LONG-TERM INVESTING IN HIGH-QUALITY DIVIDEND STOCKS - …
[Pages:75]Sure Dividend
LONG-TERM INVESTING IN HIGH-QUALITY DIVIDEND STOCKS
March 2019 Edition
By Ben Reynolds, Nick McCullum, & Bob Ciura Edited by Brad Beams
Published on March 3rd, 2019
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Table of Contents
Opening Thoughts - On Newell Brands, Value, & Patience - ................................................... 3 Sell Recommendation: Clorox (CLX) ........................................................................................ 4 Sell Recommendation: Nike (NKE)............................................................................................ 5 The Sure Dividend Top 10 ? March 2019 ................................................................................... 6 Analysis of Top 10 Stocks............................................................................................................. 7
AbbVie Inc. (ABBV) .................................................................................................................. 7 Walgreens Boots Alliance Inc. (WBA) .................................................................................... 12 Caterpillar Inc. (CAT)............................................................................................................... 17 Eaton Vance Corp. (EV) ........................................................................................................... 22 Bank OZK (OZK) ..................................................................................................................... 27 Ameriprise Financial Inc. (AMP) ............................................................................................. 32 WestRock Co. (WRK) .............................................................................................................. 37 AT&T Inc. (T) .......................................................................................................................... 42 Cardinal Health Inc. (CAH) ...................................................................................................... 47 Western Digital Corp. (WDC) .................................................................................................. 52 Closing Thoughts - On The Dividend Aristocrats - ................................................................. 57 Real Money Portfolio .................................................................................................................. 58 Buying & Ranking Criteria ....................................................................................................... 59 Portfolio Building Guide ............................................................................................................ 60 Examples................................................................................................................................... 60 Past Recommendations & Sells.................................................................................................. 61 Sell Rules .................................................................................................................................. 61 Current Holds............................................................................................................................ 61 Pending Sells............................................................................................................................. 64 Sold Positions............................................................................................................................ 64 List of Stocks by Dividend Risk Score ...................................................................................... 65 List of Stocks by Sector .............................................................................................................. 70
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Opening Thoughts - On Newell Brands, Value, & Patience -
Newell Brands (NWL) traded over $50/share briefly in the summers of 2016 and 2017. The stock is currently trading for less than $20/share, including a ~20% decline since the company released its 4th quarter earnings on February 15th. What's going on at Newell?
First, the company acquired Jarden in 2016 for a total deal value of $16 billion. Newell over-paid and over-leveraged itself trying to grow rapidly by making a transformative acquisition. The company has had to divest many brands to streamline its operations (certainly a positive) and pay down debt (due to its overly aggressive Jarden acquisition). To the company's credit, the dividend has grown each year since 2010, even through this difficult restructuring period.
Newell released its 4th quarter and fiscal 2018 earnings results on February 15th. Debt was reduced from ~$10.5 billion to ~$7.0 billion on the year, a significant improvement. The company also reduced its share count by more than 7% in fiscal 2018. And, Newell grew adjusted earnings-per-share 4.4% in the quarter versus the same quarter a year ago. But guidance was troubling...
Specifically, the company is expecting operating cash flow of $400 million at the midpoint of its guidance in fiscal 2019 versus $680 million in fiscal 2018. On more careful analysis, the underlying business will be more profitable than the $400 million cash flow number suggests, because it includes reductions of $200 million for divestiture closing costs and taxes, and $200 million for restructuring and related costs. It also does not include operating cash flow from expected divestitures. The first $200 million is obviously a one-time charge. The second $200 million should be, but companies tend to throw more costs into restructuring than are merited. Conservatively, Newell Brands will generate $700 million plus in operating cash flow after fiscal 2019 (assuming no recession occurs). This comes to $1.65/share in operating cash flows at the current share count (versus a dividend of $0.92/share).
