DividendInvestor May 2011

Transcription

Morningstar DividendInvestor
DividendInvestor
1
May 2011
May 2011
SM
Volume
Number
7
4
Quality recommendations for current income and income growth from stocks
Dividends Down Under
After nine days, 32,000 frequent-flier miles, and more
than my fair share of Cadbury Dairy Milk bars, I came
back from the Land Down Under convinced of one
thing: Australia has a lot to teach Americans—both
investors and companies—about the way the stock
market is supposed to work.
Australia isn’t just on the other side of the world.
When it comes to the way investors interact with the
financial markets, Australia might as well be on
a different planet. Not that the country doesn’t have
other fine attributes: The chocolate is better (I have
an irresistible affinity for British candy bars and their
cousins throughout the Commonwealth), the beer
is great, and the bacon—for some reason I can’t quite
put my finger on—is awesome. But nothing made
a bigger impression on me than the dividend yield of
the Australian stock market: 4.25% as of late March.
Seems like a place worth getting to know.
Australian Economics
I’ve written before that a high yield cannot turn a bad
business into a good stock, and the same logic
applies to countries. If Australia had a big structural
trade deficit, skyrocketing government debt, utterly
incoherent political leadership, persistently high
unemployment, nonsensical regulation of its banking
system, and a monetary policy that a third grader
would laugh at, a fat yield alone probably wouldn’t be
enough to get me interested. But if the problems
listed above sound familiar, it’s because they apply to
the United States, not Australia.
Australia, like America, is blessed with an abundance
of natural resources. Unlike America, though, only
about 22 million people share directly or indirectly in
this wealth, while our 310 million-plus souls are forced
to import half of their most important resource (oil).
Australian unemployment, which peaked at only 5.8%
during the global recession, has already retreated to
4.9%. These facts alone might seem like a sufficient
prescription for prosperity, but as a nation, Australia
has handled its blessings with prudence and restraint.
Measured relative to gross domestic product, total
government borrowings are a fraction of U.S. levels.
Even as America robs its savers with negative interest
rates after inflation, a one-year, government-backed
term deposit in an Australian bank pays 6% —and
inflation is running at only 3%.
No economy is without problems, and Australia’s
proximity to resource-hungry emerging economies in
Asia is regarded rather nervously. ( What if China
cracks?) Everyone I asked thought the Australian dollar,
which now costs $1.05, is overvalued. Maybe they’re
right; historically, the long-term exchange rate has
tended toward the $0.75–$0.85 range. Then again,
maybe it takes an outsider’s perspective to see just
how good the Australians have it—particularly when
compared with their profligate cousins in the U.S.
and parts of Europe. Economic cycles in Australia are
bound to track commodity prices, and mean reversion
may catch up with the Australian dollar and everything that changes hands with it. Yet the country’s
long-term prosperity strikes me as the product of not
just luck, but also thoughtful economic policies—the
benefits (or rather the absence of burdens) of which
ought to outlast the current commodity boom.
The cost of housing could be regarded as another
threat. The median home price is $450,000 —not just
Continued on Page 2
Josh Peters, CFA
Equities Strategist and Editor
Builder Portfolio
Finally, finally, finally—our
banks are raising their
dividends!
4
Builder Focus
McCormick & Company:
Spices turn modest revenue
growth into solid total returns
7
Harvest Portfolio
8
A batch of changes combine
to hike the Harvest’s income and
raise its potential for growth.
Harvest Focus
11
Health Care REIT:
We think prospects for dividend
growth are improving
Income Bellwethers
12
Five new names for our roundup
of leading payers, including
Raytheon and Digital Realty
The Dividend Drill
American Electric Power
AT&T
Procter & Gamble
17
2
Dividends Down Under
Continued From Cover
in metropolitan Sydney, which is indeed insanely
expensive, but for the country as a whole. No less an
authority on bubbles than Jeremy Grantham has laid
the fateful label on the Australian housing market.
Yet I’m not sure that bubble is the right word: Housing
is costly compared to median incomes, but some state
governments restrict the supply of land, and mortgage
lending standards never loosened—in fact, when
house prices started rising quickly early in the last
decade, central bankers quickly tightened the screws.
on the domestic profits on which they have paid a 30%
corporate income tax, which they cannot use for
themselves but can pass along to shareholders along
with dividend payments. A dollar of fully franked
dividend income arrives with a tax credit worth 30
cents, which offsets the income tax the investor
will owe. In fact, an investor in Australia’s lowest tax
bracket (15%) would actually get a 15 -cent refund
from the government, while one in the highest bracket
(45%) would owe just 15 cents of additional tax.
Australian Investors
Perhaps the starkest difference between U.S.
economic policy and that of Australia is the pension
system. The idea of private investment accounts
to replace Social Security has been floated in the U.S.
before, with all the popularity of the proverbial lead
balloon. I don’t know whether it would work here, but
Australia did it decades ago with a system called
superannuation. Every employer must contribute a
certain percentage of employee wages (currently 9%)
to a private, portable, tax-advantaged retirement
account that belongs to the employee. Employees
generally have a wide choice of options for investing
these savings, including self-directed accounts if
they like, and they may add some contributions of their
own. A state-funded pension similar to our Social
Security system is also in place, but unlike ours, it is
means-tested with fairly low cutoffs—and therefore
presents few long-term demographic problems.
Not all Australian companies are able to provide full
franking credits. Some are only partially franked
based on their income sources, while Australia’s real
estate investment trusts and infrastructure trusts
(cousins to our master limited partnerships) don’t pay
income taxes and therefore have no franking credits
to share. Still, this system gives Australian investors
another big reason to demand dividends from their
companies—and the companies the means to deliver
that much more aftertax value to their investors.
What kind of a stock market would you expect if most
people had sole responsibility for funding their retirement through investment accounts? You’d probably
look for a lot more interest in dividends and a lot less
tolerance when they’re obviously missing. Yet the
Australians’ ardor for dividends doesn’t stop there.
Australian Taxes
In the U.S., as in most of the world, corporate profits
are said to be taxed twice—first at the corporate
level, then again when they are distributed (either
through dividends or capital appreciation) to shareholders. Not so in Australia, where an imputation
system called franking attaches a lucrative tax credit
to most of the dividends that are paid Australian
investors. Companies receive franking credits based
A Few Australian Stocks
One thing I didn’t like about the Australian stock
market was its lopsided sector weightings. Basic
materials—led by global mining giant BHP Billiton
BHP —represent a hefty 30% of the market’s total
value. The Australian Securities Exchange lists
hundreds of (speculative) penny stocks representing
minuscule miners, although even the big guys
(including BHP) tend not to pay large dividends because
of their capital-hungry expansion plans.
Elsewhere in the market, though, yields are bountiful.
The top four banks all yield around 6%, never needed
to cut their dividends during the crisis, and thanks
to the extremely consolidated nature of the industry
(similar to Canada’s) managed to preserve strong
returns on equity. Woolworths WFAFY, the nation’s
top grocery chain, yields 4.6%, has been increasing
its earnings at a 15% annualized clip for years, and
hauls in profit margins much higher than a Kroger KR
or Safeway SWY. QBE Insurance QBIEY is a
remarkably capable, almost Berkshire-esque underwriter in property/casualty lines around the world—
and yields 7.0%. Oh, and the yield on those Australian
REITs—easily double the sub-4% median of ours!
BHP Billiton BHP
Star Rating
Economic Moat
QQQ
Narrow
Uncertainty Rating
Medium
Fair Value
89.00
Dividend Buy
64.60
Current Price
100.25
Dividend
1.82
Yield (%)
1.8
Payout (%)
5-Yr Growth (%)
Stewardship
23
29.3
—
Westpac Banking ADR WBK
Star Rating
Economic Moat
Uncertainty Rating
QQQ
Narrow
High
Fair Value
147.00
Dividend Buy
106.77
Current Price
130.34
Dividend *
6.41
Yield (%)
4.9
Payout (%)
70
5-Yr Growth (%)
5.8
Stewardship
—
*Dividend rate for foreign stocks
calculated from total payments on
ADRs in last 12 months. Forward
rates and yields may be higher due
to exchange rates.
3
May 2011
For a U.S. investor, a bigger problem is access. Only
three Australian companies (BHP, Westpac Banking
Group WBK, and News Corporation NWS) are
listed on the New York Stock Exchange. A handful more
are available with American depository receipts
traded on the Pink Sheets, but the only one that does
a respectable volume is Telstra TLSYY, the former
government-owned phone company. Trading others
might mean paying a wide spreads and moving prices
with even modest-size orders. (As of this writing,
the Woolworths ADR hadn’t traded in three weeks!)
Yet going directly to the ASX may not be much easier:
One well-known brokerage firm I deal with would
charge a hefty 1% commission, with no way to place
or change an order while the ASX is actually open.
Having mentioned Telstra, I should note that the stock
looks cheap and yields about 10%, but investors had
best watch out. The government is trying to buy back
Telstra’s legacy fixed-line business, which it intends to
replace with fiber optic connections to virtually every
home and business in the country. The terms of this
complex deal are still up in the air, and it’s not clear
how sustainable the dividend will be if it proceeds.
The best idea I came back with—and the only one
I’m considering adding to our portfolios, given the
access problems described above—is the local Coke
bottler, Coca-Cola Amatil CCLAY. Although its Pink
Sheets-listed ADRs trade about 9,000 shares a day,
the stock yields 4.6% and has increased earnings and
dividends at a low-double-digit clip by acquiring
additional beverages (even beer and spirits) to push
through its distribution system. Amatil also owns
the Coke bottling operation in Indonesia, where per
capita consumption of Coke is tiny but incomes are
rising fast. It’s a small part of the business today, but
as it grows larger, Amatil’s growth rate could get
even better. (If you decide to pursue Amatil or any of
the other stocks I’ve mentioned, however, please,
please enter your orders with care!)
The Bottom Line
Perhaps I’ve overstated the pluses of the Australian
economy and its system of investment, while overstating the challenges facing the U.S. too. Anything
new is automatically more interesting than anything
old, and I can’t deny that just being in Sydney—with
friendly people, spotless streets, and warm, mostly
sunny weather to a winter-parched Midwesterner—
put a glow on the whole situation. Still, as American
leaders (political, corporate, and financial) ponder
solutions to our long-term problems, I’d like to think
they’d consider adopting some of the policies that
Australia has demonstrated work well for ordinary
investors. If not, I’m confident that the few American
firms that “act Australian” with their dividend policies
will continue to serve us well. œ
As you might expect, the easiest way for a U.S. investor
to buy into Australia is furnished through exchangetraded funds. The largest is iShares MSCI Australia
EWA, but being a market-weighted index fund, its
yield of 3.1% is bogged down by that fat allocation to
lower-yielding resources firms.
