Seeking Alpha

My Top 3 Undervalued Retirement Stocks

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Includes: LAZ, NHI, OKE
by: The Dividend Guy
Summary

Many retirees struggle to invest their money in this all-time high market.

They fear to lose their capital, but they need income at the same time.

While part of the market is expensive, there are still some gems to pick for your retirement portfolio.

I’ve selected three companies based on dividend yield, dividend growth, and current valuation.

Being retired and managing your portfolio is both a blessing and a curse at a time like this. On one side, most courageous investors stayed the course and made double-digit returns in the past decade. On the other, many of you were expecting the bear to come out of hibernation and crash the market. Therefore, you patiently waited for this moment to happen, but the wait goes on.

In the meantime, your portfolio isn't generating the income it should. The only way your money could work for you is if you invest it properly. While part of the market is expensive, there are still some gems to pick for your retirement portfolio. I've handpicked a few of my favorite companies showing similar characteristics that are important for retirees:

  1. They show a dividend yield over 4% to ensure a stable income.
  2. They show a strong dividend growth history to ensure you beat inflation.
  3. Their balance sheet is strong enough to support economic headwinds without touching their dividends.
  4. Their current valuation gives you a good margin of safety.

So, here are my favorite dividend growth stocks for retirees:

National Health Investors (NHI) for a REIT beating the inflation

REITs are required to distribute at least 90% of their taxable income to shareholders, making them attractive for both retirees and people seeking a regular income stream. One of the problems many REITs face is their lack of dividend growth. They pay a high yield but fail to maintain their payouts in line with inflation. NHI is doing more than that. It's a dividend powerhouse on top of being a high yielder.

Source: NHI 2018 Q4 presentation

NHI is a high-quality healthcare REIT that owns a diversified property portfolio in over 30 U.S. states. Management has built a solid portfolio with wide tenant diversification across different healthcare service sector (Seniors housing need driven (33%), Seniors housing discretionary (34%) and Medical (31%).

Its cash flow is safe and regular as its tenants are engaged in providing healthcare services and senior living assistance to a large and growing older generation.

How's the dividend?

When you compare NHI to its peers, you understand why management is optimistic for the future and expects volatility but not deterioration of its tenants' credit. The REIT has posted solid funds from operations (FFO) growth in the past 6 years, each time outperforming its peers.

Source: NHI investors presentation

In 2014, the NHI dividend was at $0.77/unit quarterly where it grew all the way to $1.05/unit in 2019. This is a 36.36% increase good for 6.4% annualized retirement paycheck increase. NHI is able to increase its dividend while keeping an AFFO payout ratio under control (below 80%):

Q4 2017

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Normalized AFFO per diluted common share

1.21

1.22

1.26

1.28

1.27

Dividend Paid

0.95

1

1

1

1

Payout ratio

78.51%

81.97%

79.37%

78.13%

78.74%

Author's table, data from NHI Q4 2018 presentation

What will happen during a recession?

I guess that's the advantage of a company like NHI as seniors need healthcare facilities, no matter if there are major layoffs or not. Regardless if we enter in a recession or not, the population will continue to age and the need for more seniors facilities will increase. In a recession scenario, the Fed will have to keep interest rates at this level (or decrease it), which is even better for REITs.

In fact, the biggest concern around NHI right now is related to what will happen with the entire healthcare system going forward. Many politicians want to "play with the rules", but we don't know which kind of outcome it could have on Medicare/Medicaid reimbursement rates. This could potentially affect tenant's ability to pay their rents. However, we are very far from facing an imminent threat now.

Finally, if we use the dividend discount model with lower dividend growth numbers than the past 10 years, we still get a great valuation.

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$4.20

Enter Expected Dividend Growth Rate Years 1-10:

5.00%

Enter Expected Terminal Dividend Growth Rate:

4.00%

Enter Discount Rate:

9.00%

Discount Rate (Horizontal)

Margin of Safety

8.00%

9.00%

10.00%

20% Premium

$142.18

$113.40

$94.23

10% Premium

$130.33

$103.95

$86.38

Intrinsic Value

$118.48

$94.50

$78.53

10% Discount

$106.63

$85.05

$70.68

20% Discount

$94.78

$75.60

$62.82

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

NHI currently trades around $75. This means that you can grab a solid REIT, offering you a 5%+ yield at a 20% discount. This is the kind of deal you want in your retirement portfolio!

Don't mind the roller coaster ride and buy Lazard

Investors who follow me for a while will notice that I'm a big fan of Lazard (LAZ). I've been questioned about this pic a few times as LAZ's price doesn't really follow a smooth trend.

Source: YCharts

Lazard, together with its subsidiaries, operates worldwide as a financial advisory and asset management firm. Each business segment represents about 50% of Lazard's revenue.

