Cabot Dividend Investor Issue: August 9, 2023

An All-Weather Stock for an Unpredictable Market

“The stock market always acts to fool the greatest number of people.”

That’s one of the oldest adages on Wall Street, and perhaps the truest, especially in the short term. This year began with high inflation, a hawkish Fed, and a looming recession. Pundits almost unanimously predicted more 2022-style bear market ugliness in the first half of this year. But the S&P 500 rallied 19.5% in the first seven months of the year and moved to within 4% of the all-time high.

The pandemic was another confounding experience in the market. Stocks initially crashed 30% as Covid took hold and the government crashed the economy with strict lockdowns. But the market began to rally in March of 2020 and never looked back, despite the fact that lockdowns would persist for another year plus. That was a head scratcher.

These are just the most recent examples of the market’s unpredictability. I could go on and on. No one can figure out the direction of stocks in the near term. One of the greatest scientists who ever lived, Sir Isaac Newton, attempted to apply his mathematical genius to the stock market. It didn’t work. He lost his shirt. Later, he famously quipped, “I can calculate the motions of heavenly bodies, but not the madness of people.”

The market looks great right now. Inflation is falling fast, the Fed is just about done hiking rates, and there is no recession in sight. It looks like we will get through the steepest rate-hike cycle in decades without much economic pain. Bull markets rarely fade at this early stage and there is still a historically very high level of cash on the sidelines that could give stocks a huge boost if deployed.

But nothing is certain. Inflation could rise again. The Fed may keep rates high for longer than the market expects. The economy may turn south in the quarters ahead. There could be more trouble with bank failures or the war in Ukraine. S&P earnings have been contracting for three straight quarters. That could be a tough backdrop in which to build on what is already a 30% S&P 500 rally from the October low.

This is the uncertain environment in which we are invested. The market could take off and provide fantastic returns for the rest of the year. Or it could pull back again or go sideways. The Cabot Dividend Investor portfolio is prepared for any event with a combination of diversification and mega-trend investing.

Many portfolio positions will continue to benefit if the market stays strong in the quarters ahead. There are also many defensive stocks that should deliver strong relative outperformance if the market turns south again. All positions have an excellent longer-term prognosis, and the portfolio is built to provide strong returns with less volatility than the overall market.

In this issue, I introduce a stock that diversifies the portfolio into the consumer space. The company operates in an incredible niche market that has provided earnings growth for 31 consecutive years and enabled the stock to outperform the market in every measurable period over the last 15 years. The company is positioned for strong growth in the years ahead and the stock has a long track record of delivering stellar returns in all kinds of markets.

What to Do Now

No one ever really knows in which direction the next 10% move in the market will be, but the next 100% move will surely be higher.

We’ll see if the market can add to the 30% rally from the low, or if it turns south again. A reasonable argument can be made for either scenario. But you’re probably not going to cash in all your investments at the end of the year and stop investing. You’re in this for the longer haul.

I tend to be contrarian and I like cheap stocks that have underperformed recently. Consider what has happened over the past couple of years. In 2022, energy was the top-performing S&P 500 sector and technology was the worst performing. The situation reversed this year. Technology is the top performer and energy is the worst.

Not many investors wanted to buy technology stocks at the beginning of the year after they had been dogs for a year. But that would have been a great time to buy those stocks. In a similar vein, not many investors want safe stocks in the utility or healthcare sectors now, as they have been this year’s worst performers next to energy.

The portfolio’s utility stocks including Brookfield Infrastructure Partners (BIP), NextEra Energy (NEE), and Xcel Energy (XEL) have had a rotten year, especially the latter two. NEE and XEL are selling very near the 52-week lows. Yet, these stocks have historically been very strong performers. And the operational performance of the companies has been fine.

The market reinvents itself and changes personality all the time. This year it invented a market that doesn’t like utilities. But these stocks are dirt cheap and among the best stocks to own if the economy does turn south in the quarters ahead. With a longer-term outlook, it’s a great time to buy these stocks if you don’t own them already.

Sure, the stocks could flounder for a while longer. But I doubt very much that you will regret buying them a year from now.

