- Howard Marks gives a very relevant insight about risk and investor complacency that seems to have played out over the last year or so.
- Could the spreading coronavirus of 2020 be the equivalent of the collapsing housing market of 2007-2008?
- I am trying to buy only in small amounts so as to preserve cash in the case that stocks continue to fall.
- The eight picks this week include a net lease REIT, two energy companies, two insurance companies, an independent investment bank, a soon-to-be Dividend King, and an iconic logistics company.
- Here's to health and wealth in the week ahead!
Every week, I try to find the five most opportunistic and timely dividend stocks to highlight as "buy" ideas and present them in these articles. This week, due to the continued stock selloff, I just couldn't narrow it down to only five picks. So I'm presenting eight high-quality, undervalued dividend stocks that offer stellar starting yields.
There are many dividend stock "listicles" (list articles) on the Internet, but relatively few of them focus solely on stocks that are good values today. In a time of very low yields in both stocks and bonds, value investing becomes a vital way to generate a decent, reliable income stream.
That is as true for younger investors like me who focus on dividend growth and compounding as it is for retirees and near-retirees in search of current yield. So let's examine this week's picks and explore why they could make strong long-term dividend investments.
But first, a little reminder about risk from the brilliant Howard Marks.
Fear, Greed, and Complacency
Sometimes, during particularly placid and minimally volatile periods in the markets, it can be easy to forget how much stock prices are influenced by investor psychology. We hear often about the vacillations between fear and greed, but I think there's a third investor emotion that sometimes dominates. This emotion is neither fear nor greed, but rather something in the middle.
That emotion is complacency. When the stock market remains overvalued for some time but isn't skyrocketing on irrational exuberance, it's likely that the emotion predominant among investors is complacency rather than greed. The Fed's constant asset purchases since early last Fall have fueled stock prices up to all-time highs, despite the lack of earnings growth in 2019.
Could this stock price run-up that ended in the last few weeks be described as extreme greed or irrational exuberance? Well, it certainly involved greed, and many investors were irrational. But the attitude was more one of uncritical satisfaction and unwarranted optimism. That's complacency.
Complacency can be as dangerous as extreme greed. As Howard Marks notes in his excellent book, The Most Important Thing, "a prime element in risk creation is a belief that risk is low, perhaps even gone altogether. That belief drives up prices and leads to the embrace of risky actions despite the lowness of prospective returns" (p. 48).
Sound familiar? In one of Marks' famous notes, titled "Now It's All Bad," he writes:
Of the many fairy tales told over the last few years, one of the most seductive — and thus dangerous — was the one about global risk reduction. It went this way:
- The risk of economic cycles has been eased by adroit central bank management.
- Because of globalization, risk has been spread worldwide rather than concentrated geographically.
- Securitization and syndication have distributed risk to many market participants rather than leaving it concentrated with just a few.
- Risk has been "tranched out" to the investors best able to bear it.
- Leverage has become less risky because interest rates and debt terms are so much more borrower-friendly.
- Leveraged buyouts are safer because the companies being bought are fundamentally stronger.
- Risk can be hedged through long/short and absolute return investing or the use of derivatives designed for that purpose.
- Improvements in computers, mathematics and modeling have made the markets better understood and thus less risky.
That note was from September 10th, 2007, but it could have almost as easily been written about today's environment. People under the impression that the central bankers have corrected their past mistakes and gotten ahead of the cycle through adroit monetary management? Check. Risk spread around the world? Check. (How many times in recent years have you heard that it's a global economy now?)
In terms of securitization and syndication, substitute toxic mortgage-backed securities for various ETFs and you've got the situation today. Substitute improvements in computers and technology with increased access to investment information from numerous sources, including Seeking Alpha, and you've got the situation today. And, of course, low-cost leverage has only increased since 2007, and loan terms have become far more borrower-friendly than they were 12 years ago.
This leads me to the conclusion that the complacency felt by investors up until the last few weeks is starkly reminiscent of that felt in 2007 and early 2008. Many pundits are still arguing for a V-shaped recovery to come at some point, even though most experts agree that earnings this year should come in flat, even accounting for hundreds of billions of dollars worth of buybacks.
