Buy These Industrial Aristocrats Now For Growth, Dividends, And Dividend Growth

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Includes: CAT, UTX, XLI
by: Thomas Hughes
Summary

The industrial sector is expected to be a top three producer in terms of earnings growth in 2019.

Global economic activity and infrastructure projects will drive revenue and earnings.

These names stand out in a field characterized by healthy dividends and dividend growth.

The opportunity is simple; earnings-driven capital gains, dividends, and dividend growth.

Among my top-three sectors for 2019 is the industrial sector, a sector characterized by dividends, dividend safety, and dividend growth. The sector is currently trading at attractive price levels with a strong earnings outlook and presenting an opportunity for us today. That opportunity is for capital gains, dividend income, and long-term dividend growth.

While there are many attractive names within the Industrial Select Sector SPDR ETF (NYSEARCA:XLI), there are two that stand out from the rest.

The Outlook For Earnings Growth Is Market Leading

The industrial sector is expected to see earnings growth decelerate in 2019, along with every other sector in the market, but deceleration will end in the first quarter. After that, the sector is expected to see earnings growth reaccelerate throughout the year and post a market-leading performance. Relative to other sectors, it is the only one still expected to see double digits in 2019.

Revenue for this sector is driven by global economic activity as well as infrastructure spending. Infrastructure spending is expected to expand steadily long into the future, bolstered by the build-up of first-generation services in emerging markets and maintenance/upgrade in established markets, while global economic expansion is expected to continue at a rate near 3.5% for the next two years at least.

The IMF's downgrade to the economy is a warning that should be heeded by Presidents Trump and Xi. It is also a rear-looking, lagging indicator. We already know that growth has slowed, all the data shows it, and we didn't need the IMF to confirm it. Looking forward, growth is still in the forecast and, with US/China trade negotiations on an upswing, global economic activity could easily reaccelerate this year.

The US for one is not showing any signs of economic recession. Labor markets remain strong, manufacturing data shows expansion, and consumer demand is healthy. Jamie Dimon, one of Wall Street's most respected oracles, spoke in praise of the US economy while at Davos, although he did note some dangers (trade, Brexit)

United Technologies

United Technologies (NYSE:UTX) is a new addition to the Dividend Aristocrats list (25 years of dividend increases) and one that should continue to producing dividend increases into the foreseeable future. The stock is a bit pricey at $112 a share, more than I usually like to pay, but fairly valued relative to the broader market and a steal at today's prices.

Others in the industrials group including Boeing (NYSE:BA), 3M (NYSE:MMM), and Honeywell (NYSE:HON) are trading between 17X and 19X forward earnings while United Technologies only 14X.

The company just released earnings for the fourth quarter and blew past analysts' expectations on stronger-than-expected growth in key units. The company says after-market commercial sales at Pratt & Whitney were up 11%, organic sales were up 8.0% at Collins Aerospace, and orders are up 3.0% at Carrier. The only weak spot is the Otis unit sales there remained flat.

More importantly, the company guided 2019 revenue and EPS above the consensus, a sign of expected strength. An analyst at RBC says the impact of slowing global activity has not been factored into that outlook, but is still encouraged by the results and guidance.

The dividend yield is about 2.5%, above average for the Aristocrats, and among the safe. The net-payout ratio is a bit above average for the group at 37.6, but balanced by a lower-than-average 63% cash payout ratio. Debt is also low, only 21% of net assets, which strengthens the company's ability to maintain the distribution and increase it in the future.

"Looking to 2019, our segment profit is expected to grow faster than sales, and free cash flow, excluding separation costs, is expected to grow faster than earnings."

A simple multiple expansion could see this stock rise $24 or 21% over the next six to twelve months, although there are some significant resistance targets at $120 and $130. Longer-term, earnings growth, free cash flow, dividends, and dividend growth should see this stock set new all-time highs.

Caterpillar

Caterpillar (NYSE:CAT) is another junior member of the Aristocrats having grown its dividend each year for a mere 25 years. The industrial machine giant is faced with the fact global growth has slowed, but that slowdown is in the acceleration of growth, not in growth itself. Global GDP estimates are still a modest 3.5%, plenty to fuel this cash-flow machine.

The distribution is just over 2.5% at today's share prices. Shares are trading around $132, which is kind of high on a per-share basis, but the value is there. The forward P/E is a low 10X which is grossly undervalued relative to peers United Technology, Deere & Company (NYSE:DE) and Boeing which are trading at 14X and 19X forward earnings.

The payout ratio is a low 27.03%, which ensures plenty of cushion for the dividend should the economy truly enter a recession (not likely). The cash payout ratio is a bit high at 87%, but balanced by low net-debt, only 22.25%, so obligations that may interfere with distributions are small.

Caterpillar is scheduled to report earnings in less than a week. The company stood by its full-year guidance at the end of the previous quarter, but the analysts are not too optimistic. I say not too optimistic, because there have been a number of downgraded price targets, but the overall rating is a strong buy with a consensus upside of 17%. Based on past performance, it is likely Caterpillar will beat the consensus revenue and earnings estimates and that will be a trigger to buy.

Looking at the chart, a clear bottom has been put in over the past two months. The $120 level has been acting as strong support and the indications are good that a move up to and above $140 is on the way. This move will be driven by earnings, dividends, and dividend growth; forces that could easily take it up to retest the $160-170 level over the next 12 to 18 months.

Summary

There is concern that the slowing global economy will result in an economic recession, but that fear is overblown. The US-China trade war and the Fed's overly aggressive rate-hiking trajectory have led to slowing global activity, but they are both correcting, and both could lead to economic reacceleration.

On the interest rate side of the equation, the FOMC's mandate is to ensure economic growth, and its governors have gone out of their way to assure the market the committee would be patient and flexible. Former Fed Chief Janet Yellen, well-known for her view that the Fed's interest rate trajectory would be gradual and low for a prolonged period of time, has recently said we may have seen the last interest rate hike of this cycle, a situation that will allow economic activity to stabilize and begin reaccelerating.

On the trade-front, Xi and Trump have brought the world to the brink of recession, but the economy has not yet been pushed over the edge; neither can afford for that to happen. The upcoming trade talks are a sign of positive momentum that should result in more talks, progress, and eventually a trade deal. Until then, it's the high-quality dividend-paying stocks in the top earnings sectors that will perform best.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XLI over 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.