Source: Lazard Feb. 2019 presentation

Lazard is another victim in the financial sector. Many asset managers got hit in 2018 as the market feared a potential crash. As a relatively small investing firm ($215B in assets under management and market cap of $2.8B), LAZ is easily getting tossed around for the wrong reason. If you can stomach the price fluctuations, you will be highly rewarded.

How's the dividend?

One of the investor rewards will be found in Lazard's dividend policy. LAZ increased its payout for more than 10 consecutive years, making it part of the elite list of Dividend Achievers. In addition to increasing your paycheck, you will also receive a "bonus" once a year through a special dividend based on performances.

Source: Lazard Feb. 2019 presentation

The regular dividend already gives you a comfortable ~4.75% yield. If you add the special dividend received, you have likely found your next 6%+ candidate for your retirement portfolio.

What will happen during a recession?

One of the reasons why LAZ has taken a beating on the market in the past 12 months is mostly due to the Street believing the party is over. Therefore, I believe the company is already priced accordingly. Interestingly enough, investors tend to forget that LAZ thrived during the last crisis. Not only the company didn't cut its dividend, it even increased it. Also, Lazard has been gaining market shares since its IPO:

Source: Lazard Feb 2019 presentation

In other words, while others will be failing during the next market crash, chances are LAZ will grab more market shares. Their reputation has been made, and their financial advisory services will be needed for restructuration.

Similar to NHI, Lazard offers a good margin of safety at the moment. LAZ's dividend increased by 46% in the past 5 years (excluding special dividends). Using the dividend discount model with a dividend growth rate of 7% and then 6%, we get fair market price of $50.

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.76

Enter Expected Dividend Growth Rate Years 1-10:

7.00%

Enter Expected Terminal Dividend Growth Rate:

6.00%

Enter Discount Rate:

10.00%

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$81.11

$60.64

$48.38

10% Premium

$74.35

$55.59

$44.34

Intrinsic Value

$67.59

$50.54

$40.31

10% Discount

$60.83

$45.48

$36.28

20% Discount

$54.07

$40.43

$32.25

You can't go wrong with this kind of valuation.

If you invest in a taxable account, please note that LAZ is an MLP.

ONEOK expects to grow its dividend 9-11% annually through 2021

I'm not a big fan of energy stocks. They are too dependent on commodity prices and tend to cut their dividend each time they hit a speed bump. This is completely different for pipelines. These types of companies work as a toll on a highway. Everybody must pass and pay their fee. This is why ONEOK (OKE) appeared on my radar not too long ago. While the stock rapidly bounced back along with the rest of the market, I believe OKE still has potential going forward. On top of that, its dividend yield is over 4.50%, and management expects strong growth going forward.

Source: OKE fact sheet

How's the dividend?

You will rarely find such dividend history with a high yield stock:

Source: YCharts

You can see that between 2014 and 2017, OKE has been "shy" with its dividend growth policy. But overall, management has been overly generous. ONEOK is one of the rare energy stocks on my top list for this sector. The company expects double-digit dividend growth through 2021 as the economy should continue to rise.

Source: OKE 2019 April update

Your ~4.5% yield is safe, and your paycheck will continue to increase going forward.

What will happen during a recession?

Most OKE revenue comes from pipeline contracts. This means commodity price has a minimal impact on OKE's business. However, if the economy slows down for a while, demand for natural gas will likely to drop and affect pipeline traffic. This could hurt OKE's results temporarily. We saw a slowdown in the dividend growth a few years ago, but management kept increasing its payouts, nonetheless.

Since the company is in the middle of an aggressive growth project (OKE managed to invest $2B in CAPEX for 2018 and expects a $3.1B CAPEX for 2019.), I used a 10% dividend growth rate for the first 10 years but decreased it down to 4% afterward. These cautious calculations gave me a fair value at $81:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$3.46

Enter Expected Dividend Growth Rate Years 1-10:

8.00%

Enter Expected Terminal Dividend Growth Rate:

4.00%

Enter Discount Rate:

10.00%

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$118.24

$97.49

$82.73

10% Premium

$108.39

$89.37

$75.83

Intrinsic Value

$98.53

$81.24

$68.94

10% Discount

$88.68

$73.12

$62.04

20% Discount

$78.83

$64.99

$55.15

The margin of safety is smaller compared to NHI and LAZ, but I also used a very low terminal dividend growth rate.

Final thought

If you dig deep enough, it is possible to find high quality companies offering a sustainable dividend for your retirement at an attractive price. This is why I think that waiting on the sideline isn't necessary. Even considering the current state of the market.

Disclosure: I am/we are long NHI, LAZ, OKE. 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.

Additional disclosure: I do hold NHI, OKE and LAZ in my DividendStocksRock portfolios.

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.