Featured Action:

Buy Tractor Supply Company (TSCO)

Tractor Supply is the largest operator of farm and ranch stores in the United States. Stores target recreational farmers and ranchers in primarily rural areas. The 85-year-old company operates 2,181 Tractor Supply stores in 49 states and 192 Petsense stores in 23 states. Tractor Supply is ranked 291 on the Fortune 500, has 52,000 employees, and over $14 billion in annual revenue.

It’s a significant company and a serious powerhouse in its area. The stores are huge with an average of 15,500 square feet of selling space and a similar amount of outside space. It does have some competition from big boys like PetSmart and Lowe’s (LOW), but it offers a uniqueness that makes it its own destination for rural customers. It also blows away smaller competitors with size and scale.

The store provides an environment and experience that its customers love. It also has the advantage of being partially insulated from e-commerce competition by offering many products that serve an immediate need or are expensive to ship. Here’s a sample of the things people buy at Tractor Supply:

• Clothing
• Power tools
• Equine and pet supplies
• Fencing
• Tractor/trailer parts
• Welding & pump services
• Lawn and garden supplies
• Sprinkler and irrigation parts.

In 2022, here’s how overall company revenue was distributed among the product categories: Livestock and Pet (50%); Hardware, Tools, and Truck (19%); and Seasonal Gift and Toy (21%). Tractor Supply has a diversified product offering that enables the store to thrive in just about any economy. That’s a big part of the reason the company has been able to generate 31 consecutive years of sales growth.

Resilience was evident in the second quarter. It’s basically a lousy consumer environment with tepid growth and inflation, at least in rural areas. As a result, sales on bigger ticket and seasonal items struggled. But the company still grew net revenue 7.2% and earnings per share (EPS) by 8.5% versus last year’s quarter. Pet and livestock sales grew at twice the rate of its competitors, and it also got double-digit growth from its consumable, usable, and edible (CUE) product subcategory.

An interesting thing happened with the second-quarter earnings report. Tractor Supply reported earnings that were below expectations and reduced earnings guidance for the year, but the stock price rose 4.2% on the day of the report. That’s because the company raised its store growth target from 2,800 (currently 2181) to 3,000 in the next decade. Investors are wisely looking past the temporarily weak consumer toward strong growth over the longer term.

Tractor anticipates adding 80 new stores in 2024 and an average of 90 stores per year thereafter. That’s serious 37% store growth over the next 10 years. Tractor Supply had anticipated growing the bottom line by 8% to 11% per year for the next decade. But it may be more now.

The company has a proven ability to profitably integrate new stores. It has grown the store base at a strong clip over the past couple of decades and its return on invested capital (ROIC) has soared from 10% in 2000 to 35% today.

The Dividend

TSCO currently pays an annual dividend of $4.12 per share, which translates to a 1.84% yield at the current price. The payout is well supported with a 39% payout ratio where retained earnings provide expansion money, and the company is buying back shares. True, 1.84% is a rather lame yield, but the payout is rapidly growing. Tractor Supply has grown the payout by a whopping 28% per year average over the last five years.

The yield on cost is likely to rise significantly if the stock is held long term. But even more importantly, companies that grow their dividend tend to be among the best performing stocks over time. TSCO has outperformed the S&P 500 in every measurable period over the last 15 years. A $10,000 investment in the S&P 500 index 5 years ago would be worth $17,280 now (as of August 3), but the same investment in TSCO would be worth $30,873 today. Of course, that’s no guarantee that it will outperform the market in a similar fashion in the future. But companies with consistently growing earnings tend to continue to outperform.

I scanned quite a few dividend stocks in search of this month’s highlighted stock. Most were far less stable and predictable. There were solid dividend stocks that are highly touted like Medtronic plc (MDT), Gilead Sciences (GILD), Walgreens Boots Alliance (WBA) and others. But these stocks have been lackluster performers for many years. I want a portfolio addition with a much better chance of providing significant capital appreciation.

Tractor Supply is a more serious retail player than you might realize if you don’t live in a rural area. The company has a proven ability to consistently grow earnings and deliver on stock performance. Few retailers have grown earnings every year for 31 straight years. Last quarter, the company delivered 8.5% EPS while average S&P 500 earnings were down over 7%, and down for the third straight quarter. TSCO should be solid in just about any environment with a low beta and many products that are considered staples.

