The bull market turns five-years old this year and many investors are looking to the exits. While strong M&A activity and the return of retail investors may support stock prices, weak sales growth could eventually drive shares lower. Dividend investors may want to avoid the traditional playbook of running for bonds and utilities and instead look to energy and basic materials for safe yield.
Going to safety without going traditional
With about 90% of the S&P 500 reporting quarterly results, revenue growth has come in at just 1% for the fourth quarter compared to a year ago. Earnings growth has managed to continue around 10% as companies buy back shares and cut costs but weak sales growth may eventually ruin the investor sentiment that drove prices up almost 30% last year.
When the market looks shaky, the traditional roadmap for dividend investors is to look for safety in utilities and bond funds. This may not be such a great idea this time around as rising rates threaten to limit the total return to bonds and bond-like stocks.
Instead, investors may want to look to ideas from the business cycle for sectors that could perform well in the latter stages of the bull market but are not as negatively exposed to rising rates. During the latter stages of the business cycle, sales growth slows and inflationary pressures start to increase. The slower sales growth drives a build in inventory and profit margins come down.
Because of their hedge against inflation, energy and basic materials do relatively well during the period. Many of the companies in these sectors sell products that are more counter-cyclical than others or that should do well even as the rest of the economy looks ready to decline.
Strong balance sheets with solid outlooks
Agrium (NYSE:AGU) is the largest agricultural retailer in the United States and one of the largest suppliers of nutrients in the world. Shares pay a 3.3% dividend and trade for 13.1 times earnings, well under the five-year average of 14.8 times earnings. The company has come under pressure over the last year, along with other nutrient providers, as agricultural prices bottom out on strong harvests. Long-term demands for higher crop yields and extreme weather patterns are strong growth drivers and the shares should perform well through any stage of the business cycle.
Agrium announced last week that it would begin a $720 million expansion of its Borger, Texas nitrogen facility in March. The expansion, expected to be completed in the second half 2015, will add a new urea production unit of 610,000 tonnes and increase the annual ammonia capacity of the facility by approximately 145,000 tonnes.
Chevron (NYSE:CVX) may be a $221 billion integrated oil company but its real advantage is in its upstream production business. The company has a history of exploration success in deep-water and has made significant investments lately in several LNG projects. Shares pay a 3.2% yield and trade for 9.3 times trailing earnings. While the shares will be more cyclical than Agrium when a recession eventually occurs, the stock should do relatively in the later stages of the bull market.
The company has been active in the news lately with several reports that it is exploring asset sales of its midstream storage and pipeline business. The assets, estimated at between $3 and $5 billion, could be sold individually or as a spin-off. Either way, they would be worth more to a master limited partnership structure than to Chevron for the tax advantages so the company should be able to get some fairly attractive offers. If the company were to eventually sell most or all midstream assets, I would suggest investors take a position in an MLP to maintain exposure to that part of the industry.
While the two companies above are strong options in the energy and basic material sectors, there are certainly others you should check out. Within energy, look for companies with cost advantages in production that will be able to protect margins even if energy prices come down. Within basic materials, look to companies that sell a product that may not be as correlated to the business cycle and has end-uses that serve the consumer staple sector.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.