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Dividend Investor
Safe Income and Dividend Growth

Cabot Dividend Investor 1018

October has been a challenging month for many investors, but dividend stocks and income investments have been a rare safe haven. After a few sells last week, our portfolio is looking ready for whatever November throws at us. So far, investors are optimistic about turning the calendar page: the market managed to rally yesterday and then opened higher today.
However, we’re not out of the woods yet, and as always, I recommend sticking with what’s working. That’s why today I’m adding another conservative consumer staples stock to the Safe Income tier, which I expect to provide us with a secure income stream for a long time.
Read the whole issue for the story, plus earnings updates on many of our holdings, and a look into why REITs have been doing so well recently.

Cabot Dividend Investor 1018

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Ready For Whatever Comes Next

The stock market is trying to pull itself together as October ends. Following Friday’s massive selloff, bargain hunters attempted to take control Monday, but selling pressures overwhelmed the rally and all three major indexes closed lower once again. Yesterday’s rally had more sticking power though, and now investors can look forward to closing the book on October tomorrow. It’s still too early to signal the all-clear, but an edge of optimism seems to be creeping in.

[highlight_box]What To Do Now: I don’t have any more defensive moves today: I sold Occidental Petroleum (OXY), the rest of McGrath RentCo (MGRC) and half of CSX Corp. (CSX) last week. The rest of the stocks in our portfolio are healthy enough to stay for now, although the weakest link is BB&T Corp. (BBT). You could also take some profits in Broadridge Financial (BR) if you haven’t yet.

Even though it’s been a lousy month, not everything has been affected equally. A few stocks are even still performing well! McCormick (MKC) and our utilities are benefitting from buying in defensive stocks, and I’m adding another consumer staples position to the Safe Income tier today (it just hit a new 52-week high yesterday).

Financial exchange operator CME Group (CME) is in a volatility-fueled uptrend, REITs are up thanks in part to a slight decline in the odds of a December rate hike, and Dunkin’ Brands (DNKN) and American Express (AXP) have both found buyers post-earnings. Our portfolio is well-prepared for whatever November brings. [/highlight_box]

Featured Buy

Hormel Foods (HRL)

The market is in a correction, and Cabot’s market timing indicators suggest that it could go on a bit longer. So to find this month’s new recommendation, I looked for investments that were still doing relatively well. Utilities have been the best-performing sector over the past month, but we already own two, Consolidated Edison (ED) and Xcel Energy (XEL), in the Safe Income portfolio. Both are doing great, but utilities are highly cyclical and highly correlated, so I don’t want to overweight our portfolio just because they’re temporarily leading the market.

Many consumer staples stocks have also been largely ignoring the correction, and we only own one of them: McCormick & Co. (MKC), currently the strongest stock in our portfolio. The staples’ outperformance won’t necessarily be short-lived either: the sector underperformed the market for two solid years from June 2016 to June 2018, so its uptrend is still relatively new. That brings us to Hormel Foods (HRL), a dividend aristocrat that started a new uptrend just a few months ago and hit a new 52-week high just yesterday.

The Company
Hormel is best known for their meat products, including their Hormel-brand pepperoni, bacon, deli meats, chili and prepared meals. But the company also owns a range of other brands you might know from your grocery store, including Jennie-O, Applegate Organics, Columbus, and SPAM.

Refrigerated foods, mostly meat products, contribute 66% of net sales. But Hormel is increasingly expanding into other areas of the grocery store as well, with strategic acquisitions like Skippy peanut butter, Justin’s nut butters, Wholly Guacamole dips, and Muscle Milk beverages.

Groceries are a stable business. Hormel’s operating income, net income and EPS have all increased in each of the last 10 years except 2017.

This year is shaping up to be a return to form. Hormel already reported third-quarter earnings in late August. Earnings were up 15% year-over-year, thanks to the combination of 7% sales growth and a lower tax rate.
The company will report fourth-quarter and full-year earnings November 20, before the market opens. For the quarter, analysts are expecting Hormel to report 2.9% revenue growth and 19.5% EPS growth. For the full year, analysts are expecting 4.7% revenue growth and 19.1% EPS growth.

The Dividend
Hormel has paid dividends since 1928, and has increased the dividend every year for 51 years, making the stock a longtime member of the dividend aristocrats. Over the past five years, Hormel has increased the dividend by an average of 17% per year.