Tractor Supply Company (TSCO)

Security type: Common stock
Sector: Consumer staples/discretionary
Price: $226.00
52-week range: $181.40 - $251.17
Yield: 1.8%
Profile: Tractor Supply in the largest operator of farm and ranch stores in the U.S. with 2,181 stores in 49 states and over $14 billion in annual revenues.

Positives

• The company has a stellar track record of earnings growth and stock performance over time.
• Earnings are resilient in any economy.
• Ambitious growth targets are well supported by a long track record of doing so profitably.

Risks

• Competition could increase in the company’s niche.
• A recession in the quarters ahead would likely hurt earnings and stock performance.
• The company has a relatively high level of debt and may not be able to deliver on expansions as in the past.

Tractor Supply Company (TSCO)
Next ex-div date: August 26, est.

Recent Activity

July 12
Purchased Digital Realty Trust, Inc. (DLR) - $117.75
Qualcomm (QCOM) – Rating change “HOLD” to “BUY”
Intel (INTC) – Rating change “HOLD” to “BUY”

August 9
Buy Tractor Supply Company (TSCO)

Portfolio Recap

Digital Realty Trust, Inc. (DLR – yield 4.1%) – Digital also reported better-than-expected earnings last week because of strong data center demand and solid growth. Even more importantly, the company assuaged fears that had driven the stock price down earlier this year by executing capital recycling plans that raised over $2 billion by selling joint venture assets. The move strengthens the balance sheet and secures the dividend. Now the REIT is poised to benefit from accelerating data center demand growth prompted by the AI craze. BUY

Digital Realty Trust, Inc. (DLR)
Next ex-div date: September 14, 2023, est.

Enterprise Product Partners (EPD – yield 7.5%) – The company reported second-quarter earnings that reflected a decline in earnings per share to $0.57 per unit versus $0.64 per unit in last year’s quarter. The decline was primarily due to lower natural gas liquid prices. Although the partnership has minimal exposure to commodity prices directly, the lower prices resulted in diminished volumes through its systems.

The decline was partially offset by higher volumes across the board in other areas as expansions came online. The dip in gas prices is temporary, but the additional capacity is permanent. Prices have been on the rise since the end of June and the increasing volumes will lead to higher earnings in the future. EPD is flirting in the range of close to a dollar off the 52-week high. (This security generates a K-1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: October 27, 2023, est.

ONEOK Inc. (OKE – yield 5.9%) – After getting clobbered in May when the market hated its purchase of Magellan Midstream Partners (MMP), OKE came right back and regained all those losses and moved to within less than 10% of the 52-week high. But the stock was down more than 2% on Tuesday after reporting better-than-expected earnings that grew 13% over last year’s quarter on robust volumes and raising 2023 guidance. It’s perplexing.

Investors spit on stellar earnings during an ugly day in the market, probably because the report reminded investors of the pending Magellan Midstream Partners merger. The market doesn’t like the merger even though it will a be a longer-term positive because it will limit growth in the short term. Plus, the “stand-alone” earnings don’t necessarily reflect the status of the soon-to-be combined company. HOLD

ONEOK Inc. (OKE)
Next ex-div date: October 28, 2023, est.

Realty Income (O – yield 5.1%) – This legendary monthly income stock reported earnings that slightly beat estimates. It also revealed a stellar 99% occupancy rate for its properties and an additional $3.1 billion invested in the quarter in 710 properties. The REIT has been solid, but this market is not rewarding solid at this point. O currently sells well below the pre-pandemic high, despite having higher earnings. But income and safety will come back into vogue eventually. BUY

Realty Income (O)
Next ex-div date: August 30, 2023, est.

