Raise Your Portfolio Quality With These 6 Blue-Chip Dividend Stocks
- The combination of the near-pandemic spread of COVID-19 and the newfound oil price war between Saudi Arabia and Russia has battered stocks, causing a ~15% correction in the last month.
- It is not clear that either issue will resolve quickly or easily, and neither is it clear how helpful fiscal or monetary stimulus will be to the underlying economy.
- These six high-quality dividend stocks are the baby that has been thrown out with the bathwater, now offering wonderful starting yields at low valuations.
- Included in the list is a telecom giant, a high-yielding midstream natural gas MLP, a fast food franchisor, a producer of construction equipment, a data center REIT, and a shopping center REIT.
- Cheers to those of you who took my advice last year and held back a decent cash position to deploy in times like these.
The spread of the coronavirus, along with the mounting oil price war between Saudi Arabia and Russia (and, to a lesser extent, American shale companies), has wreaked havoc on the stock market. The S&P 500 (SPY), Nasdaq (QQQ), and Dow Jones Industrial Average (DIA) are down 15-17% from where they sat just a month ago.
Both the virus and the oil price rout have turned out to be much worse than many assumed even a few weeks ago. And neither appear to be letting up in the foreseeable future. On Tuesday, Saudi Arabia announced that they would be ramping up oil production with the belief that sustained low oil prices will hurt Russia more than them. Meanwhile, the Russians claim to be prepared to hunker down and endure this oil price war.
This will unavoidably lead to a wave of bankruptcies in the exploration & production sector of the American energy industry, with perhaps 15-25% of companies going bankrupt or being forced to restructure. Weaker players will likely be acquired for pennies on the dollar by stronger players. And what about other unstable, oil-dependent countries like Venezuela and Iran? It wouldn't be surprising to see some geopolitical turmoil arise related to these countries in the relatively near future.
Will the Trump administration provide a bailout for American oil & gas producers? Perhaps. That would provide some relief for severely beaten down energy names. But low-cost (or zero-interest) loans can't fix oil prices in the $30s. The more likely result would be to create more zombie companies and delay the bankruptcy/restructuring process.
What about the virus? Is there light at the end of the tunnel yet? Here is how the advance of the coronavirus looks as of the afternoon on Tuesday, March 10th (new cases and deaths as of the last 24 hours):
The growth rates of cases in China and South Korea have slowed dramatically, giving hope that those two countries have seen the worst of it already. However, both new cases and deaths continue to rise swiftly in Italy, Iran, France, Spain, the United States, and now Switzerland. The Scandinavian countries (Sweden, Norway, Denmark) are seeing a sharp rise in cases as well.
Since it is unclear how deep and how long the economic disruption will be, I think it is imperative for dividend investors to focus right now on enhancing portfolio quality by buying the highest caliber companies that enjoy the strongest balance sheets. These may not be the deepest values out there, but more important to income investors than value is dividend safety, and these six blue-chip stocks all exhibit strong dividend safety metrics.
1. Verizon (VZ)
- Dividend Yield: 4.42%
- P/E Ratio: 11.3x
Verizon is a well-known telecommunications giant, being the company that many Americans pay every month for the use of their cell phones. Unlike rival AT&T (T), VZ is more of a pure play on telecommunications and thus is a great way to play the oncoming 5G revolution. VZ boasts the best network quality and the most 5G progress thus far with 31 cities, 16 NFL stadiums, and 4 basketball arenas already covered. And now it has announced a partnership with Pacific Northwest National Laboratory to provide 5G to a Department of Energy research facility.
Source: Q4 2019 Earnings Presentation
In 2019, adjusted EPS only rose 2.1% YoY, although analysts estimate faster EPS growth of 4% this year and 3.6% over the next 5 years. Meanwhile, in 2019, operating cash flow rose 4.1% YoY while FCF rose 0.6%. Net unsecured debt to adjusted EBITDA fell from 2.1x in 2018 to 2.0x in 2019, and total debt fell by nearly $2 billion.
VZ has raised its dividend for 15 consecutive years and has not cut its dividend since 1998. The company has paid out 50.4% of EPS and 56.2% of FCF over the last twelve months. FCF per share has not always covered the dividend, but it has been growing in recent years.
Notice that FCF per share remained steady during the Great Recession of 2008-2009, signifying a fairly recession-resistant business model. After all, when money is tight, there are a great many things people will stop paying before they give up their cell phones.
VZ has raised its dividend payout for 15 consecutive years, including a 6% raise in 2008 and a 6.7% raise in 2009. Assuming the dividend grows at its historical average of ~3% per year, buyers at today's 4.42% starting yield would end up with a respectable 5.94% yield-on-cost ("YoC") after ten years.
This projected YoC is decent for such a safe dividend stock as Verizon, but investors should be looking to buy shares at the lowest possible price in order to lock in the highest possible starting yield.