But where Newell gets more interesting is how it plans to use the cash from its planned brand divestitures. Newell expects to generate roughly $4 billion in fiscal 2019 from divestitures. This money will be used to further pay down debt and repurchase shares. If management follows its guidance, the share count could fall 30% into fiscal 2020 ? and keep in mind these repurchases are at low valuations, enhancing shareholder value. Also, if any of the company's cost reduction and restructuring moves bear fruit (which we believe is likely), operating cash flows will be even higher. The company could easily have operating cash flows of $3.00/share by the end of fiscal 2020. Assigning a reasonable valuation multiple, the company's shares will likely be worth $30 to $45 by the end of fiscal 2020 making reasonable assumptions about the divestiture plan and share repurchases.
And that's where value and long-term investing come into play. Newell posted worse guidance than we expected for fiscal 2019. But the company's plan remains in place, and it's likely investors will benefit from a significantly reduced share count (done at a low share price no less). This is not the type of opportunity open to someone investing for the next quarter. This story will play out over the next 1 to 2 years. That's why it's important to have a long-term outlook while analyzing shorter-term results closely. Further, understanding the expected value of a security through reasonable analysis can give a reason to hold for the long run. And with stocks like Newell that pay dividends (which management has no plan to change), investors get paid to be patient.
Disclosure: I (Ben Reynolds) am long NWL.
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Sell Recommendation: Clorox (CLX)
As a reminder, we are selling up to two securities a month from our past recommendations that have low expected total returns.
Having low expected total returns does not mean the underlying business is weak in any way. In fact, it could be an incredibly high-quality business that has weak expected total returns due to being significantly overvalued.
And that's the case with Clorox. Clorox is one of the safest businesses around. It does well during recessions. It has trusted disposable consumer products that are unlikely to be replaced by advances in technology. In short, Clorox is the type of business you want to own for the long run at the right price.
But other investors have noticed Clorox's strength and bid the share price up. The stock looks overvalued at current prices. With great businesses, investors can hold when they are unappreciated or fairly valued and take advantage of market mispricing when they are overvalued. That's why we are recommending selling Clorox today.
We first recommended Clorox in the first-ever edition of The Sure Dividend Newsletter (April 2014), where it was ranked 7th out of 10. Since that time, Clorox shares have gone on to deliver total returns1 of 102.9% (15.6% annualized) versus 66.1% (10.9% annualized) for the S&P 500.
Our Clorox recommendation has worked out better than expected, trouncing the market and doubling in value (including dividends).
Clorox's Growth Clorox's earnings-per-share have grown from $4.26 in fiscal 2014 to $6.26 in fiscal 2018, a 46.9% increase (10.1% on an annualized basis). And, the company has grown its earnings-per-share each year since 2014. Clorox's future growth strategy is centered around cost reductions, bolt-on acquisitions, modest organic growth, and share repurchases. The company does not have excellent growth prospects ahead; we forecast just 5% growth annually moving forward.
Clorox's Yield & Valuation What is a fair price-to-earnings ratio for a secure company with a 5% expected growth rate and a slightly-above-average dividend yield of 2.5%? We do not think it's anywhere near 25, around where Clorox's current price-to-earnings ratio is. We peg fair value for Clorox at a price-to-earnings ratio of 19. If the company reverts to our estimate of fair value in 5 years, total returns will be reduced by around 5% annually. When valuation is factored in, Clorox is poised to generate total returns of around 2.5% a year over the next several years. This is about in line with inflation ? and does not properly compensate investors for holding Clorox.
Performance, Recommendation, & Review Our Clorox recommendation delivered strong total returns due to the dual tailwinds of solid earningsper-share growth and a rising valuation multiple. It is time to harvest these gains and reinvest the proceeds into a security with better expected total returns ahead ? like any of those in this month's Top 10. We recommend selling Clorox now.
1 Return data from morning trading 2/28/19.
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Sell Recommendation: Nike (NKE)
We first recommended Nike in the May 2017 edition of The Sure Dividend Newsletter where it was ranked 6th out of 10.