DividendInvestor Portfolios: Combined Performance
Date
Builder
Portfolio
Period
Return (%)
Harvest
Portfolio
Period
Return (%)
MDI Portfolios
Combined
Period
Return (%)
S&P 500
Return (%)
MDI B/(W)
than S&P
M* Div Ldr
Return (%)
MDI B/(W)
than MDL
01/07/2005*
100,000.00
100,000.00
12/30/2005
102,324.82
+2.3
12/29/2006**
124,722.19
+21.9
100,000.00
12/31/2007
121,180.73
-2.8
101,776.82
+1.8
222,957.55
-0.8
12/31/2008
99,046.55
-18.3
70,128.71
-31.1
169,175.26
-24.1
12/31/2009
105,161.54
+6.2
94,045.47
+34.1
199,207.01
+17.8
12/31/2010
120,339.85
+14.4
120,346.67
+28.0
240,686.52
+20.8
Year-to-Date 2011
125,557.39
+4.3
127,428.61
+5.9
252,986.00
+5.1
+5.1
+0.0
+5.0
+0.2
Totals (since inception)
125,557.39
+25.6
127,428.61
+27.4
252,986.00
+40.4
+26.1
+14.3
+14.4
+26.0
102,324.82
+2.3
+7.1
-4.8
+5.2
-2.9
224,722.19
+21.9
+15.8
+6.1
+25.5
-3.6
+5.5
-6.3
-10.2
+9.5
-37.0
+12.9
-31.4
+7.2
+26.5
-8.7
+14.8
+2.9
+15.1
+5.8
+16.7
+4.2
Data through April 13, 2011. Combined cumulative returns calculated on a time-weighted basis. “M* Div Ldr”5 Morningstar Dividend Leaders index of high-yielding stocks. *Inception of Builder **Inception of Harvest
4
The Dividend Builder Portfolio
Morningstar Stock Portfolios | Josh Peters, CFA
What is the goal of the
Builder Portfolio?
To earn annual returns of
11%–13% over any
three- to five-year rolling
time horizon.
For our portfolio as a whole,
this goal is composed of:
2%–4% current yield
8%–10% annual income
growth
Income Update
Dividends Received
Interest Income
Total Income
395.87
0.02
395.89
On March 18, two years of waiting for banks to begin
restoring adequate dividend payments finally started
to pay off. As regulators concluded their review of
large banks’ plans for capital, all three of the Builder’s
were in the very first crop of dividend raisers. U.S.
Bancorp led the pack, hiking its quarterly dividend rate
150% to $0.125 a share. Wells Fargo boosted its
dividend to $0.12 a share (up 140%), while BB&T—
the least likely of our banks to raise, given its smallerthan-average cut during the financial crisis—managed
to squeak out a 6.7% rise to $0.64 a share. BB&T and
Wells Fargo also declared small special dividends to
make their total first-quarter payments equal the new
rate for the second quarter. In all, these three hikes
added $174.20 to the Builder’s annualized income.
Performance Update
Yield on Original Cost
Yield on Current Value
3.1
3.1
Income Yield, Year Ago
Income Growth (TTM)
2.6
12.9
Price/Fair Value–Portfolio
Price/Fair Value–Market
0.87
1.02
Reporting Period: March 11 to April
13, 2011. Yield and Price/Fair Value
data exclude cash balances.
Income growth (TTM) measures the
impact of dividend increases net of
dividend cuts, excluding the effect of
portfolio transactions.
Invest in the Dividend
Portfolios’ Approach—The
Hassle-Free Way
Did you know that Morningstar
Investment Services now offers a
customizable portfolio patterned
after the Dividend Builder and
Dividend Harvest portfolios? To
learn more, call 1-866-765-0663.
Morningstar Investment Services,
Inc. is a registered investment advisor
and wholly-owned subsidiary of
Morningstar, Inc.
We still have a long way to go: Before the cuts of 2009,
these three positions were together paying at the
rate of $1,487 annually— $1,179 of which was lost.
Thus far, we’ve recovered only 15% of our missing
income. But just seeing these dividends rise at all was
a huge step in the right direction, and I’m very optimistic that these are but the first of many increases
in the next few years. I wouldn’t be a buyer of bank
stocks at their current prices, but I’m a much happier
holder than I’ve been in a long time. I’ll also be
listening closely to upcoming quarterly conference
calls for details of dividend prospects.
Portfolio Update
I made four trades in the Builder last month—two
sales of overvalued stocks, the addition of a new,
undervalued one, and an add-on buy. The last took
place March 16, when I used the cash that had been
building up through dividend payments to buy 35
more shares of Abbott Laboratories at $47.07 apiece.
With Abbott having raised its dividend 9% in February,
this purchase offered a current yield of 4.1%. This
purchase made Abbott the Builder’s largest holding,
matching my enthusiasm for its dividend prospects.
The other trades I made all took place April 12 (transaction prices include the effect of commissions):
YSold 200 shares of NSTAR NST at $44.43.
The 18-month stint for this utility in the Builder was a
rewarding one, producing a total return of 49.1% —
more than double what the S&P 500 returned over the
same stretch. NSTAR is, or was, the kind of business
that I would just as soon hold forever, but two factors
prompted me to let it go. First, valuation: In addition
to being priced at a 14% premium to our fair value
estimate, 17 times forward earnings estimates for a
utility stock struck me as awfully rich. Second, the
NSTAR we bought in October 2009 won’t exist much
longer—its pending merger into Northeast Utilities
NU, though justifiable and potentially beneficial,
introduces new risks (integration challenges and regulatory interference to name two) to continuing holders.
Still, I would consider buying NSTAR (or the postmerger Northeast) again if gets cheap.
YSold 100 shares of Graco GGG at $42.68.
This small-cap industrial manufacturer with a rare
wide-moat rating also served the Builder well,
returning 31.1% from a purchase in March 2008 (S&P
500: just 6.6%). But with the stock trading at a
modest premium to our $41 fair value estimate,
carrying a yield slightly under 2%, and—most important—offering relatively weak prospects for dividend
growth until profits recover fully from the recession,
I was already considering Graco as a source of funds
for other purchases. Tack on the stock’s volatility,
and I saw little merit in hanging on.
TBought 100 shares of Procter & Gamble at
$63.02. P&G needs little introduction, but I am
amazed at how poorly the market has been treating
the stock—it’s made no net forward progress in
five years, even though the dividend has continued to
grow at a double-digit clip. This compressed valuation had left P&G among the tiny handful of stocks
meeting my basic qualitative and quantitative criteria
for purchases, and I saw no reason to sit on the sidelines any longer—especially after the 9% dividend
hike announced April 11, which marked a 55 th straight
year of continually higher pay for shareholders.
Continued on Page 6
5
May 2011
Builder Portfolio Performance and Transaction Summary
Morningstar Ratings & Fundamentals
Portfolio Data
Star
Rating
Economic
Moat
Steward
Grade
Fair
Value
Current
Price
Div
Rate
Yield
(%)
First
Purchase
# of
Shares
Cost Per
Share
Current
Value
% of
Acct
Total
Rtn (%)
Annual
Income
Å Abbott Laboratories ABT
QQQQQ
Wide
C
68.00
Low
Johnson & Johnson JNJ
QQQQQ
Wide
C
75.00
Low
58.00
50.45
1.92
3.8
04-28-08
205
50.55
10,342.25
8.2
7.7
393.60
64.00
59.60
2.16
3.6
01-10-05
150
64.61
8,940.00
7.1
6.9
324.00
Spectra Energy SE
QQQ
Wide
X
30.00
QQQQ
Wide
X
77.00
Low
27.00
26.96
1.04
3.9
09-14-10
255
21.87
6,874.80
5.5
25.6
265.20
Low
66.00
62.99
2.10
3.3
04-12-11
100
63.02
6,299.00
5.0
0.0
210.00
Philip Morris Int’l PM
QQQ
Wide
X
U.S. Bancorp USB
QQQQ
Wide
Z
65.00
Med
53.00
66.11
2.56
3.9
05-21-10
140
44.30
9,255.40
7.4
54.9
358.40
31.00
Med
22.00
25.99
0.50
1.9
11-18-05
350
31.38
9,096.50
7.2
-2.3
175.00
BB&T BBT
QQQQ
Narrow
Diageo PLC ADR DEO
QQQ
Wide
C
32.00
Med
24.00
26.85
0.64
2.4
01-30-07
330
39.94
8,860.50
7.1
-20.5
211.20
X
76.00
Med
59.00
77.82
2.49
3.2
03-18-05
110
58.73
8,560.20
6.8
53.5
273.62
Clorox CLX
QQQ
United Parcel Service UPS
QQQ
Narrow
X
68.00
Low
59.00
69.42
2.20
3.2
10-22-09
110
58.43
7,636.20
6.1
24.2
242.00
Wide
X
80.00
Med
60.00
72.61
2.08
2.9
01-03-07
100
75.10
7,261.00
5.8
6.9
208.00
Paychex PAYX
Wells Fargo WFC
QQQQ
Wide
Z
38.00
Med
30.00
32.35
1.24
3.8
03-11-08
200
28.55
6,470.00
5.2
20.9
248.00
QQQQ
Narrow
Z
39.00
Med
28.00
30.68
0.48
1.6
11-01-05
200
30.00
6,136.00
4.9
17.7
96.00
General Electric GE
QQQQ
Wide
X
25.00
Med
19.00
19.94
0.56
2.8
04-17-08
275
29.38
5,483.50
4.4
-25.4
154.00
Sysco SYY
QQQQ
Wide
X
36.00
Med
28.00
28.19
1.04
3.7
11-15-05
170
30.38
4,792.30
3.8
7.3
176.80
Bemis BMS
QQQ
Narrow
—
36.00
Med
28.00
31.84
0.96
3.0
08-05-05
150
28.64
4,776.00
3.8
20.2
144.00
Waste Management WM
QQQ
Narrow
X
37.00
Med
30.00
37.59
1.36
3.6
03-11-08
100
33.06
3,759.00
3.0
24.5
136.00
McCormick & Co MKC
QQQ
Wide
X
47.00
Low
40.00
47.57
1.12
2.4
12-04-08
70
29.30
3,329.90
2.7
71.1
78.40
7,302.59
5.8
Portfolio Holding
Fair Val Dividend
Uncert Buy Price
Stocks to Consider Buying
C Procter & Gamble PG
Stocks to Hold
F
Cash Holdings
0.1
Dividends Receivable (ABT, BBT, GE, MKC, NST, SYY, USB)
—
382.25
0.3
Builder Portfolio Total
2.9
125,557.39
100.0
7.30
3,701.52
Portfolio Performance Breakdown
Cumulative Total Return Comparison (%)
p Builder Portfolio p S&P 500 Index
Trailing Return (%)
p Morningstar Dividend Leaders Index
25
0
-25
Legend:
Å Shares added
Í Shares sold
C New holding
UR Under Review
2007 2008
2009
Taxing the Builder:
F Foreign stock, income treated as
qualified dividends
All of the stocks currently held in
the Builder Portfolio are eligible for
“qualified” dividend tax rates.
2010
2011
Annualized
Since Inception
0.3
6.9
3.7
S&P 500 Index
1314
0.9
10.8
3.8
M* Dividend Leaders
3168
2.2
18.3
2.2
Top Sectors (%)
2006
This Month 12 Month
Builder Portfolio
50
2005
Index Level
Style Breakdown (%)
s Consumer Defensive
31.7
y Financial Services
19.2
p Industrials
15.4
d Healthcare
10.9
o Energy
7.4
Value Core Grwth
23
46
13
Lrg
4
9
0
Med
0
0
0
Sm
p51 – 100
p26 – 50
p11 – 25
p0 – 10
Footnotes:
Morningstar ratings and fundamentals
data as of 04-13-11. Builder Portfolio
inception: 01-07-05.
Cost basis for individual holdings, as
well as all portfolio returns, include
commissions we have paid.
Buying” are those holdings trading
below their Dividend Buy prices as of
the portfolio valuation date.
