2021 Could be the Year of the Dividend Investor with these Five Stocks Standing Out for Cash Flow
This year was nothing short of a disaster for dividend investors. Total S&P 500 dividend payments for the nine months through September were $39.7 billion lower compared to the 2019 period according to S&P Dow Jones Indices.
But there’s hope on the horizon and reason to believe that 2021 could be a cash bonanza for investors. Record bond borrowing has boosted balance sheet cash to all-time highs for companies in the large cap index. Cash held by non-financial companies in the index surged $90 billion to a record $1.89 trillion in the second quarter.
When COVID cases start declining next year, aided by vaccine distribution, the focus for many companies will turn to paying down the mountain of 2020 debt but investors could also be rewarded with increased dividends. Not only will cash-rich companies unfreeze their dividend increases but less economic uncertainty will drive confidence in sending more of that cash flow to yield-hungry investors.
I started my 2021 dividend portfolio recently with five stocks paying yields twice the average dividend yield on the market and focused on four cash-flow sectors; real estate, financials, energy and utilities. All four sectors are traditional dividend plays and some great rebound potential next year.
Here I want to add five more dividend stocks to my portfolio, five companies with catalysts for cash flow growth and price appreciation.
The potential for a cash rush from companies next year doesn’t mean you can throw your money at any dividend stock and expect outsized returns. The economy is still in a precarious position and leverage held by S&P 500 companies is also high.
Looking for the dividend stocks with cash flow ready to return, I used three factors to narrow my search.
- A payout ratio below the industry average that holds some income back for growth and reinvesting into the future of the business.
- An earnings before interest, taxes, depreciation & amortization (EBITDA) interest coverage ratio below the industry average to find the companies with no problem meeting their financial obligations.
- A dividend yield above 3.5% to find the companies with a true commitment to shareholder cash return.
The dividend yield requirement is arbitrary but almost exactly twice the 1.74% average yield on stocks in the S&P 500. Beyond the three criteria for my dividend picks, I also researched stocks for insider ownership, valuation and a potential catalyst for 2021.
Omnicom Group, OMC, is the world’s second-largest ad holding company based on revenue and pays a 4% dividend yield. It should be no surprise that shares have been weak this year, still down 21% from the 52-week high, as investors worry that ad budgets are the first to be cut in a recession.
The recession could become a hidden opportunity for the company as it cuts operating expenses and uses its scale to win market share from smaller ad agencies. Revenue was reported lower by 11.3% in the third quarter versus the same period last year but the company managed to cut its expenses by a greater amount. On the expense program, the company was able to report an increase in operating profits of 6% against last year’s numbers and beat analyst estimates for earnings by 13% to report $1.21 per share.
Omnicom had increased its dividend by a 6.8% annual rate in the four years through 2019 but has yet to increase the payment this year to protect cash flow. As business improves and uncertainty comes out of the economy, I expect next year’s dividend to increase at a similar rate.
Hedge funds have been reluctant to add to their positions lately as a rise in COVID infections scares investors from economically-sensitive companies. Citadel Investment Group is the largest shareholder with $230.1 million as of early December. Even as institutional investors play the waiting game, it could be a good opportunity to pick up shares of a value-play in the space ahead of a 2021 recovery.
Shares trade for 12.5-times the $5.21 in per share earnings booked over the last year with the multiple reaching 14-times last year. Analysts expect earnings to rebound to $5.37 per share over the next four quarters for a price target of $75 on the 14-times price multiple.
Kinder Morgan, KMI, is one of the largest energy infrastructure companies in North America with over 80,000 miles of oil and gas pipeline and pays a 7% yield. Everyone in the energy space has been slammed this year with the crash in oil price and shares of KMI are down 30% from January.
The company is one of the few in the energy space to increase the dividend this year and a 20% annualized growth in the payment over the last four years speaks to its commitment to shareholder cash returns. The current payment works out to $2.38 billion a year, just 47% of the company’s $5.1 billion in distributable cash flow expected this year.
Beyond the return of cash through the dividend, KMI is using an aggressive share buyback program to reward investors with nearly $2 billion still available to repurchase shares. The recent cancellation of the Atlantic Coast Pipeline and potential regulatory hurdles as the Democrats take the White House could make existing pipeline assets more valuable and command higher fees over the next four years.
Executive Chairman and co-founder Rich Kinder has continued to add to his ownership stake, buying in the last quarter to bring his position to 245 million shares or about 11% of the company. Hedge Fund FPR Partners, led by Bob Peck and Andy Raab, continues to be the largest institutional holder with a $221.7 million interest in the shares.
On that expectation for $5.1 billion in distributable cash flow this year, shares trade for just 6.6-times. The one-year average analyst target of $16.67 is 12% above the current price and in addition to the healthy dividend investors collect while waiting.
Besides owning the dominant tobacco brand in the U.S. and a dividend that has grown by 53% over the last five years, Altria Group (MO), has some key investments that could help it grow. The company holds a 10% stake in the world’s largest brewer, Anheuser-Busch, and a 45% stake in cannabis giant Cronos Group.
While volume for cigarettes was reported down slightly in the third quarter, Altria managed to use strong pricing gains to drive a 5% increase in revenue. Add in an impressive expansion of 2% in the operating margin on cost cuts and earnings rose 9% from the year-ago period.