What's more, it's not even clear at this point how much more the coronavirus will spread across the world and here in the United States. Having surpassed 100,000 cases globally, it is still getting worse, and the total death rate is already 4x higher than that of the SARS outbreak in 2002-2003. While it may not be a perfect comparison, the market's reaction to the spreading coronavirus outbreak reminds me of investor complacency around collapsing home prices in 2007-2008. While each problem got worse, investors continued to assume that it wouldn't have a sustained effect on the broader economy and more growth was just around the corner.
As for me, I still have a decent amount of cash to deploy into stocks, even after significant buying over the last few weeks. But I am trying to remain cognizant that my dry powder is limited, and thus I'm trying not to deploy it all at once. Rather than trying to call the bottom and buy stocks in large tranches, then, I'm taking advantage of my brokerages' zero commission trading and buying only a few shares at a time. Besides, the line of thinking presented above would suggest that even more downside in stock prices is distinctly plausible.
With that said, let's look at eight dividend stocks that look like good buys this week.
1. Spirit Realty Capital (SRC)
- Dividend Yield: 5.53%
- Price/FFO: 14.45x
Spirit Realty Capital is a real estate investment trust that owns 1,752 triple net leased properties in 48 states across the country. Most of its properties (82.8%) are in the retail space, while 9.5% are industrial and 7.7% are offices, data centers, or hotels.
Source: Q4 2019 Presentation
Its portfolio enjoys a weighted average remaining lease term of 9.8 years and 99.7% occupancy. The company enjoys an investment grade credit rating of BBB, a debt-to-EBITDA ratio of 4.9x (quite low for a REIT), and a fixed charge coverage ratio of 4.6x.
With interest rates low and a relatively high stock price in Q4 2019, Spirit was a net buyer, investing $575 million to purchase 139 properties while disposing of 11 properties for $24 million.
Source: Q4 2019 Presentation
And the company ended 2019 with just shy of $700 million in liquidity, giving it ample room for further growth acquisitions. Management expects to deploy $700-$900 million on growth projects in 2020, which they expect to translate into AFFO per share of $3.14-$3.18.
This is lower than 2019's AFFO per share of $3.34, but that is only because Spirit spun off its lower quality properties into a master trust and subsequently sold them to another REIT. That lowered the company's cash flow, but it gave them a windfall of cash to deleverage and redeploy into higher quality properties.
With liquidity on hand and interest rates falling, which should lower Spirit's already ultra-low average interest rate of 3.85% (with 6.7 average years remaining to maturity), Spirit now looks like a mini-National Retail Properties (NNN) with many years of growth ahead of it. The spin-off in the second half of 2019 will cause the dividend payout ratio to rise from 69% to 79% in 2020, but even that is lower than some of Spirit's triple net lease REIT peers.
What's more, Spirit's 14.45x FFO multiple is very attractive relative to Realty Income's (O) 21.8x, National Retail Properties' 18.5x, Essential Properties Realty Trust's (EPRT) 18x, and even STORE Capital's (STOR) 15.9x.
Assuming a dividend growth rate of 4.5% going forward, buying in at today's 5.53% starting yield would result in a yield-on-cost after ten years of 8.59%.
2. EOG Resources (EOG)
- Dividend Yield: 2.71%
- P/E Ratio: 11.7x
EOG Resources, formerly known as "Enron Oil & Gas Company," is an upstream oil and natural gas producer. In other words, it engages in energy exploration and production. Now, that may immediately turn off readers from the stock, as the price of oil has collapsed in the past few weeks to the low $40s per barrel. With energy companies cutting back on production, EOG will undoubtedly be hit hard.
Hence, the stock price is currently trading at its lowest level since 2012:
But EOG is one of the best run E&P companies in the nation, having raised or maintained its dividend since 1995, lowered operating costs by 6% YoY in 2019, and reduced debt by $1.85 billion over the last three years. The company now enjoys a low net debt to total market capitalization of 13%.