Total returns for individual holdings
include dividends and realized capital
gains and losses, if any.
Dividend Buy prices reflect the most
we would typically be willing to pay
for new shares. “Stocks to Consider
Other definitions may be found in the
DividendInvestor’s Owner’s Manual.
6
Builder Portfolio
Continued From Page 4
Graco GGG
Star Rating
QQQ
Wide
Economic Moat
Uncertainty Rating
Medium
Fair Value
41.00
Dividend Buy
30.00
Current Price
43.60
Dividend
0.84
Yield (%)
1.9
Payout (%)
41
5-Yr Growth (%)
9.0
Stewardship
X
The combination of these changes left the Builder with
an atypically large cash position—$7,303, or 5.8%
of the account’s value on April 13. I could see adding
a bit to the existing positions in Abbott or P&G, but
I think it is reasonable to expect that the market will
serve up at least a few new possibilities in the months
ahead. Don’t get me wrong—I’m not attempting to
time the market. But as I price the market day by day,
I’m not enthusiastic about what I see—or rather what
I don’t see: high-quality stocks at attractive prices.
On the other hand, it might not take much of a market
move to push other high-quality, defensive, dividendraising stocks like PepsiCo PEP or Wal-Mart Stores
WMT below their Dividend Buy prices ($64 and
$50, respectively).
I don’t expect to hold this cash all that long, and
when fresh opportunities arise I plan to act quickly—
so keep an eye on your inbox. I’ll also be looking to
at least replace the $214 worth of annualized income
I gave up in making the three trades April 12. Based
on the cash raised by being a net seller ($6,852), this
goal translates to a yield objective of 3.1%, just above
the midpoint of the Builder’s long-term target.
Research Update
Last month, we increased our fair value estimates
for three Builder holdings: $2 a share for U.S. Bancorp,
$7 for McCormick, and $8 for Philip Morris International. A portion of each change reflects the time value
of money: Rolling one year forward in a discounted
cash flow model increases the current value of forecast
financial performance, even if the forecast hasn’t
changed much. The larger hike for McCormick also
reflects a lower cost of capital estimate (which
increases the present value of future cash flows), while
Philip Morris benefited from the falling U.S. dollar
relative to other currencies (its profits are sourced
entirely abroad). These changes haven’t altered my
view of these fine companies, but I did boost my longterm dividend growth outlook for Philip Morris by 1
percentage point to 8% a year. œ
© 2011 Morningstar, Inc. All rights reserved. Any opinions, recommendations, or information contained herein: (i) are for educational purposes only; (ii) are not guaranteed to
be accurate, complete, or timely; (iii) have not been tailored to suit any particular person’s
portfolio or holdings; and (iv) should not be construed as investment advice of any kind.
Neither Morningstar nor any of its agents shall have any liability with respect to such
opinions, recommendations, or information. Morningstar has not given its consent to be
deemed an “expert” under the federal Securities Act of 1933. Past performance is no
guarantee of future results. Before making any investment, consult with your financial
advisor. Morningstar employees may have holdings in the stocks recommended.
Builder Portfolio Payment Schedule
Expected Payment
Payment
Cycle
Procter & Gamble PG
2, 5, 8, 11 04-27-11
05-16-11
0.525
EPS to start growing again after recent divestitures, solid L-T prospects intact
11.8
Paychex PAYX
2, 5, 8, 11 04-28-11
05-16-11
0.31
Leverage to employment & interest rates means 2x benefit from econ. recovery
19.5
8.0
Wells Fargo WFC
3, 6, 9, 12 early May
early June
0.12
Initial div boost a bit disappointing, but earning power means far more to come
Cut
15.0
Bemis BMS
3, 6, 9, 12 mid May
early June
0.24
Profits accelerating after large acquisition, but Feb. 4 div hike was disappointing
5.0
7.5
United Parcel Service UPS
3, 6, 9, 12 mid May
early June
0.52
Div up 10.6% as mgmt sees return to record profits, bodes well for next few yrs
7.3
8.0
Spectra Energy SE
3, 6, 9, 12 mid May
mid June
0.26
Pleased that div growth resumed in Q1/11, wide moat to drive good L-T returns
—
6.5
Johnson & Johnson JNJ
3, 6, 9, 12 late May
mid June
0.57 1 Recalls take heavy toll on reputation, stock is cheap but J&J has lost my respect
10.6
8.0
Waste Management WM
3, 6, 9, 12 late May
mid June
0.34
Strong cash generation, discipline w/pricing and capital remain key attractions
9.5
7.0
General Electric GE
1, 4, 7, 10 mid June
late July
0.14
Lots of div recovery potential still to come. Could GE surprise again at mid-year?
Cut
8.0
Philip Morris Int’l PM
1, 4, 7, 10 late June
early July
0.64
Could see another double-digit hike in Sept. if mgmt’s 2011 EPS outlook reached
—
8.0
US Bancorp USB
1, 4, 7, 10 late June
mid July
0.125
Unlikely to restore pre-crash payout ratio, but lots of recovery still left in the tank
Cut
15.0
Sysco SYY
1, 4, 7, 10 late June
late July
0.26
Food inflation hurts short-term results, but squeezes Sysco's rivals much harder
11.3
7.5
McCormick & Co MKC
1, 4, 7, 10 early July
late July
0.28
Dominates spices/seasonings industry, moat and resilient growth justifies yield
10.2
9.0
BB&T BBT
early Aug
0.16
Despite tiny (6.7%) hike relative to peers, surprised by getting any increase at all
Cut
15.0
Abbott Laboratories ABT
2, 5, 8, 11 mid July
mid Aug
0.48
Still top Builder pick: Investors excessively worried about top product (Humira)
9.7
9.0
Clorox CLX
2, 5, 8, 11 late July
mid Aug
0.58 ¹ Looking for modest div hike in May amid divestitures/buybacks, L-T outlook good
12.7
8.0
Diageo DEO
4, 10
late Oct
1.62 ² Volumes sluggish, but div growth is improving, and L-T boosted by strong brands
5.6
7.0
Ex Date
early Sept
Pay Date
Anticipated
Amount ($)
Dividend Growth
Company Name
Our most recent thoughts
Data through April 13, 2011. 1Denotes an increase we expect, but which has not yet been announced. 2Dividend to be paid in foreign currency; subject to exchange fluctuations.
Past 5 Yrs 5-Yr Forecast
8.0
McCormick & Company MKC
Builder Focus | Josh Peters, CFA, and Erin Lash, CFA
Josh’s View
Everything here tastes grrreat (wait, that’s a different
food company) except the current yield, which at 2.4%
is lower than I’d prefer. However, I remain impressed
by the quality of the firm’s competitive standing,
and its long-term growth helps justify the low yield.
McCormick & Co. MKC
Star Rating
Economic Moat
Uncertainty Rating
QQQ
Wide
Low
Fair Value
47.00
Dividend Buy
40.00
Current Price
47.57
Dividend
1.12
Yield (%)
2.4
Payout (%)
5-Yr Growth (%)
Stewardship
39
10.2
X
Morningstar’s Take
McCormick’s unparalleled scale and pricing power
have earned the firm a wide economic moat. With
leading brands such as McCormick, Lawry’s, and Old
Bay, the firm controls at least half of the market for
spices and seasonings in North America and is more
than twice the size of its next-largest branded
competitor. Although consumers at the grocery store
have been more price sensitive as of late, McCormick’s market share has been steady. McCormick’s
dominance in its category is marked by a unique
feature: its private-label presence. Because the firm
is the largest producer of private-label spices and
seasonings in North America, the pricing threats
many consumer packaged goods companies face are
limited for McCormick, ensuring that no other
company gains enough scale to significantly affect the
pricing of the firm’s branded offerings. This rare
position is very profitable, as McCormick consistently
generates handsome returns on invested capital.
McCormick & Company: Stock Price and Dividend Rate
p Stock Price ($)
p Dividend Rate ($)
44
1.04
33
0.78
22
0.52
11
0.26
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Data through April 13, 2011.
May 2011
7
We continue to believe that lackluster wage growth
and persistently high unemployment levels will keep
a lid on consumer spending, but we expect McCormick’s sales will be propped up by new product introductions and recent acquisitions. In our opinion, cost
savings from the firm’s efficiency initiatives, as well
as the inclusion of the higher-margin Lawry’s business,
will lead to further margin expansion, even as the
firm continues investing in research, product development, and marketing support for core brands.
The Dividend: Is It Safe?
We give McCormick a credit rating of A+, which
reflects the company’s stable revenue, strong competitive position, and modest debt levels. Although
McCormick periodically hikes its borrowings to fund
acquisitions (such as the Lawry’s purchase in 2007),
strong free cash flows and ongoing growth tend
to reduce its leverage metrics quickly. The firm’s dividend payout ratio target of 35%–45% is somewhat
low by peer standards, but nevertheless provides very
good security for the current dividend.
The Dividend: Will It Grow?
Last November’s dividend increase of 7.7% was the
25 th straight year of higher pay for shareholders,
and the dividend rate has grown an average of 10.8%
annually over the past decade. With the current
dividend landing squarely in the middle of firm’s payout
ratio target, we expect future dividend increases to
track earnings growth; McCormick’s business model
calls for advances of 9%–11% per year. This is based
on 4%–6% revenue gains, slight rises in profit margins,
and a 2% boost from share repurchases. While we
find the revenue targets (which include the probable
benefit of bolt-on acquisitions) reasonable, we’re
a bit more cautious on the other factors; our long-run
dividend growth rate forecast is 9%. That said, similar
performance targets laid out in 2007 have mostly
been met or exceeded.
The Dividend: What’s the Return?
We think McCormick shares are fairly valued today,
but our Dividend Buy price of $40 (which represents
a 15% discount to our fair value estimate) would
generate a current yield of 2.8% and a long-term total
return profile around 12%. œ
8
The Dividend Harvest Portfolio
Morningstar Stock Portfolios | Josh Peters, CFA
This has been one of the busiest stretches for the
Harvest in years—but unlike the busyness of 2008 and
2009, when rapidly deteriorating financial conditions
(combined with some earlier mistakes on my part)
forced me to act in defense of the Harvest’s income
and capital, recent activity has been on offense. So
far this year, changes to the portfolio have added
$265 to the Harvest’s annualized income stream while
enhancing our prospects for income growth.
What is the goal of the
Harvest Portfolio?
To earn annual returns of
9%–11% over any
three- to five-year rolling
time horizon.
For our portfolio as a whole,
this goal is composed of:
5%–7% 3%–5% current yield
annual income
growth
Income Update
Dividends Received
Interest Income
Total Income
422.74
0.10
422.84
The Harvest entered its most recent reporting month
(March 11 to April 13) with a cash balance of $9,291,
most of which came from selling First Potomac
Realty Trust FPO on March 9. These funds were put
to work with a trio of purchases on March 16:
Performance Update
Yield on Original Cost
Yield on Current Value
7.3
5.5
Income Yield, Year Ago
Income Growth (TTM)
5.9
4.0
Price/Fair Value–Portfolio
Price/Fair Value–Market
1.01
1.02
Reporting Period: March 11 to April
13, 2011. Yield and Price/Fair Value
data exclude cash balances.
Income growth (TTM) measures the
impact of dividend increases net of
dividend cuts, excluding the effect of
portfolio transactions.
