I Own 3 Of The Dow's Worst Performers - 'Oh My!'

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 |  Includes: KO, MCD, XOM
by: Larry Smith

I was on the Internet this weekend perusing various investment articles and stumbled on this article titled "The 5 Worst Performing Stocks in the Dow". The article originally appeared on 24/7 Wall Street, however I read the re-posted version that appeared in the online version of USA Today.

The article listed the five worst performers and gave reasons why they were struggling. The article gave no advice as what to do in the future just spelled out the issues and summarized the returns so far this year.

For the record, the five worst performers and their total returns to date (as of 11/01/13) are.

Company YTD - Total Return
Caterpillar (NYSE:CAT) -4.92%
IBM (NYSE:IBM) -4.64%
Exxon Mobil (NYSE:XOM) 4.7%
McDonald's (NYSE:MCD) 11.48%
Coca-Cola (NYSE:KO) 11.67%
Click to enlarge

For the year, the Dow is up 19%. Of the five stocks listed, I own XOM, MCD and KO.

Obviously, I was not overjoyed to open a list of the worst performers and see that I own three of the stocks listed. I would prefer to open a list of the top performers and own three from that list. However, as a long term dividend growth investor, I know there will be years where the stocks I own will underperform. I understand that and I accept that. It is not my goal to outperform the Dow or the S&P 500 on a yearly basis. It is my goal to own quality companies that have strong balance sheets, have a sustainable product or service, pay an ever increasing dividend, and operate with some level of a moat. As long as the business of the company I own continues to perform well, I will hold that company, as I believe companies with the attributes I mentioned above, will grow my income and provide a solid capital gain over time.

I also believe, trading out of a stock because the short term performance has been sub-par is a mistake. As I documented in an article titled "My Investment Advice Do Nothing", I found when looking back on my investing history, that more often than not, the stock I sold to buy something else outperformed what I bought. When I buy a stock I have an investment thesis. I am buying this stock because (fill in reason). As long as that investment thesis remains, I will hold the stock. There are only a handful of great companies, if you are fortunate enough to buy them when they are on sale, selling them when they have a slow patch is seldom a good idea.

Why I Will Continue to Hold the 3 Underperformers.

Let's take a look at the reason given in the article for the underperformance of the three stocks I own and why I do not think it will matter over the long term.

Coca-Cola - Reason for underperformance -Has had to contend with weak demand for soda among U.S. consumers, as well as weaknesses in emerging markets' currencies.

Reason it does not matter. - Coca-Cola sells beverages, including sodas, juices, teas, sports drinks, energy drinks and water. Beverage products have been consumed by the world's population for decades and will continue to be consumed for decades. In 2009, the company unveiled its 2020 Vision; this long-range plan calls for doubling sales to over 3 billion by 2020 (here). Coca-Cola currently sells over 3,500 different products in over 200 different countries worldwide.

Here is what Coca-Cola CEO Muhtar Kent said to start out the recent 3rd quarter earnings conference call.

"We delivered sequential volume growth in the third quarter, while capturing global nonalcoholic ready-to-drink beverage value shares for the 25th consecutive quarter. We gained volume and value share across core sparkling and juice drinks, sports drinks, and ready-to-drink teas. Importantly, we're able to do this in combination with a 2% increase in price mix. Excluding the impact of structural items, we generated comparable currency-neutral net revenue growth of 4% and strong operating income growth of 8%"

KO delivered volume growth while raising prices and still managed to take value share. Not many companies can increase prices, sell more product and gain share. Simply put, KO is a marvelous company being run in a disciplined shareholder friendly manner.

Soda sales may be falling in the U.S., but soda sales are increasing in places like Russia, the African continent, India and other emerging countries. Here is a quote from the 3rd quarter earnings press release.

"Coca-Cola International grew volume 3% in both the quarter and year to date, with third quarter Pacific volume up 5%, Eurasia and Africa volume up 4%, and Europe volume down 1%. The Company reported solid volume growth in the quarter in key developed markets, including Germany (+3%), the Northwest Europe and Nordics business unit (+3%), and North America (+2%). Our China business grew volume 9% and India delivered 6% volume growth in the quarter driving sequential improvements for both countries compared to last quarter due to a focus on execution amidst normalized weather."

Coke is a beverage company, not a soda company. If it is a non-alcoholic beverage, KO will sell it.

As for the currencies concerns, KO sells products in over 200 countries, the ebbs and flows of currencies will vary from quarter to quarter and year to year, but KO's relentless selling of more beverages will continue.

I will hold KO until I see a failing of the business, right now; I see a business running full speed ahead. In addition, using David Fish's excellent DRIP Investing Resource Center, I see a company that has increased the dividend for 51 straight years, is yielding 2.83% and has been growing the dividend at a 5-year average annual rate of 8.4%. Solid growing business, growing dividend, and a distribution network that cannot be duplicated are why a minor under performance is no reason to sell.

McDonald's - Reason for underperformance - For the third quarter of the current fiscal year, McDonald's announced sales that missed analyst estimates. Sales at restaurants open for at least 12 months rose just 0.9% from the year before. Struggles at the global fast-food leader have been blamed by some on the company's inability to expand its menu.

Reason it does not matter. - No doubt about it, sales have slowed at MCD restaurants. However, MCD is not alone, as this article from Bloomberg points out; restaurant sales have been slow for many operators. In addition, this article dated 10/31/13 from QSR Web states that

"As a result of softer sales and traffic levels and restaurant operators' dampened outlook for the economy, the National Restaurant Association's Restaurant Performance Index declined for the fourth consecutive month."