The stock’s current payout ratio is 43%, which is a little higher than its five-year average of 38%, but still well within the safe range.

Hormel’s long dividend history and low payout ratio earn the stock a perfect Dividend Safety Rating of 10 out of 10.

And combined with analysts’ forward earnings estimates (including estimated annual EPS growth of nearly 11% over the next five years) the company’s track record of dividend increases earns HRL a nearly-perfect Dividend Growth Rating of 9.8 out of 10.

These numbers indicate that HRL is a safe investment for anyone looking to secure a reliable, long-term, gradually rising income stream.

The Stock
While there’s no guarantee that consumer staples stocks will continue to do well, Hormel isn’t overvalued; the stock trades at a P/E of 24 and a forward P/E of 23. Plus, the stock has made no progress for nearly three years. After a sharp selloff in the second quarter of 2016, HRL traded sideways for a full 24 months before breaking out to new highs this fall.

Since breaking out past that overhead resistance in September, the stock has marched higher just above its 50-day line. The current broad market correction has attracted frightened investors to the blue chip stalwart, and HRL just hit a new 52-week high yesterday.

I’ll be adding the stock to the Safe Income Tier at tomorrow’s average price.

Hormel Foods (HRL)
Price: 43
52-week range: 43.39-30.44
Market cap: $23.12 billion
P/E: 24
Current yield: 1.7%
Annual dividend: $0.75
Most recent dividend: $0.19
Dividend Safety rating: 10.0
Dividend Growth rating: 9.8
CDI1018-hrl
Dividends since: 1928
Consecutive years of increases: 51
Qualified dividends? Yes
Payment Schedule:
Quarterly
Next ex-dividend date:
January 2019

Portfolio at a Glance

Closing Prices on October 30, 2018

Portfolio Updates

High Yield Tier

CDIpyramidHigh

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.

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HOLD – AllianceBernstein (AB 29 – yield 9.6%) – AB has pulled back just to its 200-day moving average, where the stock found support during the first phase of the correction, in early October. The asset manager reported third-quarter earnings that beat estimates by a good margin last week, but like many stocks was still dragged down by the broad market. Revenue rose 9.7%, to $727.14 million, well more than expected. And adjusted EPS of $0.69 beat estimates by 11%. AB has solid support from its 200-day here, so I’ll keep it on Hold for high-yield investors—the stock’s variable yield has now risen to over 9%.

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HOLD – Community Health Trust (CHCT 31 – yield 5.3%) – Futures markets have become less certain that the Fed will hike rates again in December. Interest rate futures were pricing in an 80% chance of a December rate hike early this month; those odds fell as low as 70% last week before bouncing back up again over the past couple days. That plus a rotation into high-yield names has given REITs a boost, and CHCT has bounced back above its 50-day moving average over the past week. The REIT, which owns rural medical properties, will report third-quarter earnings November 6, after the close. Analysts are expecting FFO (funds from operations, a widely-used measure of REIT cash flow) per share of $0.43, up 40% year-over-year. Revenues are expected to rise 37%, to $12.94 million. The stock bounced off its 200-day line a couple weeks ago and is holding up well relative to the broad market. Hold.

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HOLD – General Motors (GM 34 – yield 4.5%) – GM was scheduled to announce third-quarter results before the open today, but hadn’t released the numbers as of our publication deadline. Analysts were expecting GM to report a 3.6% bump in sales, to $34.85 billion, but a 5.3% drop in EPS, to $1.25. Before earnings, the stock was doing well. Automakers including GM popped Monday after Bloomberg reported that the Chinese government is considering cutting the sales tax on new cars in half. That would provide a significant sales boost to GM, whose largest market is China (although like all foreign automakers it operates there through a joint venture). Even before the news out of China, GM had found some support last week as bargain-hunters stepped in. The stock isn’t out of the woods yet, but we only have a small position left, and a double-digit profit, so we’ll Hold for the yield and eventual rebound.

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HOLD – ONEOK (OKE 63 – yield 5.0%) – ONEOK reported third-quarter earnings after the close yesterday. While results were mixed, management raised their full-year net income and EBITDA guidance, which should provide a tailwind to the stock in the fourth quarter. Operating income rose 40% over the same quarter last year, and revenue rose 17%, although it missed estimates just slightly. EPS of $0.75 beat estimates by four cents. ONEOK also increased its dividend by 3.6%, the company’s fourth quarterly dividend increase in a row. OKE fell below its 200-day moving average during last week’s pullback, we’ll see if this news can pick the stock back up over the next few days.