EOG also enjoys an ultra-high quality portfolio of tier 1 drilling land. In other words, its land plots are among the easiest to profitably extract oil and gas even at low commodity prices. If oil prices remain stuck in the low $40s per barrel, EOG will eventually be in trouble. But if oil demand picks back up and causes the price to revert to the mean, EOG's $2 billion in cash should give it the flexibility to survive this short-term pain.
What's more, EOG hasn't been this cheap since coming out of the Great Recession. Price to cash flow from operations bottomed at 2.5x in 2009, and the current 3.93x is getting close to that trough.
Since the Great Recession, EOG has traded at a price/CFO between 6x and 12x most of the time, with a brief spike in 2016 when oil prices collapsed. During that oil price rout, free cash flow turned negative for a time but has since turned positive again and increased nicely.
A dividend raise of 31%, like the last hike, is very unlikely for this year, but the average annual raise over the last ten years has been 13.5%. Assuming an average of 12% over the next ten, buying in at today's 2.71% starting yield would result in a 10-year YoC of 8.42%. I believe that's a reasonable assumption, given the EIA projections for rising long-term oil & gas demand in the coming decades.
3. Marathon Petroleum Corporation (MPC)
- Dividend Yield: 5.93%
- P/E Ratio: 6.9x
While EOG operates primarily in the upstream space, Marathon operates primarily in the downstream and secondarily in the midstream spaces. It refines crude oil through its 16 refineries, transports it through its network of 17,200 miles of pipelines, and sells it to consumers through its thousands of Speedway gas stations.
With the oil price collapse as well as the deal to sell its Speedway gas station assets falling through this past week, Marathon got pummeled:
But that may be creating an opportunity for value investors. By price/CFO, Marathon is nearly the cheapest its ever been as a publicly traded company.
With net debt to EBITDA of 2.8x, the balance sheet remains fairly strong, despite a rising total debt load in recent years. And, unlike EOG, free cash flow consistently covers the dividend:
And the dividend yield has never been higher for Marathon during its existence as a public company:
Marathon's dividend grew over 18% per year on average over the last five years, but the last raise was closer to 15%. Assuming dividend growth averages closer to analysts' earnings growth estimate over the next five years of 3.5%, buying in at today's 5.93% starting yield would result in a 10-year YoC of 8.36%.
4. Evercore (EVR)
- Dividend Yield: 3.76%
- P/E Ratio: 7.3x
Evercore is an investment banking advisory firm focused on M&A deals along with restructurings, IPO underwriting, shareholder activism, debt issuance, and other significant financial deals. They are the well-oiled joints of the Wall Street machine, ensuring that major deals are structured properly and proceed smoothly. EVR also provides some of the highest quality equities and economics research on Wall Street through its ISI division.
Evercore has grown from a small fish among the investment banking giants to now be competitive with the big boys, ranking as the #1 independent firm for advisory revenues and M&A volume.
Source: November Presentation
The company's bread and butter is M&A advising (see my October 2019 article for some of the major deals Evercore has advised), which makes the company susceptible to a sharp drop in revenues and earnings during the next recession. During the last three recessions (early 1990s, early 2000s, and 2008-2009), M&A volume dried up significantly from their pre-recession peaks.
Source: Q2 Company Presentation
It is important to note, however, that the overall trajectory of total M&A volume is to rise over long periods of time. Plus, lower interest rates tend to help facilitate more leveraged buyouts and M&A. It would not be surprising to see M&A activity come in quite strong in 2020 with the combination of low rates and the potential necessity to merge due to economic stresses. Alternatively, if we experience a wave of bankruptcies, Evercore could benefit from that, too.
What's more, it's reassuring to find that Evercore continued to grow its dividend even through the tough years during and after the Great Recession. In fact, the company's payout ratio based on cash flows never even broke above 40%.