Invest in the Dividend
Portfolios’ Approach—The
Hassle-Free Way
Did you know that Morningstar
Investment Services now offers a
customizable portfolio patterned
after the Dividend Builder and
Dividend Harvest portfolios? To
learn more, call 1-866-765-0663.
Morningstar Investment Services,
Inc. is a registered investment advisor
and wholly-owned subsidiary of
Morningstar, Inc.
TBought 110 shares of Abbott Laboratories
at $46.88. With Abbott priced so attractively as to
provide a current yield of 4.1% —well above the 2.8%
the shares would pay at our fair value of $68 —I had
no qualms about pulling the Builder’s best idea into
service for the Harvest’s goals for income and growth.
TBought 100 units of Energy Transfer Equity
at $39.73. As the general partner of Energy Transfer
Partners, ETE’s yield is lower than ETP ’s, but its
distribution growth—thanks to incentive distribution
rights—stands to be substantially higher. Atop the
5.4% initial yield garnered by this purchase, we think
the per-unit distribution has the potential to double
in the next five years (annualized growth of about 15%).
TBought 165 shares of AT&T at $27.51. After
months of sitting on the fence while the stock fluttered
over and under my $28 Dividend Buy price, I finally
pulled the trigger. I believe dividend growth is hardwired into the way AT&T operates, and with a 6.3%
yield at my purchase price, even a mid-single-digit rate
of dividend growth (my estimate is 4%–5%) should
make Ma Bell a thoroughly respectable holding.
In last month’s issue, I advanced each of these securities as possible uses of the Harvest’s cash; in the
end I decided all three deserved a slot. However,
getting meaningful sizes for each of these new stakes
obliged me to seek additional funds, which came by
selling 115 shares of AGL Resources AGL at $38.75.
While AGL generated a 35.4% total return for the
Harvest over two and a half years, I was disappointed
by weak dividend growth and the pending acquisition
(at an enormous premium) of Nicor GAS. I might have
continued holding in the absence of a compelling
alternative, but with three, I decided to cut AGL loose.
Within days of these trades, the fickle lightning known
as M&A struck two of the three buys. ETE announced
that its two subsidiaries (Regency Energy Partners
RGNC as well as ETP) were joining in a $1.9 billion
acquisition of privately held LDH Energy, a firm specializing in handling natural gas liquids. While financial
data around this transaction were scarce, we suspect
the subsidiaries paid a rich price, and we trimmed
our fair value estimate for ETP by $2 and reduced its
five-year distribution growth outlook by 1 percentage
point to 6% (which is still pretty good). However,
distributions received by ETE from ETP and Regency
will grow whenever these subsidiaries’ per-unit distribution rates go up, or if they issue additional units—
which both have done to help finance the LDH deal.
This nudged our fair value for ETE up by $1, and while
I think ETP is likely to resume per-unit distribution
growth in May, a healthy raise from ETE is an even
better bet.
AT&T made headlines around the world with its
$39 billion plan to acquire T-Mobile from Deutsche
Telekom DTEGY. If AT&T can get this deal done
without too many regulatory concessions, it could be
a home run. The biggest factor in my decision to buy
AT&T was that the competitive landscape would help
AT&T control its future amid technological changes,
and adding T-Mobile’s market share to AT&T’s own
would only add to its competitive strength. Normally I
hate mergers, which are often squarely at odds with
the needs of dividend investors. But AT&T’s dividend
prospects should not be hurt much in the short run
(think 2%–3% dividend hikes for the next year or two
Continued on Page 10
9
May 2011
Harvest Portfolio Performance and Transaction Summary
Morningstar Ratings & Fundamentals
Star
Rating
Portfolio Holding
Portfolio Data
Economic
Moat
Steward
Grade
Fair
Value
Fair Val Dividend
Uncert Buy Price
Current
Price
Div
Rate
Yield
(%)
First
Purchase
# of
Shares
Cost Per
Share
Current
Value
% of
Acct
Total
Rtn (%)
Annual
Income
Narrow
X
40.00
Low
C
68.00
Low
37.00
34.92
1.84
5.3
04-12-11
200
34.66
6,984.00
5.5
0.7
368.00
58.00
50.45
1.92
3.8
03-16-11
110
46.88
5,549.50
4.4
8.6
211.20
Narrow
X
29.00
Low
27.00
25.74
1.28
5.0
01-14-09
150
19.32
3,861.00
3.0
47.5
192.00
Stocks to Consider Buying
C American Electric Pwr AEP QQQQ
C Abbott Laboratories ABT
Westar Energy WR
QQQQQ Wide
QQQQ
Stocks to Hold
P
Magellan Midstream MMP QQ
Wide
X
49.00
Med
44.00
59.76
3.03
5.1
12-05-08
355
34.53
21,214.80
16.6
87.3
1,075.65
R
Realty Income O
QQQ
Narrow
Z
34.00
Med
29.00
34.54
1.73
5.0
12-29-06
425
26.64
14,679.50
11.5
48.0
737.27
Altria Group MO
QQQ
Wide
C
24.00
Med
22.00
26.68
1.52
5.7
09-11-09
435
19.01
11,605.80
9.1
50.5
661.20
P
Kinder Morgan Energy KMP QQQ
Wide
X
66.00
Med
61.00
74.31
4.52
6.1
12-29-06
140
47.81
10,403.40
8.2
73.6
632.80
R
Health Care REIT HCN
QQQ
Narrow
C
59.00
Med
50.00
51.73
2.86
5.5
02-13-09
140
37.83
7,242.20
5.7
46.2
400.40
P
AmeriGas Partners APU
QQQ
Narrow
C
44.00
Med
40.00
46.05
2.82
6.1
12-29-06
150
32.55
6,907.50
5.4
52.9
423.00
F
National Grid PLC ADR NGG QQQ
Narrow
—
51.00
Med
44.00
48.77
2.58
5.3
07-09-09
135
42.03
6,583.95
5.2
29.2
347.77
Genuine Parts GPC
Narrow
—
52.00
Med
41.00
53.65
1.80
3.4
10-03-08
100
37.55
5,365.00
4.2
53.7
180.00
Energy Transfer Prtnrs ETP QQQ
Narrow
C
58.00
Med
52.00
52.64
3.58
6.8
08-06-08
100
40.67
5,264.00
4.1
51.4
357.50
QQQ
Narrow
C
32.00
Med
28.00
30.18
1.72
5.7
03-16-11
165
27.51
4,979.70
3.9
11.3
283.80
P
Energy Transfer Equity ETE QQQ
Narrow
C
53.00
Med
43.00
45.05
2.16
4.8
03-16-11
100
39.73
4,505.00
3.5
13.4
216.00
P
Nustar Energy LP NS
Narrow
C
65.00
Med
60.00
66.78
4.30
6.4
03-11-08
65
52.03
4,340.70
3.4
52.6
279.50
I
Regions Fin. Trust III RFPRZ —
Narrow
X
25.00
—
22.20
25.65
2.22
8.7
07-14-09
100
21.19
2,565.00
2.0
39.4
221.88
R
Biomed Realty Pr. BMRPRA —
Narrow
X
25.00
—
18.40
25.10
1.84
7.3
07-14-09
100
17.25
2,510.00
2.0
64.2
184.38
I
ASBC Capital I ABWPRA
—
Narrow
X
25.00
—
19.10
24.97
1.91
7.6
07-10-09
100
19.30
2,497.00
2.0
46.7
190.63
75.53
0.1
P
C AT&T T
C
QQQ
QQQ
Cash Holdings
0.1
Dividends Receivable (ABT, BMRPRA, NST, O, T)
—
295.03
0.2
Harvest Portfolio Total
5.5
127,428.61
100.0
0.08
6,963.06
Portfolio Performance Breakdown
Cumulative Total Return Comparison (%)
pHarvest Portfolio p S&P 500 Index
Trailing Return (%)
p Morningstar Dividend Leaders Index
Harvest Portfolio
25
0
-50
Legend:
Shares added
Shares sold
New holding
C
UR Under Review
Å
Í
2008
2009
2010
2011
Taxing the Harvest
P Master limited partnerships. Income is taxed at ordinary rates, though a
portion of cash distributions may not be taxable until units are sold. Not
suitable for tax-deferred accounts including IRAs, Roth IRAs, and 401(k) plans.
I
Interest paid on trust preferred stocks; taxed as ordinary income.
R
Real estate investment trusts; mostly taxed at ordinary rates.
F
Foreign stock, income treated asqualified dividends
All other holdings are eligible for “qualified” dividend tax rates.
12 Month
Annualized
Since Inception
3.0
20.9
5.8
S&P 500 Index
1314
0.9
10.8
0.4
M* Dividend Leaders
3168
2.2
18.3
-3.3
Top Sectors (%)
-25
2007 Index Level This Month
Style Breakdown (%)
o Energy
35.9
f Utilities
19.1
u Real Estate
17.2
s Consumer Defensive
9.1
y Financial Services
5.9
Footnotes:
Morningstar ratings and fundamentals
data as of 04-13-11. Harvest Portfolio
inception: 12-29-06.
All other holdings are eligible
for “qualified” dividend tax rates.
Value Core Grwth
27
4
5
Lrg
42
16
0
Med
0
0
0
Sm
p51 – 100
p26 – 50
p11 – 25
p0 – 10
For definitions of total return, cost
basis, Dividend Buy prices and other
statistics, please refer to the footnotes on Page 5. Other definitions may
be found in the DividendInvestor’s
Owner’s Manual.
10
Harvest Portfolio
Continued From Page 8
Questions? Comments?
You can contact me via e-mail
at josh_peters@morningstar.com.
I can’t promise a reply to every
message, but I do read them all,
instead of 4%–5%) and may well benefit in the long
run. Overall, this deal seems worth pursuing despite
the regulatory gantlet involved. If it doesn’t work,
then back to business as usual.
seems unlikely to go beyond that. Overall, I was very
happy to increase the current income for this chunk
of Harvest capital by nearly 40%, particularly without
having to lose much (if any) growth potential.
On April 12, I made two additional trades, selling 150
shares of NSTAR NST at $44.48 to fund the purchase
of 200 shares of American Electric Power at $34.66.
I discussed my decision to sell NSTAR on Page 4, but I
found the logic even more compelling for the Harvest.
At my sale price, NSTAR’s yield was just 3.8%, while
AEP garnered an initial yield of 5.3%. In terms of P/E
ratios, NSTAR was the most expensive fully regulated
electric utility covered by Morningstar at 17 times its
2011 earnings outlook, while AEP was the cheapest at
just 11 times. I believe NSTAR is a better business in
terms of fundamental quality, but it and AEP are not
all that far apart, with 11%–12% returns on equity and
5%–6% long-run dividend growth potential for AEP,
versus mid-13% ROEs and 6% growth potential for
NSTAR. I also suspect that NSTAR shareholders won’t
see any dividend increase this year; merger partner
Northeast Utilities NU has committed to keep the
dividend checks of NSTAR’s former holders whole, but
In Other News
We had only one dividend increase last month, as
Realty Income issued its typical quarterly hike of 0.2%
to its monthly dividend rate. However, based on the
company’s recent acquisition activity, I’m looking for
the pace of dividend growth to improve later this year.
My best estimate today calls for a year-end dividend
rate of $1.80 a share, a 4% increase for the year.
and when a topic shows up
repeatedly I will address it for all
subscribers in DividendInvestor
or our weekly e-mail update.