The Williams Companies, Inc. (WMB – yield 5.2%) – The midstream energy company reported earnings last week that surpassed estimates and the stock got a further boost on the news. Volumes of throughput were solidly higher, and earnings grew 8%. That’s a far cry from the 30%-plus earnings growth of last quarter, but the reduction is from the lull in acquisitions coming online, which was expected. It’s solid growth under the circumstances. In addition, recent expansion and acquisition activity bodes well for growth in 2023 and 2024 beyond what was expected. The stock is now up 20% since the end of May and is within 5% of the 52-week high. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: September 8, 2023

AbbVie (ABBV – yield 3.9%) – This position was upgraded to a buy in June after it started to move off the bottom. AbbVie reported earnings that beat on both earnings and revenue and the company also raised earnings guidance for the year. The stock has spiked more than 6% since the report. Humira sales were down less than expected and AbbVie’s replacement immunology drugs did better than expected. The report emboldens the notion that the revenue drop from the Humira patent expiration will be very temporary and AbbVie will turn the corner sooner than expected en route to a promising future. Plus, the stock should hold its own even if the economy rolls over. BUY

AbbVie Inc. (ABBV)
Next ex-div date: October 13, 2023, est.

Broadcom Inc. (AVGO – yield 2.1%) – It looks like AVGO is just going to keep moving higher regardless of how high it gets. It has pulled back slightly from the high. But the stock appears to have found a new home for the time being at a much higher price level after the spring AI surge. I thought AVGO would pull back, but it never sobered up and maybe never will. The ascent has indeed slowed down. But it isn’t showing any weakness. The AVGO return now exceeds 100% since being added to the portfolio in early 2021. It is no doubt a great company and returns should be good over the next couple of years. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: September 21, 2023, est.

Brookfield Infrastructure Partners (BIP – yield 4.3%) – The infrastructure partnership once again reported stellar earnings with 8% funds from operations (FFOs) growth over last year’s quarter. Brookfield also raised the distribution by 6%. But the stock got clobbered after the report anyway.

As with most utilities, Brookfield has high debt levels, and the recent spike in rates increases borrowing costs. But this is likely a temporary situation. The partnership is growing earnings while S&P 500 earnings are shrinking for the third straight quarter. Brookfield is targeting 10% average earnings growth and 5% to 9% distribution growth over the next several years. It is a safe and currently undervalued holding. (This security generates a K-1 form at tax time.) BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: August 30, 2023, est.

Eli Lilly and Company (LLY – yield 1.0%) – WOW! Lilly reported earnings on Tuesday that blew away estimates because of soaring sales from its weight loss drug Mounjaro. Revenue grew 28% and earnings soared 85% over last year’s quarter and the company significantly raised future guidance. The market seems pleased as the stock is up over 18% on Tuesday morning to a new all-time high on an otherwise crummy day for the overall market. Diabetes drug Mounjaro, which is pending FDA approval this year for weight loss, sold $1 billion in the quarter versus a projected $740 million.

Sales would have been higher, but Lilly couldn’t produce enough – a situation that is being remedied. Novo Nordisk also reported a 21% body weight reduction in its weight loss drug, which is prompting greater insurance coverage and a higher likelihood of the FDA approving similar drugs, which also increased the Street’s optimism for Mounjaro. By the way, Lilly is also expecting FDA approval for its other potential mega-blockbuster Alzheimer’s drug by the end of the year. It’s been a tough market for the heathcare sector. But nobody told LLY. HOLD

Eli Lilly and Company (LLY)
Next ex-div date: August 14, 2023

Hess Corporation (HES – yield 1.2%) – The exploration and production company stock has moved 17% higher in the last month and is now within 5% of the 52-week high. It did report earnings that beat expectations as higher production offset lower realized oil and gas prices. But energy stocks have been moving higher as oil prices are on the rise because of strong demand and limited supply. Hess’ strong margins give it strong leverage in a rising energy price environment. BUY

Hess Corporation (HES)
Next ex-div date: September 14, 2023, est.

Intel Corporation (INTC – yield 1.5%) – The chip maker reported earnings that beat estimates and the company returned to profitability. The PC market appears to have bottomed out and is poised for a possible second half recovery as Intel is also increasing its market share. Shares had initially soared, but the stock has since lost almost all of the gains as the euphoria wore off, at least for now. Intel does still have a promising future as it has invested heavily in chips in high growth areas and insiders have been buying heavily into the stock. BUY

Intel Corporation (INTC)
Next ex-div date: November 4, 2023, est.

