The Season Of 'Coutellerie': 3 Falling Knives To Catch And 3 To Let Go

Summary

• The market drops and some stocks more than others.
• Buying opportunities are plenty, but you can also get cut catching a falling knife.
• Here is my list of good catches and some you should never touch.

Each volatile market brings its load of opportunities. While the overall market is in a slump, some stocks drop more than others. Those companies hit the perfect storm; investors are nervous and looking to sell. Then, some bad news goes around their head and everybody was looking for an excuse to cash some profit - or save their skin.

Those stocks are often called a “falling knife.” Imagine you throw a knife in the air to impress people around you and you try to catch it as it rapidly falls. If you succeed, you look like a pro. If you fail, you will catch the blade and cut yourself. Picking a stock rapidly dropping on the market is like catching a falling knife. Some stocks will bounce back and make a great investment, others will continue to drop and bleed your portfolio. Therefore, we call a stock that is brutally dropping a falling knife.

I’ve searched the market for some good examples of both buying opportunities (catch) and stocks that will bleed your money dry (fall). Here’s what I found.

Catch: Walgreens Boots Alliance (WBA) down 12.60% ytd (as of April 3, 2018)

WBA is getting hit right, left, and center. First, the Amazon (AMZN) threat is looming in the drug retail industry. We can easily imagine which kind of damage AMZN can do on any industry once it goes on “price war mode.” However, consumers will continue to look for advice provided by a pharmacist in stores. Plus, Walgreens just increased its network with the acquisition of some Rite Aids stores. WBA now covers about 75% of the U.S. population through its 10,000 drugstores.

Second, large Pharmacy Benefit Managers (PBMs) bring lots of claim volume together and use it to negotiate lower prices. This shift in the market isn’t temporary and will hurt WBA margins (which are thin already). Then again, the Rite Aids stores acquisition should answer this concern. Through a larger network, WBA will be able to scale its buying powers and offer discounts to PBMs. The goal is obviously to drive additional clients in their stores and do cross-selling. By becoming PBMs preferred drugstore, WBA should be able to mitigate the impact.

With a payout ratio of 10.86% and a cash payout ratio of 23.24%, here’s your chance to pick a solid 2.50% yielding stock.

Fall: Franklin Resources (BEN) down 22.28% ytd (as of April 3, 2018)

Franklin Resources lives up to its name, it belongs in the past. The company was once a leader in asset management and shows outstanding fund performances. Today, high Management Expense Ratios (MERs) funds aren’t praised anymore and it becomes even more difficult when you trail behind your peers. While the company performs on a 10-year basis, just 24% and 43% of its funds outperformed its peers on a 3-year and 5-year basis, respectively. Money is leaving the boat faster than the women and children.

I’m trying hard, but I don’t see the point in investing in Franklin Resources. The company is losing steam and still lives from a reputation that was built decades ago. While the company is a real cash flow maker, even with a dividend growth rate of 7% and 6% along with a generous discount rate of 9% (mainly to reflect that it’s an aristocrat), I don’t get an investing value. After lagging the market over the past 5 years, it seems that the story will continue in the same direction… the ditch!

Input Descriptions for 15-Cell Matrix				INPUTS
Enter Recent Annual Dividend Payment:				$0.92
Enter Expected Dividend Growth Rate Years 1-10:				7.00%
Enter Expected Terminal Dividend Growth Rate:				6%
Enter Discount Rate:				9.00%
	Discount Rate (Horizontal)
Margin of Safety	8.00%	9.00%	10.00%
20% Premium	$63.81	$42.40	$31.70
10% Premium	$58.49	$38.87	$29.06
Intrinsic Value	$53.17	$35.33	$26.42
10% Discount	$47.86	$31.80	$23.78
20% Discount	$42.54	$28.27	$21.13

Click to enlarge

Please read the Dividend Discount Model limitations to fully understand my calculations.

