By Serkan Unal
There are many dividend-focused funds, but one is choosing its picks as best ideas in the dividend universe. The Sterling Capital Equity Income Fund, an equity income fund with several share classes, applies "fundamental analysis overlaid with top-down macroeconomic trends" when selecting its dividend stocks. The fund's picks include reasonably-valued companies with strong balance sheets and a history of market share/sales gains, with a potential for future market expansion. The concentrated portfolio of some 46 stocks includes companies whose "business is in demand all the time," and companies that "have done well in past market downturns and where management has a vested interest in the value per share of the stock." All fund's constituents have dividend yields above 2% and the history of growing dividends for the last three consecutive years or for six of the last 10 years.
Interestingly, the fund's alpha since inception on June 30, 2004, is 5.95% relative to the S&P 500 index returns. All the fund characteristics by share class, including fees and expense ratios, distribution yields, risk/return statistics, and performance can be found here. Based on the fund's 2012 year-end portfolio, here are its top five holdings by portfolio weight.
Baxter International Inc. (BAX) is a medical products and services company providing solutions for hemophilia, immune disorders, kidney ailments, infectious diseases, and trauma. BAX has a dividend yield of 2.7%, payout ratio of 44%, and five-year annualized dividend growth of 7.2%. The stock is up more than 30% over the past year. Analysts see its long-term EPS CAGR at 8.9%. The company generates more than 70% of revenues from products in market-leading positions and is well-positioned for growth in emerging markets. Its hemophilia drug ADVATE and immune deficiency drug IVIG are driving growth. The company's leadership in renal home therapies, with specialty in dialysis machines, is increasing, especially in emerging markets. With the recent purchase of Gambro for $4 billion, subject to regulatory approvals, BAX will expand its market share and achieve cost synergies totaling $300 million by 2017 (80% achieved by 2015). The acquisition will be EPS accretive in 2014, and will help accelerate Baxter's sales growth to 7%-8% per year and adjusted EPS growth by 9%-11% per year by 2017. Following a 34% increase in dividends in 2012, the company remains "committed to dividend policy in the long-range plan" targeting a payout ratio of 40%. With a forward P/E of 14.1x, BAX is trading at nearly a 20% discount to its peers. Last quarter, Iridian Asset Management held more than $225 million in the stock.
Kinder Morgan Inc. (KMI), an owner and operator of midstream energy infrastructure, including pipelines and terminals, is generally viewed as a play on the energy infrastructure demand stemming from the surge in unconventional energy production. KMI runs the largest natural gas pipeline network in North America, is the largest U.S. independent terminal operator, and is the largest independent transporter of petroleum products and carbon dioxide. In response to rising demand for transportation of shale oil, the company has recently announced plans to boost capacity of its Trans Mountain pipeline. The company has a dividend yield of 3.9%, payout ratio of 294%, and a quarterly dividend growth rate of 4.3% over the past five quarters. The company's budgeted dividend payout for 2013 is 17.2% higher than the actual payout in 2012. The company says that, "as a result of the acquisition of El Paso and KMI's normal expected annual growth," through 2015, it should grow its dividend by around 12.5% annually from its budgeted 2011 dividend of $1.16 per share. The company's long-term annualized EPS CAGR is 20.2%. KMI is trading at 28.2x forward earnings, compared to 20.9x for Enterprise Product Partners LP (EPD) and 30.5x for Williams Companies Inc. (WMB). KMI was the most popular energy stock among hedge funds in the third quarter. The stock is up almost 14.0% over the past year.
Unilever Plc (UL), a global consumer goods company, has a dividend yield of 3.3%, payout ratio of 67%, and five-year annualized dividend growth of 1.6%. The company has paid dividends since 1937 and has raised them for 12 consecutive years. In October, the company reported third-quarter sales growth of 5.9%, with emerging market sales growing 12.1%. Importantly, the company has been able to grow revenues with both volume increases and higher prices, despite rising input costs. Analysts expect, on average, that the company's sales will rise 5.8% in 2013, with core EPS increasing 7.7% year-over-year. The stock has a positive 2013 EPS estimate revision of 4% over the past three months. For the next five years, analysts forecast the company's EPS CAGR at 5%, which, nevertheless, is merely half the growth rate of its competitor Procter & Gamble (PG). Still, Unilever, which derives 53% of revenues from emerging markets, sees long-term opportunities in those markets as incomes per capita rise, forecasting that new 1 billion people will be able to afford buying Unilever products by 2020. The stock is trading at 20.1x trailing and 15.6x forward earnings. Elliott Management initiated a small new position in UL in the third quarter of 2012, while Arrowstreet Capital significantly reduced its small position.
Travelers Companies, Inc. (TRV), a provider of property and casualty insurance, has a dividend yield of 2.4%, payout ratio of 26%, and five-year dividend growth of 8.9% annually. The company has raised dividends for eight consecutive years, and this year, it boosted its payout by 12%. Its long-term annualized EPS CAGR is 12.5%, a reversal of negative EPS growth, on average, over the past five years. In the third quarter, the company's business insurance segment, which accounts for the lion's share of revenues, delivered positive growth in net written premiums, with improvements in pricing. Travelers' investment income has also improved, rising some 4.6% in the third quarter over the year earlier. In December, TRV was upgraded from outperform to top pick at RBC Capital on expectations of margin expansion and additional rate increases this year. The insurer is trading at a 10% premium to book value. Its forward P/E is 14.9x versus 21.8x for the industry on average. At the end of the third quarter of 2012, Mason Hawkins (Southeastern Asset Management) held as much as $1.2 billion in the stock.
General Mills Inc. (GIS), the maker of branded consumer foods, has a dividend yield of 3.2%, payout ratio of 49%, and five-year annualized dividend growth of 12.7%. The company has raised dividends for the past nine consecutive years. The company's long-term EPS CAGR is forecasted at 8.3%, about the same as over the past five years. GIS has consistently strong profitability, large free cash flows, and is a market leader in key consumer staples categories, including cereal and yogurt. Its margins are among the best in the sector, and are expected to improve as input cost inflation has subsided this fiscal year. Fitch Ratings says that the company "plans below-average share repurchases this year versus historical levels," but above the level of the previous fiscal year. Recent acquisitions, including Yoplait S.A.S. and Yoki Alimentos, will drive revenue growth. Still, according to StreetInsider.com, Goldman Sachs recently cut its rating on GIS to sell, calling the company's U.S. retail portfolio "overextended" and expecting EPS underperformance relative to consensus estimates. GIS is trading at below-industry 14.9x forward earnings. Jim Simons' RenTech hiked its stake in the company by 53% in the third quarter of 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.