Cabot Dividend Investor 620

Despite the fact that the market indexes have come roaring back near the old highs, many stocks are still cheap. Cheap dividend stocks have created some of the highest yields in a decade. While there is great opportunity, it’s not as easy as it might seem.

There is also great risk. In most cases, stock prices have fallen because the coronavirus lockdown has seriously hurt business. The financial pain is yet to be realized. Many of these high-yielding stocks will be forced to cut the dividend to free up much needed cash.

It is only those rare cheap, high-yielding stocks with safe dividends that offer great opportunity for dividend investors in this market. In this issue I highlight one of the very best. It is one of the best high-yield opportunities in a decade.

Cabot Dividend Investor 620

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A Cheap Price and a Safe, High-Yield
These are humbling times for market prognosticators. Who saw the coronavirus coming? Who saw the market surging 47% from the lows in late March?

The last several months have beautifully exemplified why no one can predict the market in the near term, the unpredictability of future events. The market sees a booming recovery ahead. That’s fantastic news. And the market usually gets it right.

This has been a market for the ages. After falling 34% in record time between February 19^th and March 23^rd, the market has come almost entirely back in less than three months. The S&P 500 closed Monday less than 5% from the all time high. Both the NASDAQ and the S&P 500 closed in positive territory year-to-date.

You may think you missed the boat. Many stocks, including several in this portfolio, have moved back near the highs. And the market isn’t that cheap anymore. In fact, prices may have gotten ahead of themselves in the near term. Is there anything worth buying at this point?

There is.

While the market indexes may have come almost all the way back, there are still many stocks and sectors of the market that have not. Only four of the 11 S&P 500 sectors are positive for the year so far. Some sectors are still down a lot. And the yields on certain dividend stocks are the highest I’ve seen in a decade.

But beware. Yields are high because stock prices are still down. And prices are down because business at these companies have been hurt by the lockdown and recession. As the extent of financial damage becomes evident, many of these high yielding stocks will cut their dividend to free up cash for survival. You don’t want those.

There are bargains and high yields out there. But you have to be careful to find those with a safe dividend. Stocks still selling at bargain prices that pay high yields that are safe represent the best buying opportunities in the market right now. In this issue, I highlight one of the few diamonds in the rough.

What to Do Now
This is the most active month yet in terms of ratings changes since I took over this newsletter in December of 2018. In this issue I am reducing positions in Community Healthcare Trust (CHCT), STAG industrial (STAG), Crown Castle International (CCI), Innovative Industrial Properties (IIPR), Qualcomm (QCOM) and Valero Energy (VLO).

As I’ve mentioned in past monthly newsletters and updates, I’m skeptical that the market can keep running higher from here. I do believe the economy will come back strong and the market sees that. But there could be some bumps along the way over the course of the year. I address some of the risks in the last section of this newsletter.

These positions can be more volatile with the market and I believe the risk/return tradeoff had turned to the downside in the near term. I see more downside risk than upside potential. For that reason, I am recommending raising cash and reducing current holdings in order to less painfully endure another downturn, and be in a position to take advantage of lower prices in the future.

Featured STOCK

Altria (MO)
Yield: 8.25%

Altria Group (MO) is the largest U.S. domestic cigarette maker and one of the largest in the world. The company is the domestic part of the old Philip Morris that spun off the international division in the form of Philip Morris International (PM) in 2008. Altria now operates primarily in the United States.

In addition to cigarettes, Altria also sells E-cigarettes, marijuana, beer, wine, and smokeless products. Altria also owns a 10.2% stake in the world’s largest brewer Anheuser-Busch InBev (BUD). It may seem like a diversified company but it really isn’t. About 85% of net revenues are generated from cigarettes and the overwhelming majority of that is from its flagship Marlboro brand, which commands a stratospheric 40%-plus cigarette market share in the U.S.

That’s a problem. In case you haven’t heard, cigarettes are bad for you. The volume of cigarette smoking is declining by about 4% to 6% per year. Of course, it has been declining at a 4% pace for decades. And over that time Altria has been able to more than compensate for the declines by raising prices and via share buybacks. The company still grew annual earnings at a solid rate and had been one of the best performing large stocks in the index.

But things are changing.

The rate of annual volume declines is increasing because more people are opting for E-cigarettes, especially young smokers. To answer that problem, Altria purchased a 35% stake in dominant E-cigarette brand JUUL in late 2018 for $12.8 billion. It has since been the acquisition from Hell. JUUL has been under relentless assault by regulators primarily for marketing to young people. There is now even a question if E-cigarettes will be allowed to be sold at all.