2. Enterprise Products Partners (EPD)
- Dividend Yield: 9.3%
- P/E Ratio: 8.3x
With a dividend yield above 9% (when it usually trades around 6%), ultra-high-quality pipeline & storage giant, Enterprise Products, is a screaming buy, in my opinion. It is a midstream master limited partnership ("MLP") particularly focused on natural gas, with many of its assets positioned in and around the Permian basin in Texas. Around 59% of the company's gross operating margin is derived from natural gas or NGLs, 29% from crude oil, and 12% from petrochemicals.
Unlike most energy companies with direct exposure to commodity prices, most (86%) of EPD's gross operating profit is fee-based. For these contracts, which are mostly made with investment grade counterparties like BP (BP), Shell (RDS.A) (RDS.B), ConocoPhillips (COP), and Exxon Mobil (XOM), the commodity owners pay for certain volume of transportation, regardless of whether they use it or not. Only 4% of EPD's revenues are commodity price-based. For crude oil, specifically, 91% of revenue is take-or-pay fee-based and 7% is exposed to the price of oil.
With debt to EBITDA at only 3.2x and 99% fixed rate debt at an average maturity of almost twenty years, EPD looks extraordinarily well capitalized to continue growing well into the future. It is one of the few midstream companies able to fund growth projects and its dividend without needing to rely on share (or "unit") issuance. Management plans to fund its $7 billion+ growth pipeline through 50% retained cash and 50% low-cost debt.
Julian Lin recently wrote an excellent overview of the bull case for Enterprise Products, so I won't repeat all of his points here. However, one bears emphasis: though management has been reticent to deploy significant capital toward unit buybacks in the past, they have the cash flow and determination to engage in buybacks now.
What's more, management has been very good about repurchasing units at opportunistic prices, meaning that they are more likely than other companies to spend their buyback firepower when their units yield the highest amount. All else being equal, this will boost future cash flow per share, thus further firming up the dividend safety.
Best of all, EPD's price/operating cash flow has not been this low since the Great Recession:
Conservatively assuming dividend growth of 3% going forward, buying in at today's 9.3% starting yield would result in a massive 10-year YoC of 12.5%.
3. Restaurant Brands International (QSR)
- Dividend Yield: 3.98%
- P/E Ratio: 17.5x
When Ray Kroc brought in Harry Sonneborn, McDonald's Corporation's (MCD) first CEO, Sonneborn made an observation to Kroc: "You’re not in the burger business, you’re in the real estate business. You build an empire by owning the land. What you ought to be doing is owning the land upon which that burger is cooked."
Thus began the transformation of fast food into the model that is ubiquitous today. The corporate owners of fast food (or "quick service") chain brands hardly do any of the actual operations of the business themselves. Instead, they collect franchise fees, royalties, and rent from their franchisees.
That is certainly true of Restaurant Brands International, owner of the Burger King, Tim Hortons, and Popeyes brands. Nearly all (99.6%) of QSR's stores are operated by franchisees, who bear most of the restaurant operating costs, including marketing and advertising. QSR also owns 6% of its stores' real estate, and leases 15% from third party landlords, then subleasing to franchisees.
These are much more stable, higher-margin income streams than those of its operator-franchisees. Of course, QSR's business model ultimately relies on the success of its franchisees, but if they suffer a bad quarter or two, it will not necessarily be felt at the franchisor level.
The Impossible Whopper and other new plant-based options QSR's restaurants are rolling out this year should continue to expand and diversify the company's customer base. They are just one part of the company's desire to transform its brands into popular, go-to restaurants that compete with the likes of McDonald's, Starbucks (SBUX), and Church's Chicken.
What's more, QSR shares seem to be selling at a discount to peers right now, especially its closest peers, McDonald's and Yum Brands (YUM), owner of the Taco Bell, Pizza Hut, KFC, and WingStreet brands.
The payout ratio based on FCF sits at 66%, which is on the higher end but not alarming considering the company's stability of cash flows. My hunch is that, if the coronavirus has any effect on QSR's sales, it will actually increase them as more people pick up meals at the drive-through to eat at home rather than going out to restaurants.
Conservatively assuming an 8% dividend growth rate going forward, buying in at today's 3.98% dividend yield would result in a 10-year YoC of 8.59%.
4. Caterpillar Inc. (CAT)
- Dividend Yield: 3.87%
- P/E Ratio: 11.4x
Caterpillar is the iconic producer of industrial and construction vehicles, machinery, and equipment, along with engines and gas turbines.
CAT's stock pulled back hard recently on the news that it could be hurt by the drop in oil production that is now all but certain. In the last three months, CAT is down 25%, including a 13% one-day drop on Monday.
CAT may have a bad year in 2020, but the pullback looks like an attractive entry point for long-term dividend growth investors. Consider, for instance, that CAT is now trading at just a little above the enterprise value to EBITDA hit during the trough of the Great Recession:
The company is a Dividend Aristocrat, having raised its payout for 26 consecutive years. What's more, FCF has consistently covered the growing dividend since 2007, besides a few short periods of weakness during the Great Recession and in 2012-2013.
In the last twelve months, CAT has paid out 51.4% of FCF and 36.2% of normalized diluted EPS as dividends, making the payout quite safe and sustainable.
