These are tough times for yield seekers. The yields in many defensive, typically higher dividend-paying sectors have been driven down by fears of an economic slowdown and the specter of a looming recession.
Investors have piled heavily into consumer staples, utilities, and real estate in 2019, especially the higher quality names:
This creates a predicament for income-oriented investors with money to place or dividends to reinvest.
Of course, as I've stated in previous articles, it's not a bad idea to build up a cash position ahead of a recession, which seems probable in the next year or two. That said, when rare opportunities to pick up undervalued dividend-payers with attractive starting yields present themselves, they are worth a look.
Especially if those stocks happen to be Dividend Aristocrats — publicly traded companies that have paid growing dividends for 25 years or more. It is quite a feat to pay out not only an uninterrupted but also a growing dividend to shareholders year after year, through multiple business cycles and recessions, for that length of time.
That brings us to the present article: three Dividend Aristocrats that are arguably undervalued and offering higher than average starting yields. For investors hunting for yield, these stocks are attractive prospects for further research:
1. Cullen/Frost Bankers Inc. (CFR)
Frost Bank was founded in San Antonio, Texas, in 1868, just 22 years after Texas became a state and three years after the end of the Civil War. Frost Bank merged with Cullen Bankers, Inc. to become Cullen/Frost Bankers, which is the same year that its stock went public.
Interestingly, during the Financial Crisis of 2008, CFR was one of the few federally chartered banks that did not accept any bailout money as part of the Troubled Asset Relief Program. Earnings per share dropped only from $3.52 to $3.00 during the recession, and investors rewarded the company's conservative management by holding onto shares, for the most part.
The share price did fall by about a third from the peak in September 2008 to the trough in March 2009. But this performance, both in terms of share price and EPS, fared far better than most other banks during the Financial Crisis.
Today, the bank operates over 130 branches and 1,300 ATMs and provides consumer and commercial loans, insurance products, brokerage services, and wealth management. CFR has paid a continuously growing dividend since 1980 (39 years).
The company currently trades at 13.5x price to expected 2019 earnings, compared to an average of about 14.5x. It also looks decent in terms of price to sales and price to book value, though not nearly as good as it looked at the beginning of 2016:
A price of $101 would give the stock a P/E ratio of about 14.5x, which I estimate as fair value. That means the stock is currently about 7.2% undervalued.
Considering the most recent dividend hike (a whopping 14.3%), the current yield sits at 3.03%, and CFR pays out ~41% of earnings as dividends. As can be seen below, the current yield is not terribly attractive on a relative basis. A 3.4% starting yield or above would be ideal, but the current yield is not bad either.
Assuming a 4.5% dividend growth rate (roughly in line with the previous 10 years), plus the 3% dividend yield, plus 1.44% per year in valuation expansion, CFR currently offers an 8.94% potential average annual return over the next five years.
2. Tanger Factory Outlet Centers Inc. (SKT)
Tanger Factory Outlet is a pure play on discount retail outlet centers across North America. Its simple strategy has helped it raise the dividend for 26 straight years. Despite its long history of profitable operations, relatively conservative number of properties (40), and skilled management team (including Tanger family members), SKT has been swept up in the ongoing "Retail Apocalypse" narrative.
Indeed, forward growth appears shaky, as occupancy has been steadily eroding and retailers are struggling to compete with e-commerce companies like Amazon (AMZN). Management has been trying to combat this trend by, among other things, introducing a rewards membership that drives increased traffic and sales. However, it's difficult to know how much of this increased traffic and sales would have occurred anyway, as those who enter the program tend to be those who do the most shopping as it is.
Plus, debt is a bit high at 6.08x EBITDA, though this isn't egregious for a real estate investment trust.
The stock is currently trading at a dirt cheap 7.7x price to expected 2019 earnings. By several metrics, the stock is even cheaper than it was during the Great Recession:
And yet, the company still enjoys steady cash flow. The collapsed stock price has driven the free cash flow yield up to a mouth-watering 15%+.
If SKT can just hold sales steady while the stock returns to a 5.5x price to sales ratio (lower than the ~6 average since the Great Recession), that would imply an astounding 77% upside from the current price.
Given that SKT is expected to pay out only 66% of its funds from operations as dividends this year, the yield currently appears sustainable and able to at least rise at the rate of inflation going forward.
Assuming a 2% dividend growth rate (in line with their most recent raise), plus the 8.6% dividend yield, plus 15.4% per year in valuation expansion, SKT currently offers a 26% potential average annual return over the next five years.
But let's be even more conservative with this one. Let's say that the best days of Tanger Factory Outlet are behind them, and in the next five years, the company will grow funds from operations at only a crawling pace. Investors may never again be willing to pay a 5.5x price to sales ratio for this stock. Let's say, instead, that the most investors are willing to pay is 4x sales — roughly where the stock was trading during the depths of the Great Recession.
Even then, investors are looking at a 5.8% average annual valuation expansion for SKT in the next five years. Add in the dividend and very minimal payout raises and you still arrive at an attractive 16.4% potential annual return.
3. 3M Co. (MMM)
3M Company is a giant industrial conglomerate that produces over 60,000 individual products, from duct tape to medical equipment to airplane reflective material. It serves both businesses and consumers, with 60% of sales derived internationally and 40% from within the United States.
3M has been around for over a hundred years, has weathered the Great Depression, and has raised its dividend through the Great Inflation of the 1970s and 1980s, the Dot Com crash in the early 2000s, and the Financial Crisis of 2007-2009. The resilience this company has demonstrated to economic, cultural, demographic, and geopolitical changes over long periods of time is astounding.
That said, the stock has fallen on hard times recently as top management has changed and guidance has been repeatedly lowered. The trade war has taken its toll on the company, as I wrote about recently in this article. Roughly a quarter of 3M's sales come from China, and the tariff salvos between that country and the US have eroded its performance through either direct loss of sales or indirect shifts in foreign exchange.
Through all of this, however, management has remained confident in its five-year plan and is plowing ahead with a cost-cutting scheme that should ease some of the pressure.
Now trading at an 18.4x price to estimated 2019 earnings multiple, the stock may not be as cheap as it was in the wake of the Great Recession, but it's certainly cheaper than it has been trading in years. It now sits around the trough that it hit in the 2015-2016 correction.
Moreover, the stock looks decently valued in terms of price to sales and free cash flow.
The company is expected to pay out ~61% of its earnings as dividends this year, and analysts estimate a forward dividend growth of ~8%. Assuming the stock returns to a 21x P/E ratio (well below where it traded the last several years) at some point in the near future, that would imply a 14% upside from the current price.
Assuming that 8% dividend growth rate, plus the 3.3% dividend yield, plus 2.8% per year in valuation expansion, 3M offers a 14.1% potential average annual return over the next five years.
Of the three picks above, Tanger Factory Outlet is the most obvious "immediate buy," in my estimation. 3M is not a bad buy at current prices, but I am personally waiting to pick it up under $160 per share, a price I think I will get in the next year or two.
Cullen/Frost Bank offers a decent ~9% return at current prices, which is nothing to sneeze at. But I would much rather pick it up at a 3.5% yield or higher, which is what I am waiting to see. The current 3% yield is better than it has been the last several years, but I think investors will be able to purchase shares at a lower price sometime in the near future.
What do you think? Are any of these more obvious buys than the others? Any that you wouldn't touch with a ten-foot pole?
Disclosure: I am/we are long SKT, MMM. 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.