Altria has already written down $8.6 billion of the investment. The market hasn’t liked this and the stock is down about 50% from the 2017 high and near a five-year low.

But here’s the thing. If E-cigarettes get sued out of business Altria will sell more cigarettes. If E-cigarettes survive, Altria owns the dominant company in the space. It’s will ring the register either way. Plus, Altria has other growth opportunities.

In late 2018, Altria purchased a 45% stake in Canadian Cannabis company Cronos (CRON) for $1.8 billion. Legal cannabis is a huge growth industry still in its infancy. But the growth is undeniable. The trend toward legalization is clear and could accelerate as states opt for additional tax revenue to compensate for the budget shortfalls from this recession.

Altria, with its unparalleled regulatory expertise, deep pockets and marketing should be able to cash in on some of that growth going forward. As well, the company has a joint venture with Philip Morris International to sell heated tobacco product IQOS throughout the U.S. It is the only such product with FDA approval and could potentially capture much of what has been lost by E-cigarettes.

In the meantime, the company continues to grow earnings per share. Management is forecasting high single digit annual growth for the next several years. Earnings grew over 18% in the first quarter as people are smoking more during the pandemic.

The dividend
Is that massive 8.3% yield safe? I think it is rock solid. The company has a rather high 80% payout ratio, but that is the historical average. And the company has raised the payout every year for the last 50 years.

Historically, this has been one of the best and most reliable dividend paying companies on the market because the company generates an obscene amount of free cash flow, money left over after expenses. To give you an idea, in 2019 Altria generated $7.6 billion in free cash flow and paid $6.1 billion in dividends.

This is one of those companies that is actually doing better during this recession as people tend to smoke more. It can offset volume declines with price hikes and share buybacks. But it also has some promising growth prospects for the longer term. Meanwhile, that big fat dividend should be safe and the stock is priced near a five year low.

Portfolio at a Glance

Portfolio Updates

High Yield Tier

The investments in our High Yield Tier have been chosen for their high current payouts. These investments will often be riskier or have less capital appreciation potential than those in our other two tiers, but they’re appropriate for investors who want to generate maximum income from their portfolios right now.

Brookfield Infrastructure Partners (BIP – yield 4.4%) – This global infrastructure partnership is breaking out. The stock had been all stuck in the mud around 40 per share since early April. But BIP has turned on the after-burners since late May and is now in kissing distance of 45. The market is appreciating two things about BIP. First, about 95% of revenues are contracted or regulated, and thus not subject to falling demand in a recession. And two, the stock is still more than 12% from the high and paying a juicy 4.4% dividend. It’s a rare play that offers value, a safe dividend and momentum. BUY

Rating change “HOLD” to “SELL”
Community Health Trust (CHCT – yield 4.4%) – This fast-growing small healthcare REIT is benefitting from the recent upward thrust in the market. It’s up over 13% just this month. While the underlying business is in defensive health care properties, the stock is a lot more cyclical because it is a small, lesser known REIT. This is a stock that in the near term will mimic, and indeed exaggerate, the whims of the market. Since I believe the market to be precarious at this point, I will sell the remaining one third position while the getting is good with a 31% return in two years on the remaining position. Nice profits have already been realized on two thirds of the position during the boom times. But I see the remaining third as a prudent place to pull back right now. SELL

Enterprise Product Partners (EPD – yield 8.0%) – The energy midstream giant still offers great value and a high dividend that is safe in a market where such things are becoming rare. Many stocks have moved back up near their highs while others still remain cheap. The problem is that most of the still cheap stocks will face financial hardship that could threaten the dividend. If there is another market downturn, I believe that already cheap stocks will have less downside. As well, some stocks will run out of further upside if the market recovery continues. Cheap stocks are a great place to be but only if the dividend is safe. EPD has a cheap price, a strongly recovering business and a dividend that is as secure as any stock in the sector. HOLD

Rating change “HOLD” to “SELL ½”
STAG Industrial (STAG – 5.3%) – This is a cyclical REIT that moves more in synch with the overall market than other, more conservative REITs. The cyclical part could be a problem because many of its tenants will endure the brunt of the economic pain from this virus lockdown, that has yet to be realized. At the same time, many of its tenants are thriving because of online shopping. The longer term trend is good as these warehouse properties will continue to be in short supply and high demand. Under the circumstances, I will take half the position off the table here and lock in a 36% return in a little over two years. SELL 1/2

Next ex-div date: June 30, 2020 est.