Like Clorox, the reason to sell Nike is because it is significantly overvalued, not because of anything to do with the underlying business. We view Nike as a high-quality brand and industry leader in the athletic apparel space. Since we recommended Nike it has generated total returns2 of 62.1% (30.6% annualized) versus 20.5% (10.9% annualized) for the S&P 500 (SPY). With annual returns nearly 3x those of the S&P 500, our Nike recommendation has worked out far better than we hoped.
Nike's Growth When we first recommended Nike in May of 2017, we expected annual adjusted-earnings-per-share growth of around 11% annually. Today, we are still targeting the same 11.0% growth annually.
When we first recommended Nike in 2017, it was three quarters into its fiscal 2017. Nike generated earnings-per-share of $2.51 in fiscal 2017 and then went on to generate earnings-per-share of just $2.40 in fiscal 2018. But we expect the company to generate earnings-per-share of $2.65 in fiscal 2019, up ~10% from fiscal 2018, and up 5.6% from the fiscal 2017 numbers.
While Nike is a growth company, the strong returns (for the stock) mentioned above did not come primarily from growth. Valuation multiple expansion was the primary return driver.
Nike's Yield & Valuation We recommended Nike with a yield of 1.3% and a price-to-earnings ratio of 23x expected 2017 earnings. Price expansion has reduced Nike's yield to just 1.0% today (despite rising dividends). Nike's historical average price-to-earnings ratio over the last decade is 20.5. With strong growth prospects and high marks for safety, we believe a price-to-earnings ratio of 21.5 is fair for Nike.
But the stock is trading for a sky-high price-to-earnings ratio of 32.5 using expected fiscal 2019 earnings-per-share of $2.65. If Nike reverts to our estimate of a fair price-to-earnings ratio of 21.5 over the next 5 years, it will realize a 7.9% annualized drag on returns. When valuation is factored in, Nike's expected total returns over the next 5 years are just above 4% annually ? not nearly high enough to justify holding Nike shares. The stock is severely overvalued.
Performance, Recommendation, & Review Nike was not the typical Sure Dividend recommendation in that it had a below average yield. We typically look for stocks with higher yields and lower price-to-earnings ratios than Nike. But the stock offered growth and safety at a fair price. And the investment has worked out well, beating the S&P 500 handily since we recommended it.
Since our initial recommendation, Nike has seen its forward price-to-earnings ratio expand from 23 to 32.5 (a 41% jump). The stock now appears significantly overvalued; now is a good time to harvest gains and reinvest into better opportunities. We recommend selling Nike now and reinvesting into a company with better total return potential. Any of this month's Top 10 would make a fine replacement.
2 Total return data from mid-morning 2/28/19.
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The Sure Dividend Top 10 ? March 2019
Name & Ticker
AbbVie (ABBV) Walgreens (WBA) Caterpillar (CAT) Eaton Vance (EV) Bank OZK (OZK) Ameriprise Financial (AMP) WestRock (WRK) AT&T (T) Cardinal Health (CAH) Western Digital (WDC)
Div. Risk Score
A A A A B B B B B B
Price
$80 $68 $137 $42 $33 $132 $38 $31 $54 $51
Fair Value
$113 $98 $190 $54 $50 $192 $54 $48 $71 $61
Exp. Value Ret.
7.4% 6.4% 6.5% 5.1% 8.5% 7.8% 8.8% 9.3% 5.7% 4.6%
Div. Yield
5.3% 2.5% 2.5% 3.3% 2.7% 2.7% 4.8% 6.6% 3.6% 4.1%
Payout Exp. Ratio Growth
ETR
49% 9.5% 22.2% 28% 8.0% 16.9% 29% 6.2% 15.2% 42% 6.0% 14.4% 27% 11.3% 22.5% 24% 8.0% 18.5% 42% 4.0% 17.6% 57% 6.0% 21.9% 38% 5.0% 14.3% 25% 6.5% 15.2%
Notes: Data for the table above is from The Sure Analysis Research Database, 2/27/19 spreadsheet, and general data over the week ending 3/1/19. `Div.' stands for `Dividend.' `Exp. Value Ret.' means expected returns from valuation. `Exp. Growth' means expected annualized growth rate over the next 5 years. `ETR' stands for expected total returns and is the sum of the Exp. Value Ret., Div. Yield, and Exp. Growth columns. Data in the table above might be slightly different than individual company analysis pages due to writing the company reports throughout the week.
