This article is the first of a 5 part series discussing stocks to purchase for retirement.
It's no secret that living off a fixed income has become nearly impossible (or at the very least, extremely stressful) in this zero interest rate environment. Folks currently building a portfolio of treasuries to live off of are receiving less than 2% on their holdings, and 10 year AAA corporates only yield about 150 basis points higher (without considering taxes).
Even if the total value of your portfolio is large enough to offset the low yields, sub 3% yields will be crushed by inflation over the next decade. Today's yields reflect an excessive amount of capital being allocated to a limited quantity of perceived risk-less assets, rather than inflationary expectations.
Many members here on Seeking Alpha are extremely savvy, and have built up portfolios of dividend growth stocks over many years. The income streams of these portfolios are in some cases phenomenal, with yields on cost in the double digits and excellent unrealized capital gains. These investors are in great shape for retirement. However, the lack of a traditional dividend growth portfolio doesn't automatically subject today's retirees to the low interest rate environment that is causing many senior citizens great pain.
I believe the five stocks I will discuss in this series of articles are excellent for retirement given the following:
- Strong, appropriate yields that allow for comfortable living
- Excellent companies with superior economics and management
- Dividend growth that is in-line or outpacing real inflation (which I characterize as roughly 4%)
- Essentially no "blowout" risk (Derivative, political, etc. types of exposure)
While some of these stocks may have yields that are a bit too low to have a large weighting in a retiree's portfolio, buying them a few years before you actually need the income will give you the double benefit of strong unrealized capital gains and a much improved yield on cost.
PPG Industries (PPG)
PPG is a well diversified chemical company that operates seven segments:
- Performance, Industrial, and Architectural Coatings
- Opitcal and Specialty Materials
- Commodity Chemicals
PPG has been a major beneficiary of exceptionally low natural gas prices, and as a result, 2012 EPS is expected to come in at about $8 per share.
Earnings growth for PPG has quite frankly been phenomenal over the past several years:
2012 (EST.): $7.97
Clearly, the collapse of the 2000s bubble economy skewed the consistency of earnings growth, but the results beginning in 2010 show the undeniable growth of the long-term earnings power of PPG.
PPG's success despite global growth constraints speak volumes about PPG management and its ability to both contain and pass on costs, while also wisely deploying capital. Perhaps the best allocation has been its timing in purchasing its own shares. At the end of 2008, with the share price at record highs, PPG held off on share repurchases. After the plunge in 2009, however, PPG began an aggressive repurchase program which has been extremely beneficial to EPS and has produced a significant economic profit for shareholders.
Now, onto the dividend. PPG has been paying dividends since 1899, with 40 straight years of increases. Dividend growth over the past five years has been about 3.5%, in-line with inflation. The current yield is 2.20%, now that PPG is at its 52 week high. Look past today's yield though; 2012's free cash flow is likely to exceed $1 billion by a decent margin, resulting in a PPG payout ratio of about 30%. Don't forget PPG's massive share repurchase plan either - 10 million shares were purchased in 2011 and the company plans to spend a significant portion of its balance sheet cash on purchases of similar volume.
With fewer shares outstanding, the payout ratio will decline, and the long-term potential of huge dividends increases as a result. With ROIC at 15%, PPG seems happy with investing in its business and buying back stock for now. In a decade, however, I expect this dynamic to be drastically different. With such a shareholder-oriented management at the helm, dividend growth will pick up significantly as fewer growth prospects are found. At that point, far fewer shares will be outstanding, free cash flow will have grown sizably, and the room for dividend growth will be astounding. Even with shares at 52 week highs, investors jumping in today should be enjoying yields on cost that are about double PPG's current yield by retirement.
Let's say a hypothetical retiree is currently 55, and plans to retire at 65. Buying PPG now ensures excellent capital gains, and a YOC that I expect to be at least 4% at retirement. Looking another decade out (75), given the compound growth in FCF and assuming continued share repurchases, there is wonderful potential for yields on cost in the double digits, with huge unrealized capital gains.
The last time I recommended purchasing PPG for dividend portfolios, I noted that I was most impressed with management's approach to taking on leverage:
"In November of 2010, the company completed an offering of about $1 billion in long term notes at exceptionally low rates of interest. The company has been using that cash to contribute to its pension assets, pay off loans with higher interest rates, and deploy back into the business (where the company has enjoyed a 15% ROIC). The company should be able to make an economic profit on its pension investments by utilizing the new cash to grow its pension assets (a profitable spread between the 3.6% notes and a presumed return on marketable securities in the ballpark of 6-8%), and reinvest in the business. Additionally, this sound approach to leverage allowed PPG to achieve a 31.32% return on equity in 2011."
Management isn't utilizing leverage to achieve short-term jolts in ROE. Rather, it is using the low-interest rate environment to generate economic profits and reduce leverage elsewhere. It's a safe, intelligent method of using its access to low interest rates, and makes me confident that management is highly unlikely to engage in any risky balance sheet behavior.
PPG is a phenomenal company with an exceptionally strong franchise that has been a leader since 1883. With a nicely diversified portfolio of products, exceptional earnings & FCF growth, extremely low payout ratio, strategic share repurchases, and intelligent, shareholder friendly management, PPG is an ideal stock for future and current retirees. Current retirees should own PPG as a smaller portion of their portfolios due to the relatively low 2.2% yield; the intrinsic growth of the underlying company in conjunction with its dividend growth will increase its importance to portfolios over time.
*All data sourced from PPG's 2010 & 2011 10-Ks, 2012 Q1, Yahoo Finance, and Forbes unless otherwise noted.
Additional disclosure: PPG will likely be a core holding of mine within the next year.