Verizon Communications (VZ – 4.2%) – Most companies are getting hurt by this recession, at least temporarily, but not Verizon. Sure ,the pace of the 5G build out has slowed somewhat during the lockdown. It’s also true that sales of new smart phones are down. But people are using cellular service more than ever during the lockdown. And some of that escalated use is likely to become permanent. This company is a great place to be for the duration of the restrictions. But it will also be a beneficiary of the post-lockdown market and economy as the emergence of 5G takes center stage and VZ will be a primary beneficiary. The stock also held up very well in the last market selloff. BUY

Next ex-div date: July 9, 2020

Dividend Growth Tier

To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.

AbbVie (ABBV – 5.0%) – AbbVie jumped into the coronavirus race this week, announcing a collaboration to develop a novel antibody therapeutic to prevent and treat COVID-19. AbbVie will have an exclusive license to sell it if and when it is successful. It’s unlikely to move the needle for AbbVie, but you never know, and the market seemed to like it. The move also further established AbbVie as a cutting edge pharmaceutical company at a time such companies are in high demand while the population ages at warp speed. The stock is within a whisker of the 52-week high, but still 30% below the 2018 high and selling at a compelling valuation. The stock has also been moving independently of the overall market. ABBV is still a great place to be. BUY

Next ex-div date: July 14, 2020 est.

Rating change “HOLD” to “BUY”
Altria (MO – 8.0%) – The market has been so good that even MO is moving off its butt. The stock had been an underperformer in the bull market and had been wallowing in between 35 and 40 per share oblivion since the market bottoms. But it has moved 6% higher in the past week and has broken out over 40. Even the unloved are having a party. I don’t know how long the momentum will last or when the market will embrace this cigarette pusher. But the stock is still cheap and the dividend is safe. You’re not overpaying for an 8% yield. That is a circumstance with timeless value and investors will see the light at some point. In the meantime, enjoy one of the safest, most high quality yields in a decade. BUY

Next ex-div date: June 12, 2020

Rating change “HOLD” to “SELL ½”
Crown Castle International (CCI – yield 2.8%) – This REIT is in the right place at the right time. It owns cell tower properties at a time when cellular traffic is booming and the impending arrival of 5G offers a huge growth catalyst. In about a year since being added to the portfolio, CCI has delivered a total return of over 42%, compared to just over 18% for the market. While the market is down slightly year-to-date, CCI has returned over 23%. But the stock sells at a high valuation. It can also be bouncy and is selling near the all time high. Given the current market situation, I’d like to take some profit off the table and sell half. But I may well repurchase that half during a weak period for the stock in the quarters ahead. SELL 1/2

Next ex-div date: June 11, 2020

Rating change “BUY” to “SELL 1/3”
Innovative Industrial Properties (IIPR – yield 4.6%) – I love this stock and the story that comes with it. Marijuana is a huge growth industry. The trend toward legalization is strong and may get much stronger as states cope with budget shortfalls from the pandemic. As well, this REIT is making money, and lots of it. Earnings are expected to grow 88% this year, with more strong growth likely in future years. The only issue is that the stock is volatile and tends to exaggerate the market’s up and down moves in the near term. While the longer term trajectory is excellent, I will take a third of the position off the table here and look to buy it back if the market sells off again. SELL 1/3

Next ex-div date: June 30, 2020

Rating change “HOLD” to “SELL 1/3”
Qualcomm Inc. (QCOM – yield 2.9%) – This smartphone 5G chip maker is in a position to inherit the post coronavirus world. But we’re not there yet. In the near term, when the market moves up it tends to move up more, and when the market falls it tends to fall more. As the risk/return tradeoff in this market has deteriorated, I can’t ignore the near term risks to QCOM. As a prudent act of caution in a dangerous market, I will pull back on one third of the position, with an eye to repurchase back later. SELL 1/3

Next ex-div date: September 3, 2020 est.