Josh Peters, CFA, owns these
stocks in his personal portfolio:
BMS, CLX, GE, GPC, KMR, MMP,
O, SYY.
We also had two holdings experience increased fair
value estimates: Westar Energy (up $1) and Health
Care REIT (up $5). The nudge higher for Westar was
related to the time-value-of-money effect described
on Page 6, while Health Care REIT’s boost came from
the several large and attractive acquisitions made
so far this year. While Health Care REIT has already
announced that a 3.6% dividend increase will take
effect in the second quarter, I won’t be surprised if
another small boost follows later this year. œ
Harvest Portfolio Payment Schedule
Company Name
Payment
Cycle
Realty Income O
Monthly
Kinder Morgan KMP
AmeriGas Partners APU
Energy Transfer Equity ETE
Expected Payment
Dividend Growth
Pay Date
Anticipated
Amount ($)
04-28-11
05-16-11
0.144563
5.0
4.5
2, 5, 8, 11 late April
mid May
1.1375 1 2011 budget projects $4.60/unit in distributions, but growth is clearly slowing
7.1
5.0
2, 5, 8, 11 early May
mid May
0.74 1 Like propane's economic qualities and this #1 player's conservative approach
4.4
5.0
Ex Date
Our most recent thoughts
Surge in acquisitions to reduce payout ratio, revive div growth as early as 2H/11
Past 5 Yrs 5-Yr Forecast
2, 5, 8, 11 early May
mid May
0.55
General ptr of ETP, RGNC. Grows with their per-unit hikes and new unit issues
—
15.0
Energy Transfer Partners ETP 2, 5, 8, 11 early May
mid May
0.90 1 Two huge projects now complete, expect distribution growth to resume Q2/11
13.7
6.0
Magellan Midstream MMP
2, 5, 8, 11 early May
mid May
0.77 1 Though pricey, ability to recover inflation and expand asset base keeps top slot
8.2
7.0
NuStar Energy NS
2, 5, 8, 11 early May
mid May
1.075
Payout coverage a bit thin, growth has been disappointing, could see replacing
5.2
5.0
2, 5, 8, 11 early May
late May
0.715
Another round of big acquisitions boosts per-share cash flow, dividend prospects
2.2
4.5
American Electric Power AEP 3, 6, 9, 12 early May
mid June
0.46
Healthy ROEs, growth prospects, lowest valuation among regulated electrics
3.8
5.5
Genuine Parts GPC
1, 4, 7, 10 early June
early July
0.45
Earnings back to record levels and dividend growth appears to be accelerating
5.6
6.5
Westar Energy WR
1, 4, 7, 10 early June
early July
0.32
Pace of dividend growth should improve as major projects finished 2-3 yrs out
6.2
4.5
National Grid NGG
1, 8
mid August
1.91 ¹ ² Terms of major UK rate case becoming clearer, U.S. operations a modest drag
—
5.5
ASBC Capital I ABWPRA
3, 6, 9, 12 06-10-11
06-15-11
0.476563
Buildup of excess capital, regulatory changes suggest pfd could be called at par
—
—
Regions Financing III RFPRZ
3, 6, 9, 12 06-10-11
06-15-11
0.554688
Still struggling with high credit losses, merger or capital raise becoming likely
—
—
Altria Group MO
New warning labels unlikely to upend consumption trends, pricing power intact
—
5.5
Long-term leases and improved liquidity support good pfd dividend coverage
—
—
4.5
early June
1
,
1, 4, 7, 10 mid June
early July
0.38
Biomed Realty Pfd. A BMRPRA 1, 4, 7, 10 06-28-11
07-15-11
0.46094
AT&T T
early Aug
0.43
On a respectable dividend trajectory before T-Mobile deal, which adds to outlook
5.4
Abbott Laboratories ABT
2, 5, 8, 11 mid July
mid Aug
0.48
Stock yields only 2.8% at fair value, but bargain valuation serves Harvest well
9.7
Data through April 13, 2011. 1Denotes an increase we expect, but which has not yet been announced. 2Dividend to be paid in foreign currency; subject to exchange fluctuations.
Harvest Focus | Josh Peters, CFA, and Jason Ren
Star Rating
Economic Moat
QQQ
Narrow
Uncertainty Rating
Medium
Fair Value
59.00
Dividend Buy
50.00
Current Price
51.73
Dividend
2.86
Yield (%)
5.5
Payout (%)
85
5-Yr Growth (%)
2.2
Stewardship
C
Josh’s View
I remain very cautious on real estate investment
trusts overall; many are now trading at what I’d call
ridiculously high prices. Health Care REIT, though,
is not among them—and I’m pleased with the impact
that recent transactions are likely to have on our
dividend growth over the next few years.
We think health-care real estate has its fair share of
tailwinds, and Health Care REIT has a history of
earning attractive returns. Demand demographics are
favorable, as baby boomers approach retirement
age and life expectancy rises. Government also limits
competitive supply in skilled nursing, benefiting key
tenants. These forces help explain why Health Care
REIT’s appetite for growth remains strong. Once
planned-for 2011 acquisitions and developments are
completed, the company will own about $13 billion
in assets comprising 880 properties. Triple-net leases
will constitute about four fifths of the company’s
rents and should continue to afford Health Care REIT a
baseline level of stability, since the structure entails
that property-level expenses are passed on to tenants.
Most of its triple-net leases also contain fixed or CPIbased rent escalators, so same-property rents should
see small, steady gains.
Health Care REIT: Stock Price and Dividend Rate
p Stock Price ($)
p Dividend Rate ($)
52
2.52
39
1.89
26
1.26
13
0.63
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
May 2011
11
Health Care REIT has a clean bill of financial health.
The company has long preferred to fund more than
half of its real estate acquisitions with equity, and few
near-term debt maturities are on the docket. A conservative approach toward leverage, combined with
the steady revenue of its portfolio of largely triple-net
leases (tenants are responsible for taxes, insurance
and maintenance), allowed Health Care REIT to be one
of a handful of REITs to avoid cutting its dividend
despite a fairly high payout ratio (89% of funds from
operations in 2010). The firm’s finances are clearly
geared toward both maximizing and preserving shareholder dividends, and the payout ratio for 2011 is
likely to come down to around 85%, thanks to recent
acquisitions.
Historically, Health Care REIT’s dividend growth has
been modest, running at or slightly below the rate
of inflation with a trailing 10 -year average growth rate
of 2.0%. However, we expect Health Care REIT’s
dividend growth to accelerate over the next few years,
primarily as the result of changes in the firm’s mix
of property types, more acquisitions, and a larger
book of development projects. With inflation-driven
rent bumps providing a baseline for future growth,
we expect funds from operations per share to rise at
a 6%–7% clip over the next five years. However, we
also think the firm will trim its payout ratio modestly
in order to fund more of its growth with internally
generated resources, which results in an outlook of
4%–5% average annual dividend increases.
While we like the stability and growth prospects for
Health Care REIT’s dividend, a fair-size chunk of
our $59 fair value estimate is based on our appraisal
of development and acquisition activity. Since these
projects are harder to appraise than a fully stabilized
portfolio, our Dividend Buy price of $50 suggests a
15% discount to our fair value before buying. At $50,
the stock would offer a current yield of 5.7%—well
above the 3.6% median for our REIT coverage
universe—while its 4%–5% yearly dividend growth
potential points to average total returns running
about 10%–11% per year. œ
12
Income Bellwethers
Dividend Watch List | Josh Peters, CFA
About Income Bellweathers
This is our coverage list of
100 large, widely-held higheryielding stocks on U.S.
exchanges. Some of these
stocks—those we consider
“best in breed”—are potential
candidates for purchase if
they trade below our Dividend
Buy prices. These stocks are
flagged as follows:
o Builder candidate
c Harvest candidate
Other names are included to
provide Morningstar ratings
information and comments
about the suitability of the
stock for an income strategy.
Payouts in Peril
AllianceBernstein AB
BGC Partners BGCP
Blackstone Group BX
H & R Block HRB
Hawaiian Electric HE
New York Community NYB
Park National PRK
Pinnacle West Capital PNW
Pitney Bowes PBI
Most of the trades I made in the Builder and Harvest
portfolios this month involved our Income Bellwethers
list. All four new purchases (American Electric
Power AEP, AT&T T, Energy Transfer Equity ETE,
Procter & Gamble PG) are former Bellwethers,
while two of my sales—AGL Resources and NSTAR —
are joining the Bellwethers list in moves that might
fairly be called demotions. (The other position I let go,
Graco GGG, doesn’t furnish a dividend yield big
enough to deserve a spot on this roundup of large,
well-known, high-yielding dividend payers.)
These weren’t the only changes. The old Qwest
Communications is no more, its merger into CenturyLink having been completed April 1. Though I
have finally embraced the telecom industry with my
recent purchase of AT&T for the Harvest, I’m still
not ready to believe that CenturyLink (or Windstream
or Frontier) will be able to stem the secular decline
in fixed-line services and support their current dividends over the long run, much less increase them.
CenturyLink may offer a higher yield than AT&T (7.2%
versus 5.7%), but I think AT&T makes a far better
choice in terms of dividend safety and long-run total
return, thanks to its wireless operations.
Plum Creek Timber PCL
R.R. Donnelley RRD
All Energy Production MLPs
All Ocean Transport
All Rural Telecom
All Specialty Financials and
Mortgage REITs
Stocks whose dividends may be at
risk of being reduced. We would avoid
these stocks for income purposes.
For background, the purpose of this list is to provide
Morningstar ratings and income-oriented perspectives
on large, widely owned, higher-yielding stocks. It
isn’t a list of potential buys; the only names I might be
ready to add on the basis of price alone are flagged
with “B” and “H” icons. Selection criteria include size
(measured by total dollars paid out as dividends),
yield, dividend policy, and history. With the month’s
other changes calling for three new Bellwethers, a
few short introductions seem in order,
Raytheon, which joins Lockheed Martin as a second
representative of the defense industry, stood as
one of the largest total dividends not already on the
list (paying more than $600 million a year). Its current
yield of 3.5% is no slouch, either, thanks in part to
a 14.7% dividend hike announced March 23. Like all
defense contractors, the company could be pressured
by federal government spending cuts—but it isn’t as
if the world has become any less dangerous of a place.
Hefty free cash flows and a solid balance sheet could
make Raytheon a possible Builder holding at some
point, but given the uncertainties associated with the
defense industry, I probably would hold out for less
than the stock’s current Dividend Buy price of $47.
In addition to being one of the most valuable REITs that
lacked a Bellwether listing, Digital Realty Trust is
among the very small number of real estate investment
trusts that did not cut its dividend during the crash—
in fact, it continued to grow, and with a recent 28%
hike the firm’s payout has more than doubled from
precrisis levels. The company specializes in providing
specialized space for data centers and network
hubs—a type of “tenant” with fairly heavy switching
costs. The stock looks pretty expensive relative to
our fair value estimate, but this is another one I might
consider buying at some point.
BlackRock BLK, the world’s largest asset manager
with some $3.5 trillion of wealth in its care, has
raised its dividend swiftly since 2003 and now doles
out more than $1 billion a year. But while its yield of
2.8% strikes me as being reasonably attractive,
revenue for an asset manager is tied to the ups and
downs of the stock market—and since many costs
are fixed, profits show even greater volatility. I’d probably hold out for a real bargain before mulling a buy.