CAT grew its dividend by an average of 8.5% per year over the last decade. Assuming the same average growth rate over the next decade, buying in at today's 3.87% starting yield would result in a 10-year YoC of 8.75%.
5. CyrusOne Inc. (CONE)
- Dividend Yield: 3.41%
- Price/FFO: 15.3x
CyrusOne is a REIT that owns data centers, providing mission-critical infrastructure for over 200 Fortune 1000 companies in the United States and Europe. For this stock, I implore readers to focus not on absolute value (though CONE certainly isn't richly valued), but rather dividend sustainability and growth prospects, both of which the company has in ample supply.
In 2019, CONE's revenue grew 19% YoY, while net operating income grew 15%, adjusted EBITDA grew 18%, normalized FFO grew a whopping 27%, and normalized FFO per share rose 13%. Last year, the company signed 433,000 square feet of new colocation space representing $105 million in annualized revenue. As of the end of 2019, CONE enjoyed a weighted average remaining lease term of 6.9 years, with weighted average contractual rent escalations of 2.44% per year. A little over three-fourths (76%) of its portfolio have built-in rent escalations.
What's more, thanks to its investment-grade credit rating, the REIT enjoys an ultra-low average interest rate on its debt of 2.34% as well as low net debt to EBITDA at 5.0x. And there are no debt maturities until 2023. With $1.25 billion in liquidity (compared to $6.14 billion in assets), the company has plenty of capital to fund its $735-830 million development pipeline in 2020.
With metrics like that, an EV to EBITDA of 17x doesn't sound so bad:
What's more, with a current yield of 3.41% (based on annualizing the most recent quarterly dividend), CONE is getting close to its highest yield since becoming a public company.
If one had bought CONE at $56 per share, one would have locked in a starting yield of 3.57%. If the price drops to $55.50, then the starting yield would be 3.6%.
In the last three years, FCF has consistently covered the dividend, which has accounted for a mere 59% of FCF and 53% of FFO in the last twelve months.
This leaves a huge amount of retained cash for reinvestment without needing to tap into credit facilities or new debt. Assuming a dividend growth rate of 8% (roughly in line with the previous three year average) going forward, buying in at a starting yield of 3.5% ($57 per share) would result in a 10-year YoC of 7.56%.
6. Urstadt Biddle Properties (UBA)
- Dividend Yield: 5.81%
- Price/FFO: 13.1x
Urstadt Biddle is one of the highest quality shopping center REITs in America with a strong portfolio concentrated in the New York Metropolitan Area, which includes New York, New Jersey, and Connecticut. Being headquartered squarely in the center of this region (Greenwich, Connecticut), CEO William Biddle and Chairman Charles Urstadt declared their confidence in the 2019 annual report that "no one knows our submarkets like we do."
Source: UBA Presentation
The company focuses on commuter markets surrounding Manhattan, which puts its properties squarely in the middle of wealthy populations. Twenty-two percent of UBA's properties are located in "super-zips" (i.e. zip codes in the 95th percentile of education and income) compared to 27% for high-quality Dividend King, Federal Realty Trust (FRT).
A majority of the REIT's properties are grocery-anchored, multi-tenant shopping centers, a handful of its properties are retail-oriented single-tenant buildings occupied by the likes, for example, of Savers. Top tenants include several regional and national grocery store chains, Bed Bath & Beyond (BBBY), CVS Pharmacy (CVS), TJ Maxx & Marshalls (TJX), and Walgreens (WBA). With a portfolio dominated by grocery stores, pharmacies, fitness centers, and bank branches, UBA is remarkably recession-resistant and insulated from e-commerce.
The REIT boasts 50 years of uninterrupted dividends along with 26 consecutive years of dividend increases. And with a very low net debt to EBITDA multiple of 3.96x along with strong free cash flow coverage of the dividend, the payout to shareholders looks safe and liable to continue growing over time.
In the last twelve months, UBA has paid out 77.3% of FFO. Assuming the dividend continues to grow at its slow average annual pace of 2%, buying in at today's 5.81% starting yield would result in a 10-year YoC of 7.08%. However, if one could pick up shares at a 6.2% starting yield (~$18.00 per share), the expected 10-year YoC would rise to 7.56%.
I am a buyer at the current price but will be adding aggressively if the price falls to $18 or under.
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This article was written by
I write about high-quality dividend growth stocks with the goal of generating the safest, largest, and fastest growing passive income stream possible. My style might be called "Quality at a Reasonable Price" (QARP) in service to the larger strategy of low-risk, low-maintenance, low-turnover dividend growth investing. Since my ideal holding period is "lifelong," my focus is on portfolio income growth rather than total returns.
My background and previous work experience is in commercial real estate, which is why I tend to heavily focus on real estate investment trusts ("REITs"). Currently, I write for the investing group, High Yield Landlord.
Analyst’s Disclosure: I am/we are long VZ, EPD, QSR, CONE, UBA. 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.
I may initiate a long position in CAT over the next 72 hours.
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