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HOLD – STAG Industrial (STAG 27 – yield 5.3%) – STAG will report third-quarter results tomorrow, November 1, after the close. Analysts are expecting the warehouse REIT to report FFO of $0.45 per share, up 4.3% year-over-year. Revenues are expected to rise 12.3%, to $87.73 million. The stock dropped briefly through its 200-day moving average two weeks ago, but has rebounded along with the rest of the REIT sector over the past two weeks and looks healthy. High-yield investors can Hold.

Dividend Growth Tier

CDIpyramidDiv

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.

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HOLD – American Express (AXP 102 – yield 1.4%) – American Express is still looking all right. The credit card company reported strong earnings two weeks ago and has mostly held its ground since. Revenues rose 9% and EPS rose 25% year-over-year, solidly beating analyst estimates. The stock popped 4% to close above its 50-day, but was dragged back down by the broad market selloff over the next two days. But the stock is still above its 200-day line, where it found support back in June. I haven’t switched the stock’s rating to Hold yet, so I’ll do that today, given the severity of the market correction. But if you own AXP, I think you can be comfortable holding here—this could also be a good time to sell covered calls to generate a little extra yield.

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HOLD – BB&T Corp (BBT 48 – yield 3.1%) – After hitting a new intra-day low last Wednesday, BBT got some relief this week thanks to reports that regional banks may soon become exempt from many post-crisis banking regulations. The news helped most regional bank stocks, including BBT, close higher Monday and Tuesday despite the selloff in the broad market. BB&T’s earnings, reported earlier this month, were solid, and the bank should benefit from higher interest rates this quarter. However, the stock is still one of the weakest in our portfolio, and I’m ready to sell the rest if it hits new lows.

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HOLD – Broadridge Financial Solutions (BR 114 – yield 1.7%) – I’m moving BR to Hold today. The stock, which started its own pullback in mid-September, has been brought down to its 200-day line by the market correction. I think it probably still looks okay here, but I’ll put it on Hold until the correction tires itself out. We sold a third of our shares for a 47% profit back in August, but if you haven’t taken profits yet, you might want to sell some shares today. Broadridge is the largest investor communications firm in the U.S., and delivers steady single-digit sales growth every year. The company will report earnings November 6, before the open. Analysts are currently expecting 4.9% revenue growth, to $970.14 million, and 25.9% EPS growth, to $0.68.

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BUY – CME Group (CME 182 – yield 1.5%) – Financial exchange owner CME reported earnings Thursday, and even though revenue missed estimates slightly, the stock has been holding up well. EPS rose 22, to $1.45, two cents above estimates. Revenue rose 1% year-over-year, to $904.2 million, thanks to growth in market data, information services and access and communications fees. However, revenues from clearing and transaction fees fell slightly as average daily volume slipped. Given the significant uptick in volatility since the end of September (when the quarter ended) volume is sure to rebound nicely in the fourth quarter. Investors are looking ahead and the stock has been trending up and above its 50-day moving average since the start of the month. Although I don’t recommend loading up on anything here, I’ll keep CME on Buy. The company pays a large special dividend at the end of each year, which can more than double its normal yield.

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HOLD – CSX Corp. (CSX 69 – yield 1.3%) – I sold half our position in CSX at last Wednesday’s average price of 66.77, for a loss of 10%. The stock declined further at the end of the week, but may have found support at its 200-day moving average on Friday, and bounced nicely yesterday as buyers stepped in. Of course, with the correction as fierce as it is, that support may or may not hold. But the bounce is encouraging, so we’ll Hold the rest of our shares for now. The company already reported earnings earlier this month, and although the stock’s reaction was negative, the results were excellent.

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HOLD – Dunkin’ Brands (DNKN 73 – yield 1.9%) – Dunkin’ reported third-quarter earnings and raised full-year guidance Thursday, and the good news helped the stock resist most of the carnage of the past week. Adjusted EPS rose 69%, to $0.83, beating analyst estimates by a generous 10 cents. Revenue of $350 million beat estimates by nearly $7 million. Dunkin’s new menu strategy, which is simpler and more beverage-focused, contributed to improved profitability and will continue to be rolled out nationwide. Management also increased their full-year guidance, prompting a raft of upward analyst revisions; analysts are now expecting full-year sales growth of 55% and EPS growth of 17%. I’ll keep DNKN on Hold.