Disclosures: Ben Reynolds is personally long the following from this month's Top 10: WBA, T, CAH, & ABBV. Nick McCullum is personally long WBA, T, and CAH. The Real Money Portfolio is long EV, ABBV, and will buy shares of WBA on Tuesday 3/5/19.
There were three changes in this month's Top 10. T. Rowe (TROW), Invesco (IVZ), and Newell Brands (NWL) were replaced by Bank OZK (OZK), Ameriprise Financial (AMP), and WestRock (WRK). The stability of the top 10 list shows the ranking method is consistent, not based on rapid swings. Securities that fall out of the top 10 are holds, not sells. Selling occurs rarely; only when a security has expected total returns below the S&P 500's, or if it reduces its dividend.
An equally weighted portfolio of the top 10 has the following characteristics:
Dividend Yield: Growth Rate: Valuation Expansion: Expected Annual Total Returns:
3.8% 7.1% 7.0% 17.9%
The return estimates above are just that, estimates. Of the three expected total return factors, dividend yield is the most reliable. Future growth estimates are notoriously unreliable. Undervalued stocks tend to outperform in aggregate. However, the timing and nature of valuation is not a science but an art with a high degree of error. Overall, we expect our recommendations to outperform the S&P 500 by 1 to 3 percentage points over full economic cycles.
Note: Data for the newsletter was obtained between market open 2/27/19 and market close 3/1/19.
Return to Top 10 List
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Analysis of Top 10 Stocks
AbbVie Inc. (ABBV)
Overview & Current Events AbbVie is a pharmaceutical company focused on three core therapeutic areas: Immunology, Oncology, and Virology. AbbVie was spun off by Abbott Laboratories in 2013. AbbVie generates annual sales in excess of $30 billion and has a market capitalization of approximately $121 billion.
In late January (1/25/19) AbbVie reported its fourth quarter and full year earnings results. Revenue of $8.3 billion for the fourth quarter increased 7%, due primarily to 42% growth for Imbruvica. Humira remained the world's best-selling drug, and AbbVie's most important drug by far, but its growth rate slowed down to just 0.5%. AbbVie earned $1.90 per share during the fourth quarter, which was 28% more than the company's earnings-per-share during the fourth quarter of the previous year. For 2018, AbbVie generated earnings-per-share of $7.91, up 41% from 2017. AbbVie management expects adjusted earnings-per-share in a range of $8.65 to $8.75 for fiscal 2019.
Competitive Advantages & Recession Performance The most important competitive advantage for AbbVie, and any pharmaceutical company, is its patent portfolio. To prepare for increasing competition to Humira, AbbVie has accelerated research and development spending. AbbVie spent $10.4 billion on R&D in 2018, more than double the level from the previous year. This spending is starting to show positive results, as AbbVie has a robust pipeline.
It is unclear how AbbVie itself performed during the Great Recession, as it was still part of Abbott Laboratories. However, it is likely the company would hold up fairly well during a recession. People often cannot choose to go without healthcare, even when the economy is in a downturn.
Growth Prospects, Valuation, & Catalyst Loss of exclusivity for Humira poses a significant risk for the company going forward. AbbVie management has stated that discounting in Europe has been "on the higher end" of what the company had expected, with Humira prices being slashed from 10%-80% depending on the country. AbbVie will face biosimilar competition to Humira in the U.S. starting in 2023. AbbVie has invested billions into research and development to build a large portfolio of new products. Its two biggest areas of growth going forward will be hematologic oncology, and next-generation immunology. AbbVie expects non-Humira product sales to exceed $16 billion by 2020, and $35 billion by 2025.