Rating change “HOLD” to “SELL ½”
Valero Energy Corp. (VLO yield 5.7%) – This refiner stock has enjoyed a huge move higher since the Armageddon prices in the energy industry in March. Demand for refined products like gasoline, diesel and others fell off a cliff during the lockdown and refiners took it on the chin. But guess what. That demand is coming right back as the economy reopens. At the same time, crude oil prices are likely to remain depressed for a while for a host of reasons. That’s a good thing seeing how oil is the main cost for a refiner and there’s a likelihood that crude prices remain cheap relative to refined product prices into this recovery. But VLO can be very volatile. The price is not likely to be spared in a sharp market downturn. The intermediate term looks great for the stock while the short term has become more treacherous. For that reason, I will sell one half of the position for now. SELL 1/2

Next ex-div date: August 13, 2020 est.

Safe Income Tier

The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.

Alexandria Real Estate Equities (ARE – yield 2.7%) – Alexandria’s life science and research lab properties are not only a defensive and growing real estate niche, but the pandemic has made them more in vogue than ever. I see this unusual health care REIT as having staying power in the event of a downward move in the market and continued good fortune as the market more permanently recovers. The REIT just raised the quarterly dividend by 3% and has plenty of cash on hand for future dividend hikes. The defensive business is likely to be little affected by the recession and the dividend is safe. This is a great stock to hold through the crisis and beyond. HOLD

Next ex-div date: June 29, 2020

Invesco BulletShares 2021 Corporate Bond ETF (BSCL – yield 2.6%) – This short term bond ETF has held up well through the crisis because it isn’t in the stock market, the bonds are short term, and they are investment grade rated. It still has a yield that’s better than you’ll get in most traditional safe haven investments. I will likely sell this ETF before it matures at the end of 2021, because you might get a slight dip in price when it’s liquidated. But I will hold for now in this still uncertain stock market. BUY

Next ex-div date; June 20, 2020 est.

Invesco Preferred ETF (PGX – yield 5.4%) – This preferred stock ETF continues to recover from its selloff during the market panic. It has a high yield but it does have downside if the market takes another plunge. That said, it is only down about half as much as the stock market in this downturn. The high dividend and diversification from the market should also bolster demand for this fund in the post coronavirus market. HOLD

Next ex-div date: June 22, 2019 est.

NextEra Energy (NEE – yield 2.2%) – Utilities are a good place to be during a recession because of the defensive nature of the business. People use the air conditioning in any economy. Yet the utility sector has underperformed the market during the downturn. That’s because they had been wildly popular in the bull market and got pricy. If there is another market downturn, I expect the sector to fare much better. And NEE is the best of the best, offering both stable revenues and growth from the alternative energy business. HOLD

Next ex-div date: August 27, 2020 est.

Xcel Energy (XEL – yield 2.6%) – I like this smaller alternative energy utility right now. It has reliable earnings during the recession. But it also has growing earnings for the recovery. No one knows for certain how things will shake out. But this stock has you covered either way. It has outperformed its utility peers as well as the overall market in the downturn since the February highs. It also outperformed both in the bull market. This is a futuristic utility with strong growth that is build to thrive in any kind of market or economy. HOLD

Next ex-div date: June 12, 2020

The Risks to the Market
There are risks to any market. We are now seeing how unpredictable events can be. However, I think the current environment carries a higher level of risk than usual. And I want you to be aware.

The market has run up very far, very fast. That can be dangerous. The economy is still in the worst quarter since the Great Depression, and maybe worse. Of course, the market believes it will be short lived and so do I. The market is factoring in a booming economy in the third and fourth quarters with a market awash in Fed stimulus.

And the market usually gets it right. But it seems to be factoring in a very positive scenario that may not unfold, or could get interrupted. The virus could spread again as the economy restarts and cause a delay in the rebound. Or it could pop up again later this year.

But the virus risk is well known. There is also something else, the election. There is a wider and wider divergence between the two parties. There is a huge difference in policy between the two parties, especially as it relates to the market. The market doesn’t like uncertainty. And that uncertainty will continue to grow as we get closer to Election Day.

But there is another risk with this election. A close outcome could be a big problem. With the parties more polarized than before, I’m not sure either party would accept a situation like we had in 2000. The election result could be contested. We could even see a Constitutional crisis. That would be a big problem for the market.

I don’t believe that is likely, but it’s possible. I also believe that the economy will come roaring back and sooner or later we’ll be rid of the coronavirus. I’m still very bullish longer term. But risks are gathering and that partly explains my caution about this market.

Dividend Calendar
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates estimated.

The next Cabot Dividend Investor issue will be published on July 8, 2020.

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