Against strength in its legacy segment, Altria recognized heavy weakness in its growth segments of e-cigarettes and cannabis. The company took another write-down to its original $12.8 billion investment in Juul Labs, now valuing the stake at just $1.6 billion. The pandemic has also weighed on the company’s 45% stake in cannabinoid producer Cronos Group, reporting a twelve-month loss of $317 million on the investment.
Against this scenario, there could be a reason for optimism over the next year. The fact that Altria has been able to beat earnings expectations in three of the last four quarters by an average of 5.5% speaks to the strength in its core tobacco business. The legislative environment has clearly improved for cannabis and states scrambling to fill massive budget gaps could look to legalization as a way out. That could drive a turnaround for the company’s stake in Cronos.
Renaissance Technologies is the largest hedge fund holding shares of Altria with a total investment of $352.7 million, more than twice the next largest fund holder.
The company has grown its dividend by 8.8% annually over the last five years and had a history of share buybacks before pausing to protect cash flow this year. Shares trade for 9.4-times the $4.39 in earnings reported over the last year. Altria traded for 11-times on a PE basis as recently as December of last year which could drive the shares to nearly $50 on expected earnings of $4.51 per share over the next four quarters.
Earnings at Wells Fargo (WFC) have cratered over the last year on a drop in interest rates and higher loan loss provisions but a turnaround in both of these could be the catalyst to take the stock higher in 2021.
Despite a red-hot mortgage market this year, the net interest margin banks are collecting means they just aren’t making much money. With the Federal Reserve committed to holding down short-term rates, even a marginal increase in the long-end of the curve could drive earnings improvement.
A bigger catalyst though is in the bank’s loan loss allowance account. This is the cash reserve account banks build to cover estimated loan defaults during times of economic uncertainty. The bank moves the amount from the income statement, decreasing earnings, and holds it as a balance sheet asset.
Since the fourth quarter of last year, Wells Fargo has increased its loan loss allowance account by $9.9 billion to $19.46 billion. That’s nearly $10 billion subtracted from earnings and the reason the bank has reported just $0.37 in per share earnings over the last year versus $4.63 per share in the four previous quarters.
But if small business gets another stimulus package or the economic recovery continues to build, the bank may not need all the money it’s socked away in this reserves account. Moving even a portion of that $10 billion back onto the income statement could boost earnings considerably and surprise the market.
Even after cutting his position in the bank by 46% in the third quarter, Warren Buffett’s Berkshire Hathaway continues to lead hedge fund holders of the shares with nearly $3 billion invested in Wells Fargo as of early December. Other hedge funds have been increasing their exposure with Eagle Capital Management and Citadel Investment Group both buying shares.
The dividend was cut by 80% this year and now yields just 1.35% annually. That wouldn’t normally qualify as a dividend stock in my book but the cut was forced by the most recent Fed stress test. Next year should bring more certainty in cash flows and potentially a windfall of cash from the loan losses account and it may not be long before Wells is a top-rated dividend stock again.
Shares trade for a price of just 0.75-times book value against a 1.3-multiple as recently as December of last year. Earnings are expected to rebound to $2.09 per share over the next four quarters and an increase in the dividend could drive the shares back to price-to-book parity for a 30% gain from here.
Five years have passed since Kraft Heinz (KHC) issued shares and as is typical in a private equity deal, the company was so bloated with debt that lack of financial flexibility sapped any advantage the company may have had.
Shares halved from their 2015 IPO, finally leveling off with a new CEO in April of last year. The slide in revenues seems to have halted and cost-cutting is improving margins. The sale of its specialty cheese business for $3.2 billion announced earlier this year will go a long way to reducing the company’s $28 billion in debt, already down over $2.7 billion in the last three years.
Kraft continues to be one of Berkshire Hathaway’s largest positions with over $9.7 billion invested in the shares. Other hedge funds including First Eagle Investment Management and Citadel Investment Group increased their positions in the third quarter.
Despite the turnaround in fundamentals, investors have yet to notice with a 9.7% increase in the shares over the last year versus a 19% run for stocks in the S&P 500. That has created a solid value play with the stock trading for just 12.2-times the $2.80 in per share earnings reported over the past four quarters. Even multiple expansion back to 15-times on a PE basis would take the shares to $42 per share and a 23% return for investors.
Watch this video for my first five dividend stocks in the 2021 portfolio along with why stocks in the financials, energy and real estate sectors could produce higher returns next year.
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Next year could be a cash flow dream for dividend investors as companies increase their payments after protecting cash this year. Historically low rates will continue to make bond borrowing a cheap source of cash and stronger growth in operational cash flow means companies will be looking for something to do with record-high balance sheet cash. That could mean higher dividend payments and share buybacks.
Disclosure: 5 Dividend Stocks To Boost Cash Flow in 2021 is written by Joseph Hogue, CFA who is a former equity analyst and economist. Born and raised in Iowa, Joseph graduated from Iowa State University after serving in the Marine Corps. He worked in corporate finance and real estate before starting a career in investment analysis. He has appeared on Bloomberg and CNBC and led a team of equity analysts for a venture capital research firm. He holds a master’s degree in business and the Chartered Financial Analyst (CFA) designation.