Based on expected earnings-per-share of $8.70, AbbVie stock trades for a price-to-earnings ratio of 9.1. Our fair value estimate for AbbVie is a price-to-earnings ratio of 13.0, indicating the stock is significantly undervalued. An expanding valuation multiple could boost shareholder returns by approximately 7.4% per year over the next five years. In addition, we expect annual earnings growth of 9%-10% through 2024. Lastly, the stock has a current dividend yield of 5.3%. In total, we expect annual returns of 22.2% per year over the next five years.
Key Statistics, Ratios, & Metrics
Maximum Drawdown3:
34.8%
10-Year EPS Growth Rate:
Dividend Yield:
5.3%
10-Year Dividend Growth Rate:
Most Recent Dividend Increase: 11.5%
10-Year Historical Avg. P/E Ratio:
Estimated Fair Value:
$113
10-Year Annualized Total Return:
Dividend History: 46 years of increases
Next Ex-Dividend Date:
20.3% (since 2013) 18.0% (since 2013) 13.8 (since 2013) 18.7% (since 2013) 4/12/19 (est.)
3 Maximum drawdown occurred in October 2018.
Return to Top 10 List
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Income Statement Metrics
Year
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Revenue
N/A N/A N/A 17444 18380 18790 19960 22859 25638 28216
Gross Profit
N/A N/A N/A 12805 13872 14209 15534 18359 19805 21176
Gross Margin
N/A N/A N/A 73.4% 75.5% 75.6% 77.8% 80.3% 77.2% 75.0%
SG&A Exp.
N/A N/A N/A 5894 4989 5352 7724 6387 5855 6275
D&A Exp.
N/A N/A N/A 1272 1150 897 786 836 1189 1501
Operating Profit N/A N/A N/A 3620 5817 5664 3411 7537 9384 9592
Op. Margin
N/A N/A N/A 20.8% 31.6% 30.1% 17.1% 33.0% 36.6% 34.0%
Net Profit
N/A N/A N/A 3433 5275 4128 1774 5144 5953 5309
Net Margin
N/A N/A N/A 19.7% 28.7% 22.0% 8.9% 22.5% 23.2% 18.8%
Free Cash Flow N/A N/A N/A 5891 6012 5776 2937 7003 6562 9431
Income Tax
N/A N/A N/A 235 450 1204 595 1501 1931 2418
Balance Sheet Metrics
Year
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Total Assets
N/A N/A N/A 19521 27008 29198 27513 53050 66099 70786
Cash & Equivalents N/A N/A N/A 27 5901 9595 8348 8399 5100 9303
Acc. Receivable N/A N/A N/A 3817 4298 3854 3735 4730 4758 5088
Inventories
N/A N/A N/A 872 1091 1150 1124 1719 1444 1605
Goodwill & Int. N/A N/A N/A 9010 8453 8167 7375 32877 44313 43344
Total Liabilities
N/A
N/A N/A 7589 23645 24706 25771 49105 61463 65689
Accounts Payable N/A N/A N/A 417 556 933 1401 1597 1407 1474
Long-Term Debt N/A N/A N/A 48 15672 14723 14977 31671 36842 37368
Total Equity
N/A N/A N/A 11932 3363 4492 1742 3945 4636 5097
D/E Ratio
N/A N/A N/A 0.00 4.66 3.28 8.60 8.03 7.95 7.33
Profitability & Per Share Metrics
Year
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Return on Assets N/A N/A N/A 16.9% 22.7% 14.7% 6.3% 12.8% 10.0% 7.8%
Return on Equity N/A N/A N/A 24.8% 69.0% 105% 56.9% 181% 139% 109%
ROIC
N/A N/A N/A 24.8% 34.0% 21.6% 9.9% 19.7% 15.4% 12.6%
Shares Out.
N/A N/A N/A N/A N/A 1590 1590 1610 1590 1590
Revenue/Share N/A N/A N/A 11.04 11.66 11.71 12.40 13.96 15.72 17.60
FCF/Share
N/A N/A N/A 3.73 3.81 3.60 1.82 4.28 4.02 5.88
Note: All figures in millions of U.S. Dollars unless per share or indicated otherwise
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