Catch: Enbridge (ENB) down 22.50% ytd (as ofApril 3, 2018)

Enbridge is stuck in an ironic situation. Investors are afraid ENB is getting too generous with their dividend growth guidance. Management expects to raise its payments by 10%-12% CAGR through 2024. While there have been doubts in 2017, management answered with the promised raise. Then again in early 2018, the board approved another 10% hike.

The reason why ENB’s management team announced such juicy dividend increase is based on its significant project pipeline of $22 billion through 2020. Investors are concerned that the Line 3 replacement will face additional opposition leading to cash flow problems. However, ENB had proven its will to make the extra mile to please credit agencies and investors as it projects to sell for $8 billion of non-core assets to finance part of its projects.

With such a stellar dividend growth history (11.7% CAGR over the past 20 years), I don’t see management failing its shareholders.

Fall: General Electric (GE) down 24.19% ytd (as of April 3, 2018)

To be honest, I’ve been bearish about General Electric since early 2017. At that time, the company was too big and too complicated to find its way through profitability. GE did what may end-up to be a good move for the future of the company by laying off thousands of employees, selling divisions and cutting its dividend (for the second time in 10 years!). However, the company is far from being out of the woods as its margins and cash flow from operations have been in a serious downtrend over the past 10 years.

Source: Ycharts

I will not go on and on about GE Power’s segment's major drop in 2017 or GE's cash flow generation concerns as they have been pretty well painted across Seeking Alpha. I think you get the picture by now. Don’t trade GE solely based on hope; you deserve better than this.

Catch: Procter & Gamble (PG) down 15.12% ytd (as of April 3, 2018)

As a dividend growth investor, I’ve reviewed Procter & Gamble on a regular basis. Almost each time, I came to the same conclusion: amazing company, but overpriced. For a rare occasion, PG is now down and it offers investors a great opportunity to fill their portfolio with this solid dividend grower at a 3.50% yield.

PG took too much time to transform its business and it is being penalized for this. The latest saga including hedge funds wanting a chair on the board illustrates investors’ lack of patience. After selling over 100 weaker brands over the years, PG now shows an EPS growth of 32% over the past 3 years. I think it’s worth being a little more patient with this iconic dividend payer.

Fall: General Mills (GIS) down 25.02% ytd (as of April 3, 2018)

My final selection is another dividend classic holding. But this time, I’m telling you to let it go. General Mills dominates in a declining food sector: cereals. The stock got seriously hit during its latest quarter due to higher shipping cost and lower guidance. GIS lowered forecasts for full-year results. While it had guided to +3% in the yearly earnings, GIS lowered the estimate to +1% as the shipping costs take a toll on GIS's gross margin.

The company recently tried to diversify its business through the acquisition of Blue Buffalo (BUFF) (pet food) for $8 billion. This news had no impact on the stock as it kept going down. The problem isn’t the diversification (good idea), but GIS intends to dilute shareholder value (bad idea) through issuing for another $1 billion in shares and boost its debt by $7 billion (another bad idea). Finally, in order to wrap this deal, management announced share repurchase suspension (hum, bad idea?). You can probably expect minimal dividend raise for the upcoming years. Why would you bother with a company showing margins meltdown, high debt, and low dividend growth perspectives?

Final Thought

This is the kind of article that will be fun to read again in 2-3 years from now. My guess is as good as yours in regards to those falling knives. I guess this is what makes the beauty of catching them; the process is a great combination of science and art.

In my personal portfolio, I increased my position in Enbridge with the recent dividend payouts that were sitting in cash. What have you done recently? Did you buy any of those falling knives?

Seriously, if you made it this far, it’s because you liked what you read. Don’t be a stranger; leave a comment and tell me what you think! I’m asking you one more thing; click on the “follow” button (it’s orange, you can’t miss it!) and you will get notified each time I write a great piece like this one.

Disclosure: I do hold WBA, ENB, PG in my DividendStocksRock portfolios.

Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Analyst’s Disclosure: I am/we are long WBA, ENB, PG. 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.