In Other News
As bank dividend news broke March 18, J.P. Morgan
Chase JPM was the biggest raiser of all, quintupling
its dividend to $1.00 a share annually. But when
the company reported earnings April 13, CEO Jamie
Dimon spoiled the story by dismissing the idea
of additional increases this year. I have tremendous
respect for Dimon as a manager, but in the past he
has said he would just as soon not pay a dividend at
all. That adds to the list of reasons (including the
volatility of investment banking) that I would just as
soon not own J.P. Morgan as a dividend investor. œ
May 2011
13
Income Bellwethers
R
P
P
R
Company Name
Star
Rating
Fair
Value
Dividend
Buy
Current
Price
Dividend
Yield
(%)
5-Yr Div
Growth (%)
3M MMM
QQQ
100.00
83.00
92.86
2.20
2.4
4.6
Would reconsider this former Builder holding with a better dividend policy,
but mgmt targets div increases at half the rate of EPS growth
AGL Resources AGL
QQQ
36.00
34.00
39.01
1.80
4.6
6.3
Sold from Harvest in March—partly as I had better prospects elsewhere,
but I didn’t like AGL’s poor div hikes or the Nicor GAS acquisition either
Ameren AEE
QQQ
29.00
No
28.11
1.54
5.5
Cut
Hit with very tough regulation (MO, IL) and an uncertain future for its
merchant plants, its dividend (cut in 2009) shows no signs of rebound.
American Water Wks AWK
QQQ
25.00
20.00
28.17
0.88
3.1
—
Water is a popular infrastructure theme, but low allowed returns on equity
and huge capital intensity hinder investors’ long-run returns.
Automatic Data Proc. ADP
QQQ
52.00
40.00
52.06
1.44
2.8
17.4
Wide moat traced to scale and switching costs. Recovery in employment
should boost future earnings, although I prefer higher yield of PAYX.
AvalonBay AVB
QQ
94.00
75.00
119.00
3.57
3.0
4.7
Concentrated in densely-populated urban areas, properties target highincome renters. Great strategy, but dividend growth is disappointing.
Avon Products AVP
QQQQ
36.00
27.00
28.00
0.92
3.3
5.9
A play on emerging-market consumers with 80% of sales earned abroad,
but macro headwinds persist and management turmoil is unsettling,
Blackrock BLK
QQQQ
235.00
174.00
194.68
5.50
2.8
27.2
World's largest asset manager with a history of hefty dividend increases,
though exposure to asset values and fixed-cost leverage a concern.
Boardwalk Pipeline Ptrs BWP
QQ
28.00
27.00
32.35
2.08
6.4
—
Breadth of pipeline network is a plus, steady fee-based revenue and heavy
investment keeps distribution rising, and coverage is improving.
Bristol-Myers Squibb BMY
QQQ
28.00
24.00
27.33
1.32
4.8
2.9
Patent cliff looms in 2011–13. Threat to profits should be manageable,
underscored by recent 3% div hike, but L-T outlook remains tough.
Buckeye Partners BPL
QQQ
62.00
56.00
61.41
3.95
6.4
6.3
Campbell Soup CPB
QQQ
36.00
32.00
33.69
1.16
3.4
9.6
Modest div hike (5.4%) in late ‘10 reflects consumer headwinds and rising
input costs, but strong competitive position makes it a decent hold.
CenturyLink CTL
QQQ
38.00
33.00
40.22
2.90
7.2
—
Closed on acquisition of Qwest in April. Likely to maintain large and gently
rising dividend in near term, but long-run sustainability still murky.
Chevron CVX
QQQ
103.00
78.00
103.81
2.88
2.8
10.2
Coca-Cola KO
QQQ
64.00
55.00
67.28
1.88
2.8
9.5
Colgate-Palmolive CL
QQQQ
92.00
77.00
81.61
2.32
2.8
12.8
Dominates the oral care business with sky-high returns on capital.
Industry competition is on the upswing, but long-term still looks attractive.
ConAgra Foods CAG
QQQ
22.00
18.00
23.60
0.92
3.9
Cut
Continues to restructure brand portfolio, operations in face of competition
and rising costs, though recent 15% dividend hike is a positive sign.
ConocoPhillips COP
QQQ
73.00
58.00
77.66
2.64
3.4
12.8
Swaps growth-by-acquisition strategy (it didn't work) for asset sales and
ROIC orientation. Dividend up big, but would buy CVX or RDS.B first.
Consolidated Edison ED
QQQ
48.00
41.00
50.10
2.40
4.8
0.9
With tight regulation hindering ROEs amid heavy capital spending in NYC,
dividend growth continues long pattern of lagging inflation.
Digital Realty Trust DLR
QQ
36.00
31.00
56.78
2.72
4.8
15.2
Dominion Resources D
QQQ
41.00
35.00
43.55
1.97
4.5
6.4
Reliance on merchant profits shrinking as regulated utility VEPCO shines,
credit sharp management for shifting focus and shedding E&P assets
DTE Energy Holding DTE
QQQ
45.00
38.00
48.48
2.24
4.6
1.1
Favorable regulatory structure, but unfavorable geographic footprint (MI).
Despite mid-2010 hike of 5.7%, L-T div growth potential is low.
Duke Energy DUK
QQQ
17.00
15.00
18.08
0.98
5.4
—
Used to hold Duke in relatively high regard as a possible Harvest candidate, but can't see much point to its now-pending merger with PGN
E.I. du Pont de Nemours DD
QQ
42.00
No
53.82
1.64
3.0
2.4
Better positioned than Dow Chemical DOW and never cut its dividend, but
we find no economic moat and weak div growth potential at best.
Edison International EIX
QQQ
38.00
30.00
38.17
1.28
3.4
4.4
Attractive utility in California (SCE) with solid growth potential, but
Midwestern merchant operations will likely drag on dividend prospects.
Data through April 13, 2011. UR 5 Under Review
5 Master Limited Partnership
5 REIT
BIB
d
o
Comments
One of my worst sales as payout continues to grow in clockwork fashion.
Buy-in of general partner, recent deals enhance L-T growth outlook.
ExxonMobil has somewhat stronger assets and capabilities, but better
dividend policy (higher payout, faster increases) gives CVX appeal.
Former Builder member still a worthwhile hold, though move to acquire
North American bottling operations will increase capital intensity.
Unique focus on data centers and network hubs makes tenants sticky,
provides solid L-T growth platform. Div rose through crash and beyond.
5 Foreign Stocks Cut 5 Div. reduced in past 5 years VAR 5 Variable dividend BIB 5 “Best in Breed”, see Page 12
14
Income Bellwethers (continued)
Company Name
Star
Rating
Fair
Value
Dividend
Buy
Current
Price
Dividend
Yield
(%)
5-Yr Div
Growth (%)
Eli Lilly LLY
QQQQ
42.00
35.00
35.68
1.96
5.5
5.2
Emerson Electric EMR
QQQ
53.00
40.00
57.24
1.38
2.4
10.1
Enbridge Energy Ptrs EEP
QQ
55.00
52.00
65.10
4.11
6.3
1.8
Appeal of favorably-regulated liquids pipelines offset by recent spills,
increased regulatory scrutiny, less-attractive operations in natural gas.
Entergy ETR
QQQQ
91.00
72.00
65.53
3.32
5.1
8.5
Decent regulated utilities in TX, LA, AR, MS, but merchant nuclear plants
in the Northeast make volatile power prices the main earnings driver.
P
Enterprise Products Ptrs EPD
QQQ
40.00
36.00
42.50
2.36
5.6
6.6
R
Equity Residential EQR
QQ
37.00
No
55.84
1.35
2.4
Cut
Up, down, up, down—dividend policy keeps changing. Apartments the
presumed beneficiary of mortgage crisis, but firm lacks economic moat.
Exelon EXC
QQQQQ
67.00
52.00
39.90
2.10
5.3
5.6
Dividend unlikely to grow given reliance on (low) merchant energy prices
and roll-off of hedge portfolio. Regulated units are mediocre earners.
ExxonMobil XOM
QQQ
91.00
66.00
83.16
1.76
2.1
8.8
Unquestionably the world’s best major oil and gas producer, but I'm put
off by low yield and policy favoring share buybacks over dividends.
FirstEnergy FE
QQQQ
55.00
40.00
37.72
2.20
5.8
5.7
While rival PPL pursues regulated assets, FE doubles down on merchant
power through purchase of Alleghany Energy. Future div policy unclear.
Frontier Communications FTR
QQQ
9.00
No
8.08
0.75
9.3
Cut
Normalized free cash flow to support dividend (cut 25% last year) in near
term, but merger integration issues and secular decline threaten L-T.
General Mills GIS
QQQ
36.00
31.00
36.59
1.12
3.1
9.1
H.J. Heinz HNZ
QQQ
46.00
37.00
49.54
1.80
3.6
8.1
With 60% of sales earned abroad, Heinz has broad exposure to global
growth—but commodity costs and competition often push back.
HCP HCP
QQQ
40.00
30.00
36.77
1.92
5.2
2.1
Story changes with $6bn HCR Manorcare property acquisition, which
diminishes diversity of firm’s cash flows and hikes risk profile. Prefer HCN.
Hershey HSY
QQ
43.00
34.00
56.52
1.38
2.4
6.6
Dividend is growing again following successful restructuring, but lack of
established businesses outside U.S. hinders L-T growth prospects.
Home Depot HD
QQQ
42.00
32.00
37.67
1.00
2.7
18.8
Retailer has held up well amid dismal macro trends, thanks in part to
renewed focus on core operations. Div growth governed by solid policy.
HSBC Holdings ADR HBC
QQQ
66.00
45.00
53.74
1.95
3.6
Cut
Famous for frugality and efficiency, becomes first global bank to raise its
div in early 2011—but keep an eye on Asian real estate bubbles.
Hudson City Bancorp HCBK
QQQ
11.00
9.00
9.70
0.60
6.2
7.8
Will HCBK lose the next war (rising interest rates)? Sound underwriting
saves div during crash, but now regulators zero in on rate sensitivity.
Illinois Tool Works ITW
QQQQ
65.00
48.00
53.31
1.36
2.6
16.3
o
Diversified manufacturer with phenomenal capital allocation skills. Profits
bouncing back from recession, L-T growth prospects remain strong.
Intel INTC
QQQ
23.00
18.00
19.78
0.72
3.7
14.5
o
Cyclical, hugely capital-intensive, but still having decent L-T growth potential. Best dividend policy in tech could make it a Builder candidate.
J.P. Morgan Chase JPM
QQQQ
61.00
38.00
46.25
1.00
2.2
Cut
Dividend quintuples to $1.00/shr annually as regulators relax grip on bank
capital, but CEO Dimon would just as soon pay no dividend at all.
Kellogg K
QQQ
59.00
45.00
54.89
1.62
3.0
8.0
Generally strong competitive position, but NA cereal business has disappointed of late. L-T div growth outlook probably OK, but prefer GIS.
Kimberly-Clark KMB
QQQ
70.00
63.00
65.23
2.80
4.3
8.0
Rising pulp prices a challenge, offset in part by brands and cost cutting.
With payout ratio now over 50%, expect L-T div growth to run 5%–7%.
Kimco Realty KIM
QQ
12.00
No
17.46
0.72
4.1
Cut
Reductions in leverage, recent dividend hikes put better light on retail
property manager/developer, although joint ventures add uncertainty.