Today, the company pays out only 31.6% of earnings and 19.2% of operating cash flow, despite having grown its dividend at a 16% compound annual growth rate over the last ten years. Assuming the company's dividend growth returns to the 10-12% range it averaged from 2009 to 2016, EVR's current dividend yield of 3.76% could translate into a phenomenal 9.75-11.68% YoC in ten years.
5. Mercury General Corp (MCY)
- Dividend Yield: 5.69%
- P/E Ratio: 13.7x
Mercury General is an insurance company with the bulk of its operations based in California. Primarily, the company insures personal vehicles, of which the sunny state of California has many. Those of you who have endured the soul-grinding agony of rush hour on any of Southern California's numerous highways can attest to that.
But the company also writes home insurance in California, as well as home and auto insurance in Arizona, Georgia, Illinois, Nevada, New Jersey, New York, Oklahoma, Texas, and Virginia. As with most (if not all) insurers, MCY's revenue is split between premiums and investment income.
MCY spent 2019 repositioning its investment assets to deal with lower interest rates. Comparing the end of the third quarter of 2019 to the end of 2018, fixed income assets are up 5.2%, equity securities up a whopping 24.1%, and short-term investments up 66.4%. Total investments rose 12% during that time period, while premiums rose 13.5% and total assets rose 8.1%.
Total liabilities also rose 6.7%, but most of that was due to one-time expenses such as adjustments to loss reserves and deferred income taxes.
Holding bonds worked out well for MCY in 2019, as it turned over $48 million of net investment losses in the first three quarters of 2018 into $197.7 million of net investment gains in the first three quarters of 2019. In short, it profitably sold longer dated bonds and reinvested them into equities and short-term investments - a prudent decision, in my view. MCY also began Q4 2019 with $315 million in cash, which puts it in a strong and flexible position going forward.
This year, I imagine the company has been locking in some strong capital gains for its bonds, although it will face considerable difficulty finding safe yields in which to reinvest the proceeds.
I imagine many dividend growth investors are dissuaded even from MCY's 5.7% yield once they find out that dividend growth has averaged a mere 0.4% over the last decade. That is practically zero dividend growth. A great many other dividend-paying stocks would offer better yields-on-cost within relatively few years.
The combination of a tough regulatory environment in California and a crawlingly slow recovery from the Great Recession has held MCY back. We can see this in the erosion of its profit margin from 2010 to 2018, although it has rebounded strongly in the past year:
What's more, judging by FCF coverage of the dividend, the payout appears quite safe and able to continue growing well into the future:
However, given the 32-year streak of dividend growth under its belt, MCY's management will likely continue to emphasize sustainability over growth. That may make the stock's ~5.7% dividend yield unappealing to some investors, but for my purposes, it'll do just fine. It is a small position in my portfolio, primarily held for current income.
6. Unum Group (UNM)
- Dividend Yield: 5.52%
- P/E Ratio: 3.58x
Unum is another American insurance company that provides employees of small to midsize businesses various kinds of coverage such as disability, life, accident, supplemental health, dental, and vision. Most of the company's revenue comes from the U.S., but Unum also has operations in the United Kingdom and Poland.
Source: Unum 2019 Outlook
I rated this stock as a strong buy back in my October 2019 article, and my fundamental thesis remains more or less unchanged. Because of plummeting interest rates and fears of an upcoming recession (perhaps as early as this year), the stock has been driven down to around its ten-year low. This share price movement is based almost entirely on the expectation of strong headwinds from ultra-low bond yields.
With an investment portfolio primarily made up of bonds, Unum's asset managers will need to find ways to generate safe, sustainable yields going forward. In a lower for longer rate environment, that will be extremely difficult.
In terms of FCF coverage of the dividend, however, Unum has maintained strong metrics, even increasing coverage in recent years as rates have fallen.
Despite a dividend growth rate of 13.2% on average over the last ten years, I would expect the growth rate to come in closer to 6% in the coming years. If that is the case, then buying in at today's 5.52% starting yield would result in a 10-year YoC of 9.89%.
And, of course, the price/earnings ratio of 3.86x based on trailing earnings and 3.58x based on forward earnings is dirt cheap. For a strong, longstanding company like Unum Group, it's hard not to see this as a great deep value play.
