Dividends & Income Digest: What's On Your 2018 Watchlist?

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Includes: AAPL, ABC, BLK, BRK.B, CAH, CHCT, D, EQM, ETP, GMRE, GPMT, LADR, MAIN, MCK, MMP, MPW, NEE, O, PEG, RASF, SEP, SHLD, SKT, SPG, SPY, STAG, STOR, STWD, TCO, TRSWF, VTR, XLE
by: Rebecca Corvino

Summary

Every issue, SA explores a dividend and income investing question and shares the responses, as well as highlights recent insightful pieces of opinion and analysis.

This week, contributors answer the question: "What's on your watchlist for 2018?"

Is there a topic you'd like to see covered in a future D&I Digest? Let us know by commenting below.

As we start to round the corner into the new year, we thought we'd take a look ahead and see what our dividends and income community has its eye on for 2018.

Here's this week's Digest question, which as you'll see in the following responses was open to a wide range of interpretations:

What's on your watchlist for 2018?

Here's what several of you had to say. The rest of you, please chime in below in the comments!

Dividend Sensei

In terms of trends for 2018, I’m very interested to see if economic growth, which has been especially strong in recent quarters, can continue accelerating, and whether or not that finally starts rekindling wage growth.

While the job market is the strongest it’s been in 17 years, wage growth has remained stubbornly stuck at 2.5% all year. Stronger wage growth, coupled with ongoing low inflation (core inflation 1.4% a year), would be a potentially strong catalyst for continued strong retail spending and economic growth in 2018 and beyond.

In terms of stocks, there are four key (mostly beaten-down) sectors I’m watching: REITs (particularly retail), midstream MLPs (particularly pipelines), commercial mREITs, and yieldcos (renewable utilities).

There are a few key names in each of these sectors or industries that I’m interested in adding to my own high-yield retirement portfolio for next year, including:

Midstream MLPs

  • EQT Midstream Partners (EQM)
  • Magellan Midstream Partners (MMP)
  • Spectra Energy Partners (SEP)

Retail REITs: Sears' (SHLD) bankruptcy is likely in 2018 and could make for great buying opportunities

  • STOR Capital (STOR): waiting for a better price
  • Realty Income (O): great buy right now, looking to add lower
  • Simon Property Group (SPG): great buy now, looking to dollar cost average down
  • Tanger Factory Outlet Centers (SKT): also own
  • Taubman Centers (TCO): Grade A mall REIT I’d like to add, if it pulls back from its recent surge on activist buying

Commercial mREITs: benefit from rising interest rates

  • Ladder Capital (LADR)
  • Starwood Property Trust (STWD)

YieldCos: massive and long growth runway

  • Pattern Energy Group (PEG): just started my position
  • TransAlta Renewables (OTC:TRSWF): Canadian yieldco with rock solid dividend, paid monthly, that’s growing like a weed

I’m also potentially looking at Medical REITs (mostly hospitals) such as Ventas (VTR), Medical Properties Trust (MPW), Global Medical REIT (GMRE), and Community Healthcare Trust (CHCT) to see if ongoing uncertainty about healthcare policy offers attractive buying opportunities.

I’m also preparing a “market crash list” of my favorite Grade A premium dividend growth stocks (the ones that are always rich) to buy as soon as the next correction hits. Of course, given the strong positive catalysts going into 2018, I’m not necessarily expecting one, but if it happens, then my top five names to buy then are:

  1. Main Street Capital (MAIN)
  2. NextEra Energy (NEE)
  3. Dominion Energy (D)
  4. STOR
  5. STAG Industrial (STAG)

Trapping Value

There are two key themes we are watching for 2018.

We think 2018 could be the year where we see strong inflation show up in the numbers. We are now a decade into this expansion, and the job market has finally tightened to a point where additional hiring will not come without significantly higher wages. This will be good for the consumer, but we think the bond markets will definitely get rattled.

The other theme on our watchlist is a narrowing of the gap between the Energy sector and the rest of the market. Since the middle of 2014, the Energy Sector Fund (XLE) has underperformed the S&P 500 ETF (SPY) by 64%. The total return Alerian MLP index, which includes distributions, has done even worse in comparison to major indices.

As late cycle inflation picks up, we think energy stocks, and MLPs in particular, become strong outperformers.