Kinder Morgan Inc. KMI
QQQ
28.00
23.00
28.83
1.16
4.0
—
GP grows whether KMP raises its dist. or issues units. Possible Builder
pick, especially if we get clear 3–5 yr outlook for KMP expansion plans.
Kraft Foods KFT
QQQ
34.00
No
32.40
1.16
3.6
5.9
Stream of executive departures following Cadbury acquisition highlight
integration risks, company has too much on its plate to raise dividend.
P
R
F
R
5 REIT
BIB
Comments
One of the worst patent expiration profiles in Big Pharma (most notably
Zyprexa). Little or no hope of dividend growth, a cut can't be ruled out.
Cyclical winds now at firm’s back, and firm has a well-entrenched strategy
of maximizing cash flow and returning much of it to investors.
d
o
Giant of natural gas industry caps a decade of canny capital allocation
with Enterprise GP merger, elimination of costly incentive distributions.
Strength of franchise brands, international distribution network and solid
capital allocation should offset cost headwinds over the long run.
May 2011
15
Company Name
Star
Rating
Fair
Value
Dividend
Buy
Current
Price
Dividend
Yield
(%)
5-Yr Div
Growth (%)
Liberty Property Trust LRY
QQQ
30.00
No
33.13
1.90
5.7
Cut
Lockheed Martin LMT
QQQQ
96.00
74.00
78.31
3.00
3.8
20.3
Dominates next-generation defense capabilities to earn wide moat. Murky
outlook for gov’t spending, but huge returns of cash to investors.
Lorillard LO
QQQ
96.00
65.00
98.59
5.20
5.3
—
Industry pricing power and market-share gains for Newport a great story,
risks of menthol regulation seem to be easing, but still don't like risk.
M & T Bank MTB
QQQ
84.00
66.00
85.94
2.80
3.3
9.9
Preserved dividend during crash, and impressed by purchase of troubled
Wilmington Trust, but regulators may hold div flat for a while longer.
Marsh & McLennan MMC
QQQ
27.00
21.00
29.42
0.84
2.9
Cut
Insurance brokerage recovers from regulatory problems to remain global
leader in risk management—but profit growth remains a challenge.
McDonald's MCD
QQQ
80.00
69.00
76.89
2.44
3.2
27.5
Merck & Co. MRK
QQQQ
46.00
36.00
33.47
1.52
4.5
0.0
Microsoft MSFT
QQQQ
32.00
24.00
25.63
0.64
2.5
10.2
Can’t be the growth darling it once was, yet mgmt still reluctant to
embrace full potential to pay dividends. Shift to cloud computing a threat?
R
Nationwide Health NHP
QQQ
45.00
37.00
42.34
1.92
4.5
4.2
Ventas came calling and NHP answered, merger to create a giant healthcare-focused REIT. NHP shareholders may suffer small drop in dividend.
F
Nestle ADR NSRGY
QQQ
59.00
51.00
58.73
1.68
2.9
14.6
The world’s biggest food and beverage firm by far, it may also be the best.
Large exposure (30% of sales) to growing developing economies.
NextEra Energy NEE
QQQ
54.00
44.00
54.97
2.20
4.0
7.1
Unimpressed by recent div hikes (much less name change) as unregulated
merchant ops drive volatility and Florida regulators turn on FP&L
Norfolk Southern NSC
QQQ
77.00
56.00
67.83
1.60
2.4
23.9
o
Despite regulatory threats, railroad has turned a decades-long corner to
become an attractive business. Recent 11% div hike a positive sign.
Northeast Utilities NU
QQ
28.00
26.00
33.88
1.10
3.2
8.7
o
Set to merge with NSTAR, which should curtail the necessity to issue
additional equity to fund high-return growth projects in transmission.
Novartis ADR NVS
QQQQQ
71.00
62.00
55.27
2.35
4.3
13.9
NSTAR NST
QQ
39.00
36.00
44.14
1.70
3.9
6.6
Nucor NUE
QQQQ
58.00
38.00
44.85
1.45
3.2
27.7
Top U.S. steelmaker succeeds in deeply cyclical industry with superior
cost structure, culture. Long record of regular div growth plus specials.
ONEOK Partners OKS
QQQ
92.00
78.00
83.05
4.56
5.5
6.9
New natural gas liquids pipelines augment long-haul natural gas ops.
Gathering/processing has less attractive economics, but well managed.
PepsiCo PEP
QQQQ
76.00
64.00
66.45
1.92
2.9
13.4
Pfizer PFE
QQQQ
26.00
No
20.46
0.80
3.9
Cut
PG & E PCG
QQQ
47.00
38.00
43.86
1.82
4.1
8.2
o
Favorable regulation and infrastructure spending foster attractive div.
growth potential, though recent pipeline explosion a N-T challenge.
Piedmont Natural Gas PNY
Q
23.00
22.00
29.32
1.16
4.0
4.2
d
Long record of dividend growth bespeaks favorable regulatory environment, geography, prudent capital allocation—but wow, is it expensive!
Pinnacle West Capital PNW
Q
30.00
No
42.08
2.10
5.0
1.8
Recession in AZ actually gave Pinnacle West some breathing room, as
regulators fail to reward incremental investment. Div cut still a L-T risk.
Pitney Bowes PBI
QQQ
24.00
No
24.95
1.48
5.9
3.3
Can’t find much to like, even at this high of yield. With questionable
acquisition and diversification program, dividend may not be stable L-T.
P
Plains All American PAA
QQQ
60.00
55.00
63.83
3.88
6.1
7.8
R
Plum Creek Timber PCL
QQ
25.00
No
42.00
1.68
4.0
2.0
R
F
P
5 REIT
BIB
Comments
Can find no long-term competitive advantages for this industrial/office
landlord, while surplus space in region to pressure occupancy, rents.
o
Shift in focus from growth to profitability a few years back now pays large
dividends. Sorry I missed it, would consider again at/below $69.
Though it picks up a strong pipeline of new products by purchasing
Schering-Plough, patent issues still loom and div looks unlikely to rise.
Switzerland’s answer to Johnson & Johnson JNJ with diverse and wellrun businesses in healthcare. Expect L-T growth at a 5%-6% pace.
o
o
Sold due to high valuation (and attractive price for AEP), but remains an
outstanding utility operator. Would consider NST/NU again in future.
Competitive dominance of snack food business remains intact, while
acquisition of bottlers should make beverage operations more efficient.
Management claims earnings, dividend can still grow despite huge patent
expirations, I say “prove it.” Cannot forget or forgive ‘09 div cut.
d
Focused on delivering crude oil to Midwestern refineries, great track
record of distribution growth. Growing comfortable with mktg/trading risk.
Timber can offer inherently attractive investment qualities, but weak
demand and pricing suggest overvalued stock and risky dividend.
16
Company Name
Star
Rating
Fair
Value
Dividend
Buy
Current
Price
Dividend
Yield
(%)
5-Yr Div
Growth (%)
PPG Industries PPG
QQQ
75.00
No
92.27
2.20
2.4
3.2
Long record of annual div hikes shows this paint manufacturer allocates
capital as best it can, but lack of moat is evident in poor growth rate.
PPL Corporation PPL
QQQ
29.00
25.00
26.79
1.40
5.2
7.8
Second major deal (electric T&D in the UK) shifts mix even further toward
regulated operations, but acquisition premiums ding shareholders.
Progress Energy PGN
QQQ
45.00
44.00
45.61
2.48
5.4
0.9
Obtains a modest premium in merger deal with Duke, though Progress’
own problems (challenging regulation, weak growth) likely to persist.
ProLogis Trust PLD
QQQ
13.00
No
15.60
0.45
2.9
Cut
After three dividend cuts since early 2009, firm now set to merge with
AMB. Don’t believe either firm possesses competitive advantages.
Public Service Enterprise PEG QQQ
36.00
29.00
30.96
1.37
4.4
4.1
Failed attempt to merge with Exelon left PSEG with better mgmt of its
nuclear assets, but (like EXC) unregulated power prices drive profits.
Public Storage PSA
QQ
85.00
No
107.77
3.20
3.0
9.9
Conservative REIT wins my respect with pair of div hikes totaling 45% in
2010, but still a no-moat operator with a strikingly low current yield.
Raytheon RTN
QQQQ
61.00
47.00
48.68
1.72
3.5
11.3
A bit more diverse than LMT with international sales, more granular projects. Defense spending under pressure, but capital allocation is strong.
Reynolds American RAI
QQQ
31.00
26.00
36.07
2.12
5.9
11.9
A pure-play on domestic tobacco like Altria, but competitive standing is
weaker (narrow moat vs. wide) and brands struggle to maintain share.
F
Royal Bank of Canada RY
QQQ
59.00
47.00
62.82
2.07
3.3
11.0
Canada's largest bank by market value, RBC benefits from highly consolidated industry, effective regulation. Div maintained through crash.
F
Royal Dutch Shell B ADR RDS.B QQQ
65.00
56.00
72.76
3.36
4.6
1.3
Sara Lee SLE
QQQ
18.00
No
18.36
0.46
2.5
Cut
Rash of asset sales leaves troubled firm with domestic meats and int’l
beverages, which will now be split into separate firms. No interest here.
Simon Property Group SPG
QQQ
91.00
64.00
105.05
3.20
3.0
Cut
High-quality mall portfolio funded by solid balance sheet, encouraging
dividend raise in late 2010, but appetite for splashy deals is worrisome.
Southern Company SO
QQQ
38.00
36.00
37.58
1.82
4.8
4.1
Southern Copper SCCO
QQ
25.00
No
37.09
2.32
6.3
VAR
Time Warner Cable TWC
QQQ
65.00
50.00
72.37
1.92
2.7
—
F
Unilever PLC ADR UL
QQQ
30.00
24.00
31.33
1.13
3.6
6.5
Still grappling with legacy lacking centralized operations and strategy,
though positions in emerging mkts provide raw material for turnaround.
R
Ventas VTR
QQQ
57.00
46.00
54.39
2.30
4.2
8.3
String of big acquisitions (latest: NHP) shift healthcare real estate portfolio toward steadier, more diversified cash flows—but at a cost.
Verizon Communications VZ
QQQ
34.00
30.00
37.69
1.95
5.2
3.5
Declining fixed-line operations offset by growth at 55%-owned Verizon
Wireless. Prefer AT&T for lower payout ratio, better dividend record.
VF Corporation VFC
QQQ
107.00
79.00
100.03
2.52
2.5
17.2
Unusually attractive dividend policy in a tough industry, where we think VF
has a sustainable competitive edge. Long-shot Builder candidate.
F
Vodafone Group ADR VOD
QQQ
26.00
22.00
28.84
1.28
4.4
18.4
Well diversified around the world, good positions in emerging markets, no
legacy fixed-line operations to contend with, decent div growth.
R
Vornado Realty VNO
QQQ
76.00
53.00
87.83
2.76
3.1
Cut
Properly recognized as very astute investors in real estate, but temporary
(and unnecessary) imposition of stock-based dividend a black mark.
Wal-Mart Stores WMT
QQQQ
60.00
50.00
53.63
1.46
2.7
15.1
Williams Partners WPZ
QQQ
50.00
44.00
52.78
2.81
5.3
—
After reorganization of parent Williams Cos. WMB, WPZ now ranks as
third-largest MLP, yet distribution growth potential still looks healthy.
Windstream WIN
QQ
10.00
No
12.54
1.00
8.0
—
Fixed-line svcs in secular decline, forcing firm to spend excess cash flow
on acquisitions instead of dividend increases. No dividend growth likely.
