3 Beaten Down Stocks Yielding 4%

Summary

• Stocks are being pressured in 2022 due to the Fed's tapering, possible interest rate hikes, and conflict in Ukraine.
• Dividend yields for some stocks are more than 4% combined with 25+ years of dividend growth.
• The dividend safety metrics are excellent based on payout ratio and free cash flow.
• The valuations are below the long-term 5-year or 10-year averages.

Sergei Chuyko/iStock via Getty Images

The combination of the US Federal Reserve tapering, the possibility of higher interest rates, and now the war in Ukraine have beaten-down stocks. There is no doubt it is a riskier and more volatile time to invest. The CBOE VIX is near 30, and the normal range is 18 to 19. However, it is still an opportunity for brave investors to add to existing positions or start new positions. Below, I discuss three beaten-down stocks yielding at least 4%. All three stocks are Dividend Champions or Dividend Aristocrats with 25 or more years of annually increasing the dividend. In addition to the general downward trend for the stock market, each stock is facing its company-specific challenges. The stocks are International Business Machines (IBM), 3M Company (MMM), and Walgreens Boots Alliance (WBA). I view all three stocks as long-term buys.

International Business Machines

IBM is one of the largest IT services and software providers globally. However, the company struggled under its previous CEO due to poor operational execution, changing customer demands, and rising competition from the cloud. The result was declining revenue, increasing net debt, and a lower stock price.

However, IBM is now a transformed company under the new CEO. The company acquired RedHat for $34 billion in 2018 to expand its hybrid cloud offerings. RedHat has been serving as a growth engine for IBM. Despite predictions that RedHat growth would slow, the business grew 19% in Q1 2021. RedHat's revenue is now more than $5 billion annually. Reportedly, IBM is seeing growth from its partnerships with Amazon Web Services, Microsoft's Azure, and Salesforce.

Next, in 2021, IBM spun off the managed infrastructure services business into a new company called Kyndryl Holdings (KD). The primary problem was that this business was large but had declining revenue and was not profitable. As a result, IBM is better positioned for long-term growth by divesting this business and retaining growing segments. IBM is still working with Kyndryl, but the advantage is declining sales no longer impacts the company.

Along these lines, IBM is selling Watson Health, which is not profitable.

In addition, IBM is acquiring smaller, privately held consultant and software firms. The company spent about $3 billion in 2021 purchasing Rego Consulting, 7Summits, Bluetab, BoxBoat, Waeg, Turbonomic, SXiQ, and eight other companies in 2021. IBM has already announced the acquisition of Enzi in 2022.

IBM is currently yielding more than 5.3%, the fourth highest of the Dividend Champions and the highest amongst the Dividend Aristocrats. The quarterly dividend rate was last increased by 0.6% to $1.64 per share in April 2021. There is some possibility the dividend will be cut due to the Kyndryl spin-off, but IBM has not made any announcements yet.

Portfolio Insight

However, the dividend is covered by earnings and free cash flow (FCF). The forward payout ratio is about 66%, and free cash flow [FCF] is estimated at $10 - $10.5 billion in 2022. The dividend requires about $5,869 million in the last 12 months, giving a dividend-to-FCF ratio of roughly 60%. Furthermore, IBM has been reducing debt, adding to the dividend safety. Core debt is down to $37.8 billion, and financing debt is down to $13.9 billion. Total debt is down $21+ billion since the Red Hat acquisition.

For valuation, IBM is trading at a price-to-earnings (P/E) ratio of about 12.4X as of this writing. For comparison, the average in the past 5-years and 10-years is 12.5X to 13X, respectively. As a result, I view the stock as a long-term buy.

3M Company

3M Company is a large industrial conglomerate known for selling Post-Its, Scotch tape, ACE bandages, Command hooks, and Filtrete filters. However, the company also sells adhesives, tapes, granules, stationary, fibers, masks, and many more items for a total of about 60,000 products globally.

3M has faced significant headwinds over the past few years between the combination of tariffs, slow auto sales, and COVID-19. Sales and earnings are recovering, but the stock price has not recovered because investors fear the potential costs of litigation. 3M is litigating lawsuits about earplugs, PFAS, and respirators. The earplug lawsuits have 280,000 pending cases and the potential for substantial liability. However, according to 3M's website, it is appealing verdicts and has won several on appeal. The PFAS lawsuits are an ongoing liability, and the costs are unclear. The respirator lawsuits are ongoing despite settling for some in 2019. Lastly, the Bair Hugger lawsuits were reinstated in late-2021.

The potential liabilities and recent downgrades by Wall Street analysts have caused the stock price to decline. However, the stock price rallied with the recent Johnson & Johnson (JNJ) ruling about its talc lawsuits. 3M may be exploring a similar strategy. However, the worst-case liability scenarios are probably extreme. Furthermore, 3M is a leader in wound care, industrial safety, tapes and adhesives, home improvement, office products and has well-known consumer products. 3M will grow along as the global economy grows.

Currently, 3M's dividend yield is more than 4%, which is historically a good time to purchase the stock. The quarterly dividend rate was last increased by 0.7% to $1.49 per share in February 2022. The forward payout ratio is approximately 59% and has come down from nearly 70% in 2020. The dividend is covered by FCF too of about $5,851 million in 2021. The dividend required $3,420 million, giving a dividend-to-FCF ratio of around 58%.

Portfolio Insight

In addition, 34M has been aggressively reducing debt after using it to repurchase shares for a few years. As a result, net debt has declined from $17,819 million at the end of 2019 to $12,571 million at end of 2021. The leverage ratio is down to about 1.34X, and interest coverage is up to ~16X.

3M is now trading at a forward P/E ratio of about 14.4X. The multiple for this Dividend King is below the 10-year average of 19X. I view the stock as a long-term buy.

Walgreens Boots

The last stock we discuss is Walgreens Boots. The company is one of the largest drugstore chains in the US, with more than 8,965 stores under the Walgreens and Duane Reade brands and 4,031+ Boots and other store brands in the UK and other countries.

The company has struggled since the merger of Walgreens and Boots in 2015 due to poor operational execution and merger integration challenges. The stock price reflected the poor performance had a downward trend until August 2020. The company has a new CEO and is moving to divest Boots. Several private equity firms are seeking to buy the chain.

Walgreens is executing well on the operational front due to COVID-19 vaccinations, testing, and increasing retail sales. The company has partnered with Village Medical to open coordinated primary care and pharmacy practices. Store traffic is rising, driving increased sales.

Walgreens Boots' forward dividend yield is ~4.1%. The quarterly dividend was last increased by 2.1% to $0.4775 per share in July 2021. Earnings and FCF cover the dividend. The payout ratio is very conservative at ~34%. Free cash flow was around $4,057 million in 2021. The dividend required only $1,625 million, giving a dividend-to-FCF ratio of about 40%.

Portfolio Insight

The stock is trading at a low P/E ratio of approximately 9.1X versus an average in the past decade of 15X. However, growth is slower now, and a lower multiple is likely warranted, but even using 12X, Walgreens Boots is undervalued. Therefore, I view the stock as a long-term buy.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IBM, MMM 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.