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SOLD – Occidental Petroleum (OXY 68 – yield 4.6%) – I sold OXY at last Wednesday’s average price of 69.83, for a loss of about 17%. The stock continues to fall rapidly, along with most other U.S. energy stocks. OXY has no clear support level in sight until way down at 62.50 (25% below our purchase price). Sold.

Safe Income Tier

CDIpyramidSafe

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.

cdi1018-bscjbscl

BUY – Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 1.4%)
BUY – Invesco BulletShares 2020 High Yield Corporate Bond ETF (BSJK 24 – yield 4.8%)
BUY – Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.4%)
BUY – Invesco BulletShares 2022 High Yield Bond ETF (BSJM 24 – yield 5.4%)
The two high-yield funds in our bond ladder, BSJK and BSJM, have both pulled back fairly sharply over the past week due to a broader decline in the high-yield market. The stock market selloff, an Italian budget standoff and concerns about global economic growth have all been cited as contributors to the selloff. However, the decline has been much less severe than the losses in equity markets. I’ll keep all four bond funds on Buy; their defined-maturity features limit losses as long as they’re held until expiration (at which point Invesco disburses the net asset value, or NAV, of the ETF back to investors).

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BUY – Consolidated Edison (ED 77 – yield 3.7%) – ConEd will report third-quarter results tomorrow, November 1. Analysts are expecting revenues of $3.19 billion, down 0.8%, and EPS of $1.46, down 0.7%. But the stock usually reacts mildly, if at all, to earnings. More importantly, utilities have been safe havens during the market correction, and ED has been a good store of value over the past month. The utility provides electricity and gas to New York City and the surrounding area, and generally delivers steady single-digit earnings growth every year. Long-term investors can nibble here for safe income; ED has increased its dividend every year for 43 years.

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HOLD – Ecolab (ECL 149 – yield 1.1%) – Ecolab reported middling third-quarter results yesterday, and the stock opened sharply lower but closed higher on the day. Adjusted EPS rose 11% year-over-year, to $1.53, and met estimates. Sales rose 5%, to $3.75 billion, $10 million above the consensus estimate. However, management lowered full-year expectations by 15 cents, citing higher raw material costs and changes in exchange rates. Management now expects full-year EPS to fall in the range of $5.20 to $5.30; analysts had previously been expecting $5.36. While the news was initially greeted by intense selling, management emphasized on their earnings call that business remains very good: volume, pricing and cost savings are all meeting targets. So management is declining to offset the effect of higher raw materials costs on earnings by slashing investment, and analysts seem to have been convinced it’s the right move. I put ECL on Hold in yesterday’s special bulletin and will keep it there for now.

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BUY – Invesco Preferred ETF (PGX 14 – yield 6.0%) – After a quick interest rate-related pullback early this month, PGX has been trading sideways for the past few weeks, and remains a decent store of value until the market improves. PGX is an ETF that holds preferred shares (a type of debt) and pays monthly distributions. The fund has low overall volatility and usually trades between 14 and 16. Note that PGX offers no capital appreciation potential; instead, but it’s a good source of regular income. Buy under 15.

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BUY – McCormick & Co (MKC 145 – yield 1.4%) – MKC has gained almost 8% since the start of October, and remains above its 50-day line. Groceries are the classic counter-cyclical investment and conservative stocks have seen strong inflows ever since the correction started. I wouldn’t load up here, given the market environment, but I’ll keep my rating (which is aimed at long-term investors) at Buy. The spices company is a Dividend Aristocrat and reported excellent third-quarter earnings three weeks ago, triggering a flurry of upward estimate revisions. For a similar investment, see this month’s new recommendation of Hormel (HRL).

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SOLD – McGrath RentCorp (MGRC 48 – yield 2.8%) – I recommended selling MGRC last week. We sold the remaining half our shares at Wednesday’s average price of $47.49, for a loss of 19%. Our total return on the positon was -15%. MGRC bounced a bit after reporting earnings yesterday, but the rental company’s downtrend has been remarkably persistent, and the stock is below both its 50- and 200-day moving averages. If concerns about a global economic slowdown persist, industrials could remain out of favor even once the market moves on. Sold.

