that this high-yield MLP is a slam dunk income investment.

 

Key Risks

Since Icahn Enterprises is 90% owned by Icahn himself, IEP is basically a pure “bet on the jockey” stock, one in which you have to be willing to hold for the long-term and sustain some gut wrenching volatility.

 

 

In fact, while Icahn has a generally good track record of growing investor wealth, the fact is that this MLP is one of the most volatile stocks on Wall Street, with a beta of 1.69.

 

That means the stock has historically been much more volatile than the S&P 500 and can experience massive short- to medium-term downturns.

 

For example, IEP’s stock plunged 82% during the financial crash of 2008-2009) and more recently declined 55% from its late 2014 highs.

 

Another risk to consider is that Icahn is 81 years old, which means that at some point in the next 5-10 years Icahn Enterprises will likely have to say goodbye to its legendary founder.

 

While the remaining management will likely stay and continue to run the MLP, there is no guarantee that Icahn Enterprises will be able to continue generating strong long-term returns without him.

 

What about that 12% distribution? After all, as long as you are getting paid so handsomely to let Icahn and his team maximize their long-term strategy isn’t it worth buying, holding, and riding out such periodic crashes?

 

Unfortunately I don’t think so because the long-term sustainability of IEP’s payout is highly questionable.

 

Icahn Enterprises’ Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Icahn Enterprises’ Dividend Safety Score of 33 suggests that its distribution is unsafe and could be cut or suspended at some point in the future.

 

The company’s low score doesn’t come as a surprise given the MLP’s historically volatile distribution (a kind of tax deferred dividend).

 

 

Icahn Enterprises’ somewhat unpredictable payout history is a natural result of the highly volatile nature of the conglomerate’s business model, which has been facing years of large losses and immensely volatile free cash flow.

 

 

So if Icahn Enterprises is losing money and its free cash flow is often negative, then how exactly does it manage to pay such a high distribution? The answer is twofold.

 

First, Icahn Enterprises has a lot of cash on its balance sheet (that it uses to buy companies, and invest in their growth) and liquidity in its credit revolver, which it can use to sustain its cash payout, at least in the short-term.

 

 

However, the biggest reason that the payout has managed to survive this long, and one of the biggest risks to its security in the future, is because Carl Icahn chooses to receive his distributions in new units, instead of cash.

 

As a result, the firm’s units outstanding have more than doubled over the past decade:

 

 

That explains how the MLP only paid $103 million in 2016 cash distributions, instead of the $822 million that its per share payout would make you believe.

 

As a result, investors face accelerating dilution from Icahn’s share of the payout, as well as the MLP also continuing to raise equity growth capital via secondary offerings to make further investments.

 

In fact, based on his holdings at the end of 2016, Icahn will receive over $843 million in new shares, representing over 11% investor dilution in 2017.

 

And that’s assuming that Icahn Enterprises’ unit price stops its free-fall. Because the lower the price drops, the higher the yield and the more new shares the MLP will issue to pay its founder.

 

Icahn Enterprises also notes that it benefits from cash flows from its subsidiaries, which help support the dividend over the near-term.

 

For example, CVR Energy (CVI) pays a $2.00 per share dividend, and American Railcar (ARII) dishes out $1.60 per share in dividends.

 

However, both of these companies score low marks for Dividend Safety, making this source of cash flow more questionable over the coming quarters and years.

 

Overall, Icahn Enterprises’ distribution could remain safe over the short to medium-term, simply because the MLP’s cash reserves and liquidity is high enough that it can cover the small amount of cash it’s paying to outside investors.

 

However, in the long-term, unless Icahn can massively turnaround the earnings and free cash flow being generated by his subsidiaries (and raise the unit price quickly), investors in IEP are looking at a potentially downward spiral of dilution that could drive the unit price into the ground and more than offset the income you’re receiving.

 

It’s also worth mentioning that S&P cut Icahn Enterprises’ credit rating to junk last year, citing falling investment values within the firm’s portfolio and the company’s rising leverage ratio.

 

The world of private equity and hedge fund investing can hold great rewards when investments are delivering, but the risks taken to earn those returns are significant.

 

Many of the businesses Icahn gets involved with face numerous operational challenges and participate in industries that are under pressure. When financial leverage is added to the mix, the downside risk becomes even more severe.

 

Therefore, a company such as Icahn Enterprises isn’t appealing to me as a safe income play that will preserve and grow my capital over time.

 

Icahn Enterprises’ Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Icahn Enterprises’ Dividend Growth Score is 50, which indicates that Icahn Enterprises’ dividend growth potential is about average.

 

However, the company’s impressive 26.4% annual distribution growth over the last five years was completely driven by IEP’s most recent increase to a $6 per year distribution in 2013.

 

 

Since then the distribution has remained frozen and based on the current inflation that the unit count is facing, investors probably shouldn’t expect any growth in the future.

 

In fact, unless Icahn’s returns’ improve drastically in the coming years (which is largely dependent on the whims of a fickle stock market and unpredictable commodity prices), Icahn Enterprises’ distribution could be wiped out within a quarter or two should Icahn ever decide to receive his payout in cash.

 

Given his advanced age and absolute control over the MLP, anyone owning this stock is trusting he will never do that. However, whether his managers will continue this policy of being paid in new units after he’s gone cannot be predicted.

 

Valuation

Since Icahn Enterprises is essentially Icahn’s private hedge and private equity fund, arguably the best means of valuing it is by looking at its price / tangible book value and its yield.

 

MLP	P / Tangible Book Value	Historical P / BV	Dividend Yield	Historical Yield
Icahn Enterprises	-116.0	1.80	12.0%	2.7%

Source: Icahn Enterprises

 

However, due to its high debt levels, Icahn Enterprises’ tangible book value is actually negative. In other words, if Icahn were to pass away and the MLP be liquidated (and its liabilities paid off), investors would receive essentially nothing (in theory).

 

Of course, many of the assets on Icahn’s balance sheet are recorded at book value and are not marked up to their market value unless they are sold, which results in book value potentially being understated.

 

As a result, there is not really a practical way for the individual investor to venture a guess at how much Icahn Enterprises is really worth. There are many moving parts, and the balance sheet is rather opaque.

 

Therefore, despite the yield being so much higher than its historical norm, I can’t recommend Icahn Enterprises at this time even though the unit price is at a four-year low.

 

After all, with the risky nature of the current distribution and the negative price effects of runaway dilution, this stock could still have meaningful downside risk.

 

Concluding Thoughts On Icahn Enterprises

While the thought of investing alongside one of the best investors in history may initially be appealing, especially when it includes a 12% yield, investors need to realize that Icahn Enterprises is a very risky investment (largely due to its business model, dilution problem, and investment performance challenges).

 

Until the partnership can start to show consistent profits and cash flows, enough to make the payout sustainable, Icahn Enterprises is probably best avoided no matter how low the price or how high the yield.

 

Conservative income investors are likely better off sticking with some of the safer high dividend stocks here.