A quick review
The concept of the Grade "A" Retirement Portfolio is to supplement social security income for a retired couple. The couple needs income greater than can be achieved with U.S. Treasuries and are not experienced investors. The portfolio was first introduced in this article. The objectives of the portfolio are as follows:
- Generate an income yield of about 4%.
- Grow income at least equal to the rate of inflation.
- Invest in financially sound companies. The S&P credit rating of A- or better will be used as a proxy.
- Be resistant to recessions.
- Show better price stability over time than the market as a whole to reduce risk of panic selling.
One can argue, as it relates to point 5, that volatility provides as much opportunity as risk. While true, the couple does not desire to see great price fluctuations, and we use volatility as one type of risk that we will attempt to reduce in this portfolio. This means otherwise great DGI stocks may not qualify for the portfolio. Take a look at this article on UPS for one such example.
The initial screening for the portfolio has three criteria.
- S&P credit rating of A- or better.
- Current dividend yield of 2.9% or higher.
- Market capitalization of $5 billion or more.
Once a stock passes this screen, a more subjective business review and analysis is conducted. The analysis includes the following:
- Dividend growth, recession performance and payout ratio.
- Relative valuation.
If the stock passes the business review and analysis, it is admitted to the portfolio. So far two companies have been admitted to the Grade "A" Retirement Portfolio. They are:
There were two stocks that met the criteria for the portfolio with the exception of valuation. They were:
The market recently presented an opportunity to add both of the wait-listed stocks.
Addition number one
On May 7th 2019, GPC dropped below $100 and was added to the portfolio at a cost of $100.
The Genuine Parts Company was founded in 1928 and is one of the leading distributors into three end markets: automobile parts, industrial parts and business products.
Both the Auto Parts Group and the Industrial Parts Group can differentiate with service by having best-in-class supply chain and service in businesses that are somewhat price insensitive. Consumers and companies need their parts, often quickly, and generally do not switch from a good relationship with a vendor over a few percent in price. The Business Supply Group has a different environment. GPC tried to merge and spin off the group in 2018 with Essendant (ESND). However, Essendant chose a competing bid from Staples. Management seems to be regrouping now and has not delineated a forward plan.
Perhaps the biggest growth opportunity for GPC is global expansion. In relation to sales, only 19% came from outside the US in 2017. It has been approaching this growth through acquisition. GPC is in the beginning stages of global expansion and should have that growth runway for years.
A third leg of growth is coming from a store refresh program now in place that has shown increased sales at updated stores.
At the time of the review, this is how GPC graded out.
Let's see how GPC stacks up to the portfolio criteria
- Its credit rating estimate is A- or better. (Not rated, but estimated at A to A-).
- Its yield is not greater than 2.9%. (2.8).
- Its market capitalization is greater than $5 billion. ($16 billion).
- Its dividend growth is acceptable at 4-6% long-term average.
- The dividend continued to grow during the last recession. The payout ratio is about 50%. Expected range is 45-55%.
- Its volatility is lower than the overall market
- It is priced higher than fair value.
The company was put on the waitlist to until such time the share price dropped to $100 and the yield increased to 2.9%. On May 7th, both of those happened, and GPC was added to the portfolio. You can find the original analysis here where it is also explained how I estimated the credit rating.
Addition number two
On May 14th, the price of Target dropped to $71, and it was added to the Grade "A" Retirement Portfolio.
Target is one of the largest retailers in the U.S. and operates over 1,800 discount stores throughout all 50 states. Sales are reported across five categories: Apparel, Beauty and Household, Food and Beverage, Hardlines, and Home Furnishings and Décor. There is also revenue from its own consumer credit card, REDcard. Target attempts to distinguish itself with bright and open stores, offering a more pleasant shopping experience, high-margin categories and high-quality private label products catering to the middle- and upper-middle-income consumer.
Target embarked on a new growth strategy in 2016. This strategy had four components:
- A store remodel/refresh.
- Has shown to increase sales 2-4% for stores after completion.
- Supply chain optimization by automating distribution centers and organizing truck loading for speed by product lines.
- Has decreased truck loading/unloading time.
- Migrated from distribution center labor to less expensive labor at the stores.
- Increased employee presence on the sales floor.
- Digital fulfillment from stores.
- Increased sales per store.
- Shortened delivery time.
- Multiple delivery options with everything from shop at store to drive up to home delivery.
- Increasing customer convenience.
- Private Brands.
- Introducing multiple private brands.
- Ramping up with introduction of 20 new brands.
- Some to take advantage of the demise of Toys "R" Us and some to position themselves in fashion trends.
At the time of the article, this is how TGT graded out.
Let's see how Target stacks to the portfolio criteria
- Its credit rating is better than A-. (A).
- Its yield is greater than 2.9%. (3.3%).
- Its market capitalization is greater than $5 billion. ($39 billion).
- Its dividend growth is acceptable at 2-3% projected.
- The last recession saw a decline in earnings, but not the dividend. The dividend remained well covered.
- Its volatility is lower than market.
- It is priced at fair value, but a margin of safety is recommended for purchasing.
Target met the requirements for admission into the Grade "A" Retirement Portfolio. However, dividend growth and price were borderline to what we prefer. Conservative investors should apply a margin of safety in this case and wait for the price to come down. Target was admitted to the waitlist for the portfolio with a buy price of $71 or lower. It was trading around $76-78 at the time of the article. On May 14th, Target traded down to a price of $71 and was added to the Grade "A" Retirement Portfolio. You can find the original article here.
The goal is to have 25 stocks in the portfolio. This should provide adequate diversification without diluting the portfolio with marginal stocks. Funds not yet invested in stocks are in the iShares Short Treasury Bond ETF (SHV). The current composition of the portfolio is in the table below:
Of the four stocks in the portfolio, only BNS is currently in the buy range for the portfolio.
One of the goals of the portfolio is to have a yield of 4%, so both current yield and yield on the equity portion fall short at 3.64% and 3.77% respectively. While this is somewhat disappointing, I will not loosen the requirements of the portfolio just to make the yield or to fill it up. I will continue to search and add stocks when one is found that meets the requirements of the portfolio.
Let me know what you think of the portfolio concept or if you have stocks to suggest for the portfolio. I look forward to reading your comments.
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Disclosure: I am/we are long GPC, TGT, RY, BNS, SHV. 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.