So it is obvious, softer sales is not just a MCD problem, but, a restaurant industry problem.

For the just completed 3rd quarter MCD reported.

  • Global comparable sales increase of 0.9%
  • Consolidated revenues increase of 2% (2% in constant currencies)
  • Consolidated operating income increase of 6% (6% in constant currencies)
  • Diluted earnings per share of $1.52, up 6% (7% in constant currencies

That may not be the greatest quarter ever, but earnings per share growth of 6%, on a sales increase of 0.9%, tells me the company is being run well.

McDonald's also reported it would open over 1,300 new restaurants in 2013. That is a pace MCD has been maintaining for some time and is one of the reasons I remain positive on MCD. With 35,000 restaurants worldwide and growing, I believe MCD will benefit from a growing world population and growing incomes.

McDonald's is constantly working on new restaurant offering, recently introducing Egg White McMuffins, Mighty Wings and new McWraps. Some of the products resonate with consumers, some do not, but MCD will continue to develop new products for consumers.

McDonald's is a free cash flow machine and how they use their cash is one of the reasons I will continue to hold MCD. Here is another quote from the 3rd quarter conference call

"Consistent with our longstanding priorities regarding the use of cash, after investing in our business, we're committed to returning all free cash flow to shareholders over the long term, first through dividends and then share repurchases. In fact, we recently announced a 5% increase in our quarterly cash dividend to $0.81 per share, bringing the annual dividend to $3.24.

Combined with our share repurchases, we expect our total cash return to shareholders for 2013 to be between $4.5 billion and $5 billion."

As the restaurants grow and as the sales increase, so too, will the cash flow. I expect MCD will be raising dividends and buying back shares for a long time to come.

Exxon Mobil - Reason for underperformance - "Oil prices have exceeded $100 a barrel for much of the year, which may make the relatively weak performance of Exxon Mobil seem surprising. However, the oil industry has been less profitable for refiners, including Exxon Mobil, as price differences between U.S. and foreign oil have narrowed. The company's production of oil and gas also has slowed recently"

Reason it does not matter. - Refining margins were weak last quarter for all refining and integrated energy companies. Here is the opening line from a story on Chevron's (NYSE:CVX) 3rd quarter earnings,

"Chevron said Friday that net income fell 6 percent in the third quarter as weak refining results and higher operating costs offset higher oil and gas production and prices."

This BBC report on Royal Dutch Shell (NYSE:RDS.A) also stated refining profits were weak. "It said it was seeing lower profit margins from its refinery business - which applies across the industry."

Refining margins are always a volatile part of the energy business as refining profits are tied to "crack spreads", which are the difference between the cost of product (crude oil) to be refined, and the cost of the refined product (gasoline, diesel, fuel oil, etc.) being sold. For the 3rd quarter, crack spreads were not advantageous for refiners. As I mentioned, this is a volatile part of the industry and can change from quarter to quarter. XOM has navigated this part of the oil business for a long time and will do so for a long time to come. In fact, XOM with its integrated model, can mitigate some of the crack spread turbulence by matching the crude oil from various production fields to specific refineries and then directing the refined product to markets that will give them the best price for the product.

Minimal production growth from XOM has been a story for some time, but that is about to change. Here is what I wrote in a May, 2013 article titled "Look Beyond Tomorrow and Buy Exxon Mobil":

At the 2013 analyst meeting, XOM management stated that by 2017, production will increase by 1 million barrels a day. Here is what XOM CEO Rex Tillerson had to say about production at the 2013 analyst meeting.

"The continued development of our resource base, will deliver additions of over 1 million net barrel of production per day by 2017. Most notably, we are growing liquids production and liquids-linked gas volumes."

"We anticipate volumes will grow 2% to 3% per year from 2013 through 2017 with significant contributions from liquids."

XOM has approximately 30 projects set for start-up between 2013 and 2017, many of which are long-lived projects.

The reduced production growth is about to end, as XOM's years of investment into developing new fields and buying up promising acres is about to pay off.

Oil and gas have been with us for over 100 years and I believe will be around for another 100 years. The International Energy Agency forecasts rising demand for oil and natural gas through 2030. As the world's population grows and other areas of the world become more developed, the demand for energy will continue to rise. Renewables simply cannot scale up to meet the demands that will be placed on the world's energy providers.

In the 3rd quarter just ended, XOM returned $5.8 billion to shareholders in dividends and share buybacks. Between 2008 and 2012, XOM returned $101 billion to shareholders. A company that is returning billions of dollars to shareholders and growing its energy production is not a company that should be sold because the stock price has had a sub-par year.

Summary - As a dividend growth investor, I understand the large dividend paying companies I own will go through periods where the stock price does not move much, or even go down. As long as the business is still performing and the company's long term outlook remains promising I will not sell. These are companies with huge global scale, huge balance sheets, and market operations on every continent. When you are a large international company, it is not likely that everything will be performing perfectly everywhere. What is important, is that the overall business is moving forward. In past articles I have used the work "glacial" to refer to how these large companies move. I believe that term is fitting, as these large companies relentlessly move forward, grabbing market share, growing sales and increasing profits. As a shareholder, I am happy sharing in the profits of these companies and steadily watching my portfolio grow.

Disclosure: I am long KO, XOM, MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.