7. Leggett & Platt Inc. (LEG)
- Dividend Yield: 4.24%
- P/E Ratio: 15.1x
Leggett & Platt is a diversified manufacturer of bedding, furniture and furniture components, and automobile seats with a relatively small market capitalization of a little under $5 billion. Despite its relatively smaller size, LEG has been around for 136 years (founded in 1883) and raised its dividend for 49 straight years, making it one year away from becoming a Dividend King. This company (specifically, one of its founders, J.P. Leggett) literally invented the bed spring.
Two-thirds of the company's products are sold in the U.S., and the rest internationally.
Source: March 2020 Presentation
With the company's focus on total shareholder return, management targets revenue growth of 6-9% annually, along with continued focus on margin improvement, debt paydown, and a dividend payout ratio target of 50% of earnings. Buybacks are also pursued when excess cash is available. Debt to EBITDA sits at 2.5x based on estimated 2020 earnings, higher than the 2x average from 2016 to 2018, but management hopes to lower that multiple in the coming years.
Overall, the cash payout ratio has crept up over the last 13 years, although it has come down significantly in the last year.
In short, L&P is firing on all cylinders, and the recent pullback in the stock price provides a great opportunity to pick up shares of this dividend stalwart. Assuming a dividend growth rate of 5% going forward (slightly below its average over the last five years), buying in at today's 4.24% starting yield would result in a 10-year YoC of 6.9%. Not bad for a Dividend Aristocrat and soon-to-be Dividend King!
8. United Parcel Service (UPS)
- Dividend Yield: 4.3%
- P/E Ratio: 11.9x
Everyone knows about UPS and their brown trucks with their brown-uniformed drivers delivering countless brown packages each day. It is a logistics company that provides package delivery all around the world. With fears that the coronavirus will cause an overall economic slowdown, UPS's stock has pulled back significantly.
By price-to-sales, UPS has not been this cheap since coming out of the Great Recession:
Likewise, the logistics company's dividend yield hasn't been this high since the Great Recession either:
The company's primary problem has been translating revenue growth into profit and FCF growth. It has had to continually spend billions on capital expenditures in order to continue growing and expanding, which has eaten into its ability to expand margins and FCF. This spending is not set to be reduced just yet, as guidance for 2020 capex is $6.7 billion, compared to $6.5 billion in 2019. Business-to-consumer (e-commerce) shipping is a much lower margin model, and UPS's spending is primarily intended to solidify its market share of higher-margin business-to-business shipping.
Thus we find FCF per share rarely covering the dividend in recent years:
And then there's the coronavirus's effect on the business. Management has already stated that the virus will depress Q1 results to some degree, although activity in and out of China has already picked back up as the growth rate of new cases falls there.
At the end of the day, though, UPS is the largest player in an industry where size and scale matter. In Q4, 2019, UPS reported expanding operating margins across its business segments, a reduced cost per parcel, and a small jump in FCF. And its capex spending should translate into yet more growth in the small and mid-sized business market, which is expected to translate into FCF growth.
Assuming dividend growth of 5.5% (the same as its most recent hike) going forward, buying in at today's 4.3% starting yield would result in a 10-year YoC of 7.35%.
*** I offer (at least!) five timely dividend stock "BUY" ideas every single week. If you find these articles valuable, please follow me by clicking the orange "Follow" button at the top of the page.
This article was written by
Austin Rogers is a REIT specialist with a professional background in commercial real estate. He writes about high-quality dividend growth stocks with the goal of generating the safest growing passive income stream possible. Since his ideal holding period is "lifelong," his focus is on portfolio income growth rather than total returns.Austin is a contributing author for the investing group High Yield Landlord, one of the largest real estate investment communities on Seeking Alpha, with thousands of members. It offers exclusive research on the global REIT sector, multiple real money portfolios, an active chat room, and direct access to the analysts. Learn more.
Analyst’s Disclosure: I am/we are long SRC, EOG, MPC, MCY, UNM, EVR, UPS. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.