We will be watching to see if and when these trends develop, and that will strongly influence our capital allocation decisions.

Sure Dividend (Ben Reynolds)

The S&P 500 is trading for a price-to-earnings ratio of 25 in the last month of 2017. The S&P 500’s historical average price-to-earnings ratio is 15.7. With the market in general significantly overvalued, we have to look at the unloved and underappreciated businesses and industries to find value in 2018.

Energy sector MLPs and the pharmaceutical distribution industry stand out as possible winning investments for 2018 and beyond. Both investment theses are examined below.

Low oil prices have caused less investment in oil and gas infrastructure, resulting in slower growth for MLPs. Negative publicity for the Dakota Access Pipeline and others has likely played a role in declining prices for MLPs as well.

MLPs in general have struggled since 2015. Many are now priced at absolute bargain prices. Perhaps the best example is Energy Transfer Partners (ETP).

Energy Transfer Partners is the largest publicly traded MLP based on its enterprise value. The partnership operates more than 70,000 miles of pipelines in the United States. Energy Transfer Partners owns the Rover and Dakota Access Pipeline projects, giving it significant negative exposure – and a very cheap price.

Energy Transfer Partners is currently offering investors a 14% distribution yield. Its historical average dividend yield over the last decade of 6%. Energy Transfer Partners appears to be trading for less than 50% of its fair value.

Importantly, the partnership distributions are covered by its cash flows. Energy Transfer Partners has a distribution coverage ratio of 1.14 through the first 9 months of its fiscal 2017. This means the partnership is making $1.14 for every $1.00 it is paying out to investors. And Energy Transfer Partners prioritizes its distributions as shown by its 15 consecutive years of dividend increases.

The second area Sure Dividend is finding value in is the pharmaceutical distribution industry. Wave after wave of bad news has washed over the industry:

  • The opioid epidemic
  • Possibility of Amazon (AMZN) entering the industry
  • A price war between the 3 largest companies in the industry

While the short-term prospects of the industry in general don’t look promising, the long-term growth drivers remain. An aging U.S. population means more prescriptions per capita. Additionally, as technology advances, pharmaceuticals will be able to treat more symptoms.

The pharmaceutical distribution industry is dominated by three large players:

  • McKesson (MCK)
  • Cardinal Health (CAH)
  • AmerisourceBergen (ABC)

Of these three, Cardinal Health is our favorite. Cardinal Health is a Dividend Aristocrat with 32 consecutive years of dividend increases and a 3.1% dividend yield. Cardinal Health is trading for a forward price-to-earnings ratio of just 12 vs. its historical average price-to-earnings ratio of 17.

In both the investment theses outlined in this article, investors are likely to be significantly rewarded for investing in industries with temporary troubles. Both Cardinal Health and Enterprise Transfer Partners are high-quality businesses with long histories of dividend increases and solid long-term growth prospects trading at bargain prices.

Colorado Wealth Management Fund

Looking into 2018, I see a few potential developments that could materially move valuations in a few sectors. For mortgage REITs investing in agency RMBS and non-agency RMBS, there should be significant pressure on their net interest spreads. Unless the curve steepens materially, the mortgage REITs would need to either run very light on hedging or focus on using hedges that do not include "net interest expense." When a larger portion of investors understand the impact of the flat curve on agency RMBS and the impact of thin credit spreads on non-agency RMBS, the sector could sell off pretty hard. Several mortgage REITs are running with unsustainable dividends, but they prop up their core EPS by changing their hedging techniques. This is an area few investors understand, and it is absolutely critical to dividend sustainability.

Mortgage REITs investing in CRE lending should not see as much pressure. The thin credit spreads are still an issue and will prevent the net interest income from rising as rapidly, but these mortgage REITs benefit from increases in short-term interest rates. My pick in this space is Granite Point Mortgage Trust (GPMT) (long GPMT). Management already guided for a substantial dividend increase in Q4 2017, but it won't show up on "dividend yield" screening tools yet. When the dividend pops higher, I expect more investors to become interested in the stock.

