2 Rich Dividends To Buy Before The Santa Claus Rally

Summary

• Recent headline risks have driven great dividend stocks into bargain territory.
• This creates a buy-the-drop opportunity before a potentially strong finish to the year.
• I highlight 2 names in different sectors that pay an attractive and growing dividend. Both carry strong balance sheets and are value priced.
• Looking for more investing ideas like this one? Get them exclusively at Hoya Capital Income Builder. Learn More »

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Recent headline risk around the Omicron variant and the Fed tapering its bond purchases has created a number of bargain opportunities in the stock market. While many tech stocks have seen material drops in their prices, I still don’t see a lot of bargain opportunities there.

The Nasdaq index dropped by 1.92% on December 3^rd, far more than the 0.17% drop in the Dow Jones Industrial Average, as it seems the Market is waking up to the frothy valuations in tech.

Meanwhile, I find good value in certain names in the pharmaceutical and REIT sectors which have been left behind by this year’s rally, and have seen share price weakness as of late. This brings me to the following 2 picks, which I believe could provide investors with outsized gains at their current valuations, so let’s get started.

Pick #1: Merck

Merck (MRK) is a name that’s perhaps synonymous with ‘big pharma’, as it has been around for 130 years and generates $52B in annual revenue. It has a strong portfolio of specialty drugs that treat cancer, cardiometabolic disease, and also has a substantial vaccine business that treats Hepatitis B, HPV, and Shingles.

MRK has seen substantial share price weakness in recent days, as excitement around its COVID pill molnupiravir has fizzled. One of the catalysts for this appears to be a report that indicated the drug’s efficacy is likely to be around 30% rather than the 50% previously anticipated. In addition, concerns around Omicron has pressured the stock as patients may delay doctor’s office visits.

All of this has driven Merck’s share price down from the $90-level achieved earlier this month down to $73.34 at present. As seen below, MRK now carries an RSI score of 29.5, indicating that the stock is now officially in oversold territory.

(Source: StockCharts)

I see the sell-off as being overblow, however, as management has recently noted that molnupiravir should have similar activity against the new variant. Plus, molnupiravir can be obtained at the pharmacy and taken in pill form, thereby saving the patient from the hassle of going to the hospital and getting an infusion.

Long-term Merck’s growth story should more than offset these near-term headwinds. This is considering the robust 19% YoY revenue growth that it saw during the third quarter, driven by its blockbuster franchises in Keytruda, Gardasil, and Animal Health.

I’m also encouraged by management raising its full-year revenue growth guidance to an impressive 14.5%, and this is on top of the 8% revenue growth that Merck saw during the pandemic last year. Plus, Merck has a promising pipeline including its once-daily HIV regimen, which has demonstrated promising results, and including the recently announced Acceleron acquisition, which boosts Merck’s presence in cardiology.

Meanwhile, Merck maintains a very strong A+ rated balance sheet with a net debt to EBITDA ratio of 0.78x. It also continues its 12-year dividend growth track record with the recent 6% dividend bump, bringing its forward yield to an impressive 3.8%.

At the current price of $73.34, Merck trades at a forward PE of just 12.6, sitting well below its normal PE of 14.6 over the past decade. Analysts expect an average 12% annual EPS growth over the next 3 years, and have a consensus Buy rating on the stock with an average price target of $95. Merck is currently a Strong Buy.

(Source: F.A.S.T. Graphs)

Pick #2: National Retail Properties

National Retail Properties (NNN) is a dividend stalwart in the net lease space, with 32 years of consecutive annual dividend growth, making it a dividend aristocrat and just one of 3 REITs to achieve this milestone. Its portfolio consists of 3,195 properties spread across 48 states and over 370 tenants.

While the world ‘Retail’ in NNN’s name may scare some investors, it really shouldn’t as most of its properties are either related to convenience stores or service-related tenants. In fact, convenience stores, automotive service, and restaurants make up 48.6% of NNN’s annual base rent. Notably, 7-Eleven, Mister Carwash, and Camping World (CWH) are NNN’s top 3 tenants.

What makes NNN worth owning is its triple net leases, in which the tenant is responsible for paying property taxes, maintenance, and insurance. This results in a high 89.6% operating margin (with depreciation addback) for the company.

Plus, NNN is displaying strong fundamentals, with occupancy landing at 98.6% during the third quarter, sitting 10 bps higher than where it was at the end of 2020. Rent collection is also strong, at 99% for both Q3 and the month of October, and NNN maintains long-weighted average remaining least term of 10.6 years.

Looking forward, NNN is set for continued growth, as management raised acquisition guidance to $575M this year, and issued robust 2022 acquisition guidance of $600M at the midpoint. NNN’s acquisitions also generally come with attractive cap rates, and this includes the 6.5% cap rate on acquisitions during the third quarter.

Meanwhile, NNN maintains a strong BBB+ rated balance sheet with plenty of cash on hand ($544M) to fund its acquisition pipeline. It also maintains a low net debt to EBITDA ratio of 5.1x, sitting well below the 6.0x level the I prefer for REITs.

Risks to NNN include the Omicron variant, which could pressure NNN’s restaurant and fitness tenants. In addition, the Fed’s anticipated tapering of bond purchases could result in higher interest rates, which could raise NNN’s cost of debt. On the other hand, this signal from the Fed is an indication of an improving economy and inflation benefits owners of hard assets as in the case of NNN, as it’s able to raise rents to offset inflationary pressures.

These pressures have driven NNN’s price down to $43.89, and its dividend yield up to 4.8%. The dividend comes with a safe payout ratio (for a net lease REIT) of 75.7%, and comes with a 5-year CAGR of 3.4% and 32 years of consecutive annual raises.

NNN also comes with a reasonably low valuation, with a forward P/FFO of 15.7, sitting comfortably below its normal P/FFO of 17.8 over the past decade.

(Source: F.A.S.T. Graphs)

Its valuation also compares favorably to the 19.5 P/FFO of Realty Income (O), 16.7 of W. P. Carey (WPC), and 17.6 of STORE Capital (STOR). Sell side analysts have a consensus Buy rating with an average price target of $52, and Seeking Alpha’s Quant has a Bullish rating on NNN, with B+/B for Valuation and Growth, and A/B for Profitability and recent upward analyst revisions, as seen below. NNN is a solid Buy.

(Source: Seeking Alpha)

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MRK, NNN either through stock ownership, options, or other derivatives. 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.

This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.