Xcel Energy XEL
QQQ
23.00
21.00
23.58
1.01
4.3
3.3
Decent growth potential from environmental requirements, but disappointed by policy targeting div growth (2%-4%) lower than EPS (5%–7%).
R
R
R
P
5 REIT
BIB
d
d
Comments
Spending heavily to grow production, but it benefits from strong resource
positions in multiple regions. Likely Harvest buy if price falls back.
Leading U.S. regulated utility with good demographics, strong regulatory
relations, low costs, and high ROEs. Georgia rate case comes in OK.
Commodity px fluctuations drive huge volatility in dividend. It’s wise for
this firm to dole out most of its earnings, but I find nothing else to like.
o
o
Follows up early-2010 dividend initiation with 20% boost in January.
Mature business now throws off gobs of cash, still able to grow modestly.
Despite maturation of U.S. operations, earnings continue to grow, and an
expanding payout ratio is turning Wally World into a dividend story.
American Electric Power AEP
The Dividend Drill | Josh Peters, CFA, and Patrick Goff
Josh’s View
American Electric Power’s turnaround has gone largely
unappreciated in the eyes of investors, but I’m
grateful—appreciation usually means a high price.
American Electric Pwr AEP
Star Rating
Economic Moat
Uncertainty Rating
QQQQ
Narrow
Low
Fair Value
40.00
Dividend Buy
37.00
Current Price
34.92
Dividend
1.84
Yield (%)
5.3
Payout (%)
59
5-Yr Growth (%)
3.8
Stewardship
X
After going through a painful period of deregulation,
AEP has come full circle by restructuring itself to
generate about 95% of its earnings from regulated
operations. This removed the vast majority of AEP ’s
exposure to commodity markets and replaced it with
capital investment and regulatory decisions as key
drivers of long-term profitability and growth.
Ohio (40% of AEP ’s earnings) has a difficult regulatory
environment based on the state’s quasiregulated
generation policy. Technically, the market is open
and customers can buy power from whatever supplier
they like, but in practice AEP has remained the lowcost supplier in its service territories and kept the vast
majority of its customers. Rates are still regulated
to a certain extent, and earlier this year AEP filed an
electric stability plan that requests modest rate hikes
in addition to other regulatory changes. Given the
importance of Ohio to AEP’s total profits, we will be
watching these proceedings closely, but we don’t
think the company’s requests are unreasonable.
American Electric Power: Stock Price and Dividend Rate
p Stock Price ($)
p Dividend Rate ($)
48
2.20
36
1.65
24
1.10
12
0.55
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
May 2011
17
Over the long term, a key growth area for AEP should
be investment in transmission and environmental
upgrades. More than 65% of AEP ’s power plant fleet
burns coal, and AEP expects to spend several billion
between 2011 and 2014 to retrofit its plants. The
company should be able to recover most of this investment—plus a return on capital—through higher rates.
Transmission is an even more attractive long-term
opportunity, given government incentives to improve
the efficiency of the U.S. power grid. AEP is a leader
in this area, with several multi-billion-dollar projects
in the works for the next 5–10 years.
Despite a 42% dividend cut in 2003, we believe AEP
has successfully restructured itself operationally
and financially (including a less burdensome payout
ratio target of 50%–60%) in order to provide a sound
and growing dividend. Our credit rating of BBB +
reflects healthy but not excessively conservative
leverage ratios. Internally generated funds and incremental borrowing allow AEP to fund the $15 billion
worth of capital spending we project over the next
five years. AEP ’s primary threat (as with most utilities)
lies with regulatory rulings; fortunately, this is mitigated by operating in 11 different states.
Since AEP started raising its dividend again in 2005,
shareholders’ pay has risen five separate times at
a compound growth rate of 4.7% —a good showing for
a regulated utility and ahead of the 4.1% annual
hikes of industry bellwether Southern SO. Management’s outlook calls for per-share earnings growth
of 4%–6% from 2011 to 2014, followed by 5%–7% as
higher-returning transmission projects start hitting
the bottom line. We think this outlook is quite reasonable, as even the slower-growing portions of AEP ’s
service territory are in need of heavy investment. As
the company’s overall return on equity trends a bit
higher, our blended long-run outlook for per-share
earnings and dividend growth is 5%–6%.
At AEP ’s Dividend Buy price of $37, the stock would
offer a yield of 5.0%, which rounds out the potential
for 10%–11% average annual total returns. œ
18
AT&T T
The Dividend Drill | Josh Peters, CFA, and Michael Hodel, CFA
Josh’s View
Once I looked at the telecom industry through the lens
of competitive circumstances—steady consolidation
that has given AT&T a broad portfolio within which to
allocate capital and manage technological changes—
I became comfortable with the idea of a buy.
AT&T T
Star Rating
Economic Moat
QQQ
Narrow
Uncertainty Rating
Medium
Fair Value
32.00
Dividend Buy
28.00
Current Price
30.18
Dividend
1.72
Yield (%)
5.7
Payout (%)
70
5-Yr Growth (%)
5.4
Stewardship
C
AT&T will probably post choppy results over the next
several quarters after losing the exclusive rights
to sell Apple’s AAPL iPhone in the U.S., efforts to integrate a recent wireless acquisition, and the general
migration toward higher-end wireless devices take
a toll on growth and margins. Despite these challenges, the firm’s position in the telecom market
should enable it to consistently generate cash flow to
reinvest in the business and fund its dividend payout.
The scale and resources that AT&T and Verizon
Wireless VZ VOD enjoy is unmatched in the U.S., and
we expect these firms will have a leg up in meeting
customers’ wireless demands in the future. We aren’t
as enamored with AT&T’s consumer fixed-line unit,
but this segment constitutes only 17% of revenue and
continues to shrink in importance to the firm as
a whole. AT&T’s enterprise unit is a solid competitor
and should benefit as the economy rebounds and
customers demand increasingly complex services.
AT&T: Stock Price and Dividend Rate
p Stock Price ($)
p Dividend Rate ($)
52
2.80
39
2.10
26
1.40
13
0.70
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
The recently announced acquisition of T-Mobile USA
from Deutsche Telekom DTEGY could be a huge win
for AT&T. At $39 billion, the firm is paying a bit more
than 7.1 times T-Mobile’s cash flow, but AT&T has put
the present value of cost and revenue synergies alone
at $40 billion. It would also shift the firm’s business
that much more heavily toward wireless (55% of total
revenue on a pro forma basis). The biggest question
is whether this deal can clear the numerous and large
regulatory hurdles in its path; if not, a $3 billion
breakup fee is payable to Deutsche Telekom.
Paying a reliable and growing dividend is a top priority
for AT&T management, and the firm’s finances provide
solid support for the current annual payout of $1.72
a share. The company sports solid investment-grade
finances, reflected by a Morningstar credit rating of
A-. The current dividend rate looks to take up 70% of
our earnings forecast for 2011, but even with AT&T
spending heavily to invest in wireless infrastructure,
we believe the company has ample resources to
support its growth, pay dividends, and repurchase
shares (though buybacks are probably off the table
while the T-Mobile deal is in process).
AT&T and direct ancestors SBC Communications
and Southwestern Bell have raised their dividends
every year since the Bell System breakup in 1984.
Although certain fixed-line businesses are in secular
decline, AT&T has a well-balanced portfolio of assets
that should grow overall as customer use of telecom
services continues to increase. Excluding any benefit
from T-Mobile, we see revenue rising at a 2%–3%
annual pace over the next five years, while per-share
earnings grow at a 5%–6% rate. Our dividend forecast
is a bit more modest—4%–5% average annual hikes,
probably in the form of 2%–3% bumps most years
and the occasional bigger jump—while share-buyback
plans are on hold during the T-Mobile merger process.
AT&T is not the kind of stock that will set the world
on fire, but with a 6.1% yield at our $28 Dividend Buy
price, we see the potential for cash-rich total returns
in the low double digits—even without T-Mobile. œ
Procter & Gamble PG
Josh’s View
Procter & Gamble is a huge enterprise, but its
dividend prospects struck me as being simple—even
elegant—as I moved to buy a stake for the Builder.
Star Rating
Economic Moat
QQQQ
Wide
Uncertainty Rating
Low
Fair Value
77.00
Dividend Buy
66.00
Current Price
62.99
Dividend
2.10
Yield (%)
3.3
Payout (%)
5-Yr Growth (%)
Stewardship
49
11.8
X
P&G is the leading consumer product manufacturer
in the world. Its wide economic moat derives from the
economies of scale P&G enjoys from its portfolio
of leading brands, 23 of which generate more than $1
billion revenue per year. Underpinning P&G’s unprecedented global brand reach are core research and
development capabilities and a strong marketingdriven understanding of consumer needs, backed by
more than $7 billion in advertising spending.
After losing market share in 2009 as it fumbled with
catering to newly cost-conscious consumers, Procter
& Gamble is back on solid ground, in our opinion. The
firm has perfected trading consumers up to premium
products, but its focus following the recession is
to offer enough product diversity in its categories to
appeal to value-oriented consumers as well. P&G
also has an aggressive plan to expand its brands into
new categories and markets while streamlining
costs. While these plans aren’t particularly new, it’s
clear that the company’s strategies have become
Procter & Gamble: Stock Price and Dividend Rate
p Stock Price ($)
p Dividend Rate ($)
72
1.96
54
1.47
36
0.98
18
0.49
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
19
more coordinated. Negligible top-line growth is
possible in mature markets, but the current valuation
of P&G’s stock gives the company no credit for developing market opportunities. There, we expect the
firm’s brands and extensive distribution network to
achieve targeted sales growth of 8%–10% a year.
The Dividend Drill | Josh Peters, CFA, and Lauren DeSanto
Procter & Gamble PG
May 2011
P&G is a prudent company with a rock-solid balance
sheet. The firm has a Morningstar credit rating of AA,
generated $16 billion in cash from operations in 2010
compared with total debt of $32 billion, and produces
enough annual operating profits to cover interest
charges 17 times over. The payout ratio has risen a bit
in the past few years from the low 40s to 49%
(implied by the recently raised dividend rate of $2.10
and our fiscal 2012 earnings outlook of $4.31 a share).
But with stable revenue, excellent conversion of
earnings into free cash flow, and major acquisitions
unlikely, P&G can easily afford a higher payout level.
With the 9.2% dividend increase announced April 11,
P&G has now raised its dividend in each of the last
55 years. The compound growth rate during this remarkable stretch has been 9.4%, but size hasn’t slowed
P&G down—the past decade saw average annual
dividend growth of 10.4%. We anticipate a modest
slowdown in dividend growth during the next five years
to around 8%, based on revenue growth of 4%–5%
annually (a reachable target, given P&G’s significant
exposure to emerging markets, where margins are
actually higher than in the U.S.) and a 3%–4% annual
boost to per-share earnings growth from share repurchases funded out of free cash flow.
At our Dividend Buy price of $66, the newly enhanced
dividend would pay a yield of 3.2% for the upcoming
year and should be able to provide average annual
total returns north of 11%. A compressing valuation (a
falling price/earnings ratio and a rising dividend yield)
has hindered realized returns for P&G shareholders
in recent years, but we believe a resumption of pershare earnings growth following recent asset sales
will help the stock’s valuation metrics stabilize, and
possibly expand, in the years ahead. œ
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