The retail REIT space is particularly interesting as we have witnessed a further divergence between the stronger REITs and the weaker ones. Several of the stronger REITs have rallied significantly and are already up over 20% from their 52-week lows. The weaker ones continue to post new 52-week lows. It is difficult to tell if that trend will continue, but I do see one trend that should hit an abrupt halt. Simon Property Group (SPG) (long SPG) is the largest of the mall REITs. They have excellent economies of scale on their operating expenses and excellent credit. They have easy access to any capital they need. Investors hoping for a buyout on the smaller REITs may see Simon as a potential buyer. While such a deal could occur, SPG would be negotiating from a position of strength. I expect SPG to perform reasonably well and still carry less volatility than their peers.

Finally, I see more mortgage REITs looking to refinance their preferred shares. Some of the recent transactions have allowed the mortgage REIT to issue preferred shares at much lower coupon rates. This means investors need to be even more diligent about evaluating call risk. Some investors will opt to simply look for higher yields on preferred shares trading below call value (which is usually $25). For those investors, it will be critical to understand the credit risks. Investors need look no further than RAIT Financial (RAS) (no position) to evaluate how quickly a poor mortgage REIT can fall apart.

Dale Roberts

I have no watch list, of course. As you may know I simply add to my 7 Canadian bigger dividend payers that I call my Canadian Wide Moat 7. I also add to my 15 Dividend Achievers that I skimmed from the index back in early 2015. My U.S. picks are doing very well, and Apple (AAPL), BlackRock (BLK), and Berkshire (BRK.B) will get some new monies here and there as well. I am in the camp of BuyandHold 2012, the popular Seeking Alpha "commentor" who repeats the wonderful and simple message of buy and hold. There is no need for investors to react to anything in the political or economic or market landscape or attempt to profit from any prediction. We are not fortune tellers. But guessing about the future might lead to some fortune destruction. Buy. Hold. Add. Rebalance. Invest within your risk tolerance level.

All said, for me personally, 2018 should be more of an interesting year. In mid-year, I will leave my pay cheque behind and venture out on my own to become a full time writer and blogger and influencer. Time to make some noise in Canada. My portfolio might make that shift from accumulation stage to decumulation stage. I do not know my "employment" income for 2018 and beyond as I will have to go hunt for my own dinner. I do not know how much of my portfolio will be required moving forward. I will, of course, be able to chronicle that adventure on Seeking Alpha and on other channels. I might be able to add some real-life perspective on "living off of the dividends" vs. "dividend and share harvesting' for the (NEAR)-retiree. I will do what many Boomers are doing these days: creating a new employment or income scheme later in the career stage. It's an interesting trend.

On the portfolio side, with respect to my new stage of life, I will certainly be watching bond yields. I suffer the consequences of the low-yield environment. Savers are being punished and forced into more risk. That is of concern as my short-term corporate ladder is now "not doing" what it was designed to do and what it was doing when purchased 4-5 years ago: manage risks and deliver decent income. It did pay about 4.5% at one time; now it is closer to 2.7%. I will likely continue to hold and harvest the income for spending.

But it's something to keep an eye on. How low can you go before an income investment doesn't make sense?

In 2018, I would be pleased to see stock markets go higher whether pundits feel stock market gains are warranted or not. If required, I will harvest some shares; those gains will be real, deserved or not, ha.

Wishing everyone a happy and healthy holiday season and a prosperous 2018.

What about you? What will you be keeping tabs on in 2018? Please share below.

If you enjoy the D&I Digest and would like to be alerted to future editions, don't forget to "follow" me! And please let me know if there's a topic you'd like to see covered in a future D&I Digest, either by commenting below or sending me a private message. I'd love to hear from you.

Finally, here's some recent Dividends & Income content you might want to check out (if you haven't already):

Tax Reform And The Possible Impact On Retirement by Franklin Templeton Investments

Retirement Strategy: Dividend Growth Investing In A Scary Market by Regarded Solutions

8% Yield Wind Energy Stock, Strong Growth, Pullback Presents A Buying Opportunity by Rida Morwa

GE: Long-Term Lessons For 'Forever' DG Stock Enthusiasts by Adam Aloisi

My Best Idea Of 2018 Is Malls, Malls, And More Malls by Julian Lin

Prospect Capital's Dividend And NAV Sustainability Analysis - Part 1 by Scott Kennedy

Mall REITs: How I Messed Up, And What I'm Doing With CBL Now by Ian Bezek

Retirement Security: Shopping At Tanger Outlets Bought Us A Bargain by George Schneider

Just Retired? Combine These Strategies To Earn 6% Income With Less Risk by Financially Free Investor

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.