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HOLD – UnitedHealth Group (UNH 258 – yield 1.4%) – UnitedHealth has been marching lower since reporting earnings mid-month, but the retreat has been fairly orderly and occurred on relatively low volume. The earnings announcement was excellent: UnitedHealth beat estimates and raised guidance. But after initially jumping 5%, the health insurer’s stock succumbed to the market’s downtrend. The stock’s 200-day moving average is still down at 246, and would probably provide good support if UNH gets that low. UNH is a Hold.

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BUY – Xcel Energy (XEL 50 – yield 2.9%) – Xcel reported third-quarter results that missed estimates Thursday, but the utility’s stock ignored the report, and remains above its 50-day moving average. EPS fell 1%, to $0.96, missing estimates by two cents. Revenues rose 1%, to $3.05 billion, but fell far short of estimates. Margins rose thanks to better weather and higher sales, but earnings still declined due to higher depreciation, interest, operating and maintenance expenses. On the plus side, management increased their long-term growth objective to 5% to 7%. XEL is benefitting from outperformance in conservative stocks and utilities. The stock is above both its 50- and 200-day moving averages and can be bought on pullbacks for safe income.


Closing Prices on October 30, 2018

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.

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Why are REITs Doing So Well?

With the stock market sliding downhill fast, not many stocks hit new highs this month. But a few did. Among them last week were Realty Income Corp. (O), Omega Healthcare Investors (OHI), National Retail Properties (NNN) and Equity Lifestyle Properties (ELS). All four are real estate investment trusts, or REITs.

Why are REITs doing so well while the market is tanking?

REITs are special purpose entities, with special tax status, that own real estate and pass along most of the income from that real estate to shareholders. REITs can own any type of real estate, but most specialize in one type, like apartment buildings, malls, medical office buildings or self-storage facilities. A REIT that owns property directly and gets most of its income from its tenants’ rents is called an equity REIT.

A mortgage REIT, on the other hand, is a REIT that doesn’t own property directly. Instead, they own property mortgages and mortgage-backed securities. Their income comes from the interest they’re paid on the mortgages. They’re sometimes called mREITs. There are also hybrid REITs that own assets both ways.

Both types of REITs are exempt from taxation at the trust level as long as they pay out at least 90% of their income to investors, so they tend to have high yields. The four REITs mentioned above, O, OHI, NNN and ELS, yield 4.4%, 7.8%, 4.4% and 2.2%, respectively.

However, most REITs also have very high debt loads. They borrow heavily to invest in real estate, whether mortgages or properties. Mortgage REITs make their money on the spread between their borrowing cost and the interest rates on the mortgages they own, so they’re very sensitive to changes in interest rates. Equity REITs are less sensitive to interest rate changes, but still tend to be heavily indebted, so they still see their costs go up when interest rates rise. Better-capitalized REITs should be more insulated from rising interest rates, but the whole sector tends to get hit when rates spike.

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That’s what happened in September and early October. The yield on the 10-year note rose from 2.85% to 3.23% in about five weeks, and REITs (as measured by VNQ, the most popular REIT ETF) dropped almost 10%.

However, the spike in the 10-year yield also triggered a market pullback (or at least contributed to it), which turned into a correction as October wore on.

When the stock market really starts to struggle, many, many investors seek the safety of treasury bonds. The rising demand for treasuries drives prices up and yields down. And so, following a spike in early October, the yield on the 10-year note has fallen back to around where it started the month.

So even though rising rates (among other things) contributed to the start of the market correction, rates have been falling as the correction has worsened. The iShares 20+ Year Treasury Bond ETF (TLT) bottomed on October 8, which was just the start of the correction for the stock market.

Lower yields mean REITs have to spend less on interest. They also make REITs’ high yields more competitive, since fixed income investments begin to yield less.

However, REITs are risky, so they often decline when investors begin seeking safety. Their outperformance during this correction suggests there’s something else going on as well.

One clue might come from the junk bond market.

Junk bonds have also been doing unusually well during the market rout. Although they’re part of the fixed income market, high-yield bonds also typically decline when investors get nervous, because they’re risky assets. Usually, junk bonds decline more than twice as much as the S&P 500 during market pullbacks of more than 5% (based on data from the past five years crunched by Bloomberg). But during this year’s two corrections, junk bonds losses have averaged 12% of equity declines.

That suggests that the equity market selloff may have been more about repricing certain growth-oriented assets—like the FANG stocks—than a wholesale, across-the-board reduction of risk. Of course, only time will tell.

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