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 do 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 four companies have been admitted to the Grade 'A' Retirement Portfolio. They are:
For the latest update on the portfolio, read this article.
Finding stocks that meet all the criteria of the portfolio has been difficult so I have decided to make a waitlist of stocks that meet the criteria except for valuation or yield. In this article we take a look at a couple companies through the screen to see if they qualify to be put on the waitlist.
First up is AbbVie (ABBV)
AbbVie is a pharmaceutical company whose blockbluster drug, HUMIRA will soon lose exclusivity and face competition from generics. The stock price has been depressed due to the anticipated loss of revenue and profits associated with the event. Very recently, the company entered into an agreement to purchase Allergan (AGN). The market reacted adversely to this development and ABBV was down as much as 15%. It has since recovered some but is still below its pre-announcement price.
Looking at the screens for ABBV, we have:
- S&P credit rating of A- or better. ABBV passes here with an A- rating, however, with the additional debt that will be issued to purchase AGN, it may come under review for a downward move.
- Current dividend yield of 2.9% or higher. ABBV passes with a yield of 5.7%.
- Market capitalization of $5 billion or more. ABBV passes here at $109 Billion.
- Dividend growth, recession performance and payout ratio. ABBV passes here with 5yr CAGR dividend growth of 19% and a payout ratio of 50%. There is no way to judge recession performance because ABBV was not a stand-alone company during the last recession.
- Volatility. Seeking Alpha lists the 24 and 60 month betas as 1.10 and 1.06, respectively.
- Relative valuation. I had looked at ABBV's valuation in June, and interestingly, it was priced for no growth beyond 2020 by my DCF method. See graphic below.
If I take a look at valuation now considering the AGN transaction, the valuation looks like this.
At current prices, ABBV shows a 42% margin of safety.
There is a lot to like about ABBV. It is a great value at current prices. It has a terrific yield and the payout ratio is low for yield of 5.7%. Indeed, we owned shares before the announced AGN acquisition and purchased more on the drop. However, as has been discussed in previous articles, these factors alone do not qualify it for the 'Grade A Retirement Portfolio'. The portfolio requires a very particular type of stock. So, does ABBV qualify?
The final determination on ABBV comes down to three issues. First, the volatility is a little high for the portfolio. Second is the impending loss of exclusivity on HUMIRA. The company has taken action to mitigate this, but there are still hurdles to be cleared before the transaction is completed. Third is the additional debt taken on by the transaction puts the credit rating in peril. For these reasons combined, ABBV is not given a spot on the 'Grade A Retirement Portfolio'.
Next up is Federal Realty Trust (FRT)
FRT is a Real Estate Investment Trust with focus on retail properties on the Californian coast and Northeast coast of the United States. More specifically they operate in 8 metropolitan areas: San Francisco, Los Angeles, Chicago, Miami, Boston, New York, Philadelphia and Washington D.C. In these areas, they have 105 total properties in premium locations. Indeed, the average household income surrounding their properties is higher than peer companies such as Kimco (KIM) and Regency (REG). This results in higher rents and rent increases than the peer group as depicted in the figure below.
Over the last 20 years, FRT has been able to grow rents 15% on average and was even able to grow rents at about 9% during the Great Recession.
Their portfolio of properties is diversified by property type and tenant.
Growth for FRT will come through the aforementioned ability to increase rents as well as redevelopment and remerchandising properties and tenant upgrades. The growth opportunities are refreshed as underperforming tenants roll over.
This business plan has worked for many years as FRT has managed to raise distributions for 51 consecutive years. There is a lot to like about FRT.
But does all this mean that FRT makes cut for the 'Grade A Retirement Portfolio'?
Looking at the screens for FRT we have:
- S&P credit rating of A- or better. FRT has a credit rating of A- which is outstanding for a REIT. - Pass
- Current dividend yield of 2.9% or higher. FRT passes with a yield of 3.1%
- Market capitalization of $5 billion or more. FRT passes here at about $9 Billion.
- Dividend growth, recession performance and payout ratio. FRT passes here with 5yr CAGR dividend growth of 6% and a payout ratio of 65%, an acceptable level for a REIT. FRT has continued to raise the dividend through the last several recessions. Pass
- Volatility. Seeking Alpha lists the 24 and 60 month betas as 0.46 and 0.57 respectively. - Pass
- Relative valuation. See graphic below for FRT valuation.
The current DCF valuation for FRT is about $120 and with the margin of safety required of 7%, the buy price will be about $112. With the current market price around $131, FRT is overvalued and cannot be admitted to the portfolio at this time.
However, FRT passes all other criteria for the 'Grade A Retirement Portfolio' and is put on the waitlist and will be added to the portfolio when/if the valuation criteria is met.
Current composition of 'Grade A Retirement Portfolio'
The following table summarizes the 'Grade A Retirement Portfolio' as of market close on July 5, 2019.
The yield on cost has risen to 3.84% as Target (TGT) announced a dividend increase of 3.1% from $0.64 to $0.66 per quarter. The yield also increased due to a favorable change in the CAD/USD exchange rate on the most recent dividend. The current equity yield is lower at 3.56% and is the result of the changes in dividends and share price increases, most notably TGT. The overall yield from the portfolio is 2.49%. So, while the equity portion of the portfolio is performing acceptably, it is too small at this time to meet the yield target of around 4%. This is due to the elevated valuation of the market. There are not many stocks right now that are fairly valued. We will continue to hold short term treasuries in this portfolio until stocks are found that meet the criteria. I believe that in the long run this is the best way to meet the objective of the portfolio.
And the waitlist
While there are not many that qualify for the portfolio right now due to the stretched market, we will continue to look at stocks to find those that otherwise qualify. When one is found, it will be put on the waitlist. The current waitlist is below.
During the mini-correction in May, two stocks were moved from the waitlist to the portfolio. Perhaps if there were more on the waitlist, more could have been added. We need to be ready should there be a market decline so I am going to try to build out the waitlist so that there are many options for the portfolio. I'd be delighted if you choose to follow along.
If you enjoyed this article and wish to receive updates on our latest research, click "Follow" next to GrayBeard Retirement at the top of this article.
Disclosure: I am/we are long ABBV, RY, BNS, GPC, TGT, 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.