With the current volatility in the markets, I've been looking at adding more dividend paying stocks to my long-term portfolio. However, I wanted a balanced group of stocks: Some with high income, others with highly consistent payouts and still others with a potential capital appreciation kick. I also wanted to stick with companies I knew well, but from relatively diverse industries or with diverse earnings drivers. My top 5 ideas for a balanced dividend group were the following:
Collectors Universe (CLCT): With a juicy 8.3% dividend yield, Collectors Universe was at the top of my list. This is a stock that I have owned for years and began buying more this year. Collectors Universe provides grading and other services for dealers and others in collectibles markets, with the majority of its revenue and income coming from the coin market. The beauty of this business is that it is relatively stable from year to year, but with annual fee increases that largely drop to the bottom line. The company is also finding ways to grow through additional online service offerings and expanding to trade shows in Europe.
Genuine Parts (GPC): This is a stock that I own, have frequently written about and am buying more shares in currently on the recent pullback. GPC falls into the decent yielding (3.5% currently), extremely reliable dividend grower category. The company has raised its dividend every year for 55 years. This year's increase was 10% and earnings suggest we could see another 10% increase next February as well. Genuine Parts is a conglomerate distributor, with 50% of revenues coming from its NAPA auto parts business and the rest from more economically sensitive industries. I believe its business has no correlation with CLCT. If the economy were to double dip, GPC would likely suffer less than the market (beta=0.75). However, if the current pullback for stocks is merely a correction, I would expect GPC to recover much of the +10% loss it has had over the last several weeks.
American Eagle (AEO): American Eagle is a leading teen apparel retailer and has a business very different from GPC and CLCT. The stock was down almost 6.5% on Thursday after a negative update from its close competitor, Aeropostale (ARO). The stock now yields 3.5% and is trading at a reasonable 12x P/E on forward earnings (16x TTM, which I believe is also in line with its peer average). The company generated $1.57 in free cash flow last year and based on my forecast should generate a similar amount in 2011. In addition to Aero's negative announcement, there are other concerns about earnings in the face of rising costs and tepid consumer demand.
However, this view seems shortsighted. Aero has been underperforming its peers for several quarters now and there is no reason to assume American Eagle's business is trending as badly as Aero's. This is particularly true when another competitor, Abercrombie & Fitch (ANF), reported better than expected sales for the same period. In addition, the cost pressures the industry is facing should dissipate next spring given the falling price of key commodities, including cotton.
American Capital Agency (AGNC): While I know less about REITs than consumer stocks, the 19.7% dividend yield intrigued me enough to look into American Capital Agency. The stock sold off a bit in the recent government budget crisis, but now appears to be recovering lost ground. I am a believer that the residential real estate market will remain largely flat in the coming years, with no major swings in price. Also, I do not expect to see a meaningful increase in principle prepayments for mortgages, which should help keep yields up. Some research I have read suggests the company will not be raising its dividend anytime soon, but with a 19.7% yield that is just fine with me.
RadioShack (RSH): This is perhaps my most surprising "dividend stock" given its relatively low yield at 1.9%. However, it is one that I feel strongly fits in to this collection, providing what I believe both potential dividend increases, significant capital appreciation potential and limited downside. While it is a retailer like AEO and would suffer from a slowdown in consumer spending, the comparisons differ greatly from there given AEO's teen apparel business and RSH's consumer electronics business.
RadioShack has been paying a $0.25 dividend in the fourth quarter only for the last eight years. The actual cash being paid out has actually shrunk from $41 million during that time to only $25 million as the company has shrunk its share base through stock repurchases.
On the company's conference call in July, RadioShack stated it would be reviewing its capital allocation policy, including the dividend, with news expected this fall. Given the company's relatively mature business (in terms of store count) and strong free cash flow (I estimate over $150 million for 2011), moving to a quarterly dividend policy at a higher rate makes perfectly good sense to me. While some might argue the market uncertainty means this is a poor time to change dividend policies, I think just the opposite. Now is the time for a financially strong company like RadioShack to show its commitment to long term shareholders at its belief in its own long term staying power.
Estimating the size of the dividend increase is much harder to predict. Over the last five years, free cash flow has ranged from $75 million last year, an extraordinarily bad year due to working capital changes, to $334 million in 2007. Net income (ex-goodwill, non cash impairments) has ranged from $110 million in 2006 to $237 million in 2007. If RadioShack makes the dividend a priority but wants to make sure it's set at a sustainable level, $75 million would seem appropriate.
This is roughly 50% of the consensus net income forecast for this year and free cash flow forecast. It also meets the low point for past free cash flow over the last five years. The 50% of net income level is important is I believe this is usually considered a very sustainable level for mature companies like RSH. At $75 million a year, the dividend yield would go to a juicy, sustainable 5.5%.
Beyond the dividend, there are many reasons I think RSH is an incredible buy here. Valuation, at a mere 3.3x TTM EBITDA, makes this stock extremely cheap. While I won't get into a buyout potential discussions, other retailers have been out at multiples that are more than twice this level. Fundamentally, the new contract to start carrying Verizon wireless phones in September is big news.
I have seen analyst estimates that suggest this will add about 3.5% to same store sales next year, but this is likely a conservative forecast. Also, I don't think the company is getting credit for its growing tablet business. Its small store focused on mobile products makes it ideal for tablet sales and I believe it will get its fair share of the market as it allocation improves later this year. The $500-$600 price of these devices should provide a major boost to sales and profits in the 4Q.
RSH has already seen one analyst upgrade (Goldman) since the Verizon announcement and I think more will come. After falling about 50% from hits 52-week high, the tide is turning. The dividend provides a basis for investment, while the fundamentals offer more upside potential than more traditional dividend stocks.