Qualcomm Inc. (QCOM – yield 2.6%) – Qualcomm reported earnings results last week that the market hated and the stock has fallen over 10% since the report. Earnings were mixed with revenues missing forecasts and earnings beating. But earnings were down 37% year over year and revenues fell 23%. It’s because of lower smartphone sales as the 5G upgrade cycle ended and economic conditions tightened. Handset chip sales were down 25%. Sales are expected to remain bleak for the rest of 2023.

However, smartphones sales may be close to bottom as they are expected to increase in 2024 and Qualcomm is expected to resume earnings and revenue growth. This slump was expected and that’s why QCOM has underperformed. But it is cheap now at 13 times earnings and this lull in the cycle will certainly end at some point. BUY

Qualcomm Inc. (QCOM)
Next ex-div date: August 30, 2023

UnitedHealth Group Inc. (UNH – yield 1.4%) – UNH has leveled off over the past few weeks after catching a little bit of fire. UNH floundered after it reported higher costs from more people getting elective surgeries because of pent-up pandemic demand. But the company since reported higher-than-expected earnings and raised guidance, negating the negative catalyst that had driven the stock price down. It’s still in the lagging healthcare arena but it could have a much better rest of the year. BUY

UnitedHealth Group Inc. (UNH)
Next ex-div date: September 15, 2023, est.

Visa Inc. (V – yield 0.8%) – V loves the still strong consumer and increasing likelihood of a soft landing. Consumer spending remains strong, and the company reported another impressive quarter. The stock has pulled back after soaring to a 52-week high. But that is typical behavior for this stock. The longer-term situation is great as more people move toward cashless transaction and Visa has an unbelievable market share. The better short-term prognosis is a surprise. Hopefully, the good times last. HOLD

Visa Inc. (V)
Next ex-div date: August 10, 2023

NextEra Energy (NEE – yield 2.7%) – The weakness continues. This combination regulated and clean energy utility stock just hit a new 52-week low. The utility sector remains under pressure even in the broadening market rally as interest rates have risen and growth plays continue to be favored. But the operational performance is solid. The utility grew earnings 8.6% in the second quarter and 11% in the first half versus the same periods last year. It also has predictably solid earnings going forward because of a considerable project backlog. The market will shine on NEE again eventually. BUY

NextEra Energy Inc. (NEE)
Next ex-div date: August 29, 2023

Xcel Energy (XEL – yield 3.5%) – These are ugly days for utility investors. But sector dominance always rotates eventually. This clean energy utility reported lower-than-expected earnings last week of $0.52 per share versus $0.60 in last year’s quarter. The company attributed unusual weather and maintenance issues to the one-off decline and reaffirmed previous earnings guidance for all of 2023. XEL has been trending lower since the beginning of April in a tough market for the utility sector. But things change and XEL is cheap and one of the best utility stocks to own. BUY

Xcel Energy Inc. (XEL)
Next ed-div date: September 14, 2023, est.

USB Depository Shares (USB-PS – yield 5.8%) – This preferred issue has bounced around since being added to the portfolio. It took an unjustifiable hit during the banking issues. But it has mostly moved conversely to interest rates. It’s worth noting that the 10-year Treasury is near the high and USB-PS is still at a higher price since being added. We also may be near peak interest rates in this cycle. BUY

U.S. Bancorp Depository Shares (USB-PS)
Next ex-div date: October 15, 2023

Invesco Preferred ETF (PGX – yield 6.3%) – Longer-term rates have moved near the recent high again as a recession appears less likely in a still strong economy. The timing for buying PGX is probably good right now as rates appear likely near the peak. BUY

Invesco Preferred ETF (PGX)
Next ex-div date: August 24, 2023, est.

Vanguard Long-Term Corp. Bd. Index Fund (VCLT – yield 4.5%) – There could be some near-term turbulence with the price on the way to solid longer-term returns and diversification. The fund is holding up well in the recent rising interest rate environment and should benefit if and when rates come back down. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: September 1, 2023, est.

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 are estimated.

The next Cabot Dividend Investor issue will be published on September 13, 2023.