Cabot Dividend Investor Issue: February 8, 2023

Bank on These “All Weather” Stocks

The market is rallying this year because of increasing optimism of a soft landing. Investors have been sensing that inflation will continue to fall and the Fed will soon stop hiking rates, and we will escape this cycle without much economic pain.

A few months ago, most economists believed that it was extremely unlikely that inflation could be contained without a recession. But more are changing their tune and acknowledging an increased possibility. Recent evidence supports the optimistic view.

Inflation is coming down. The December Consumer Price Index (CPI) was 6.5%, down from a high of 9.1% in June. In addition, the Fed has indicated that it is unlikely to raise the Fed Funds rate much beyond 5%. And the rate is already 4.75%. Meanwhile, the economy is still humming.

Fourth-quarter GDP was a solid 2.9%. The recent jobs report reflected 517,000 new jobs created and the unemployment rate fell to the lowest level in 50 years. Those numbers don’t reflect an economy on the brink of recession. If this economy can endure high inflation and a Fed Funds rate raised by 4.50% in less than a year, it should easily handle a few more basis points of rate hikes.

Hopefully, a soft landing will unfold, and the market can rally out of this bear market and into the next bull market sooner rather than later. But it may not be time to buy into that rosy picture just yet. There are some risks.

Sure, inflation is down to 6.5%. But it may be too soon to declare victory. This inflation is still the highest it’s been in more than 30 years and a long way from the Fed’s target rate of 2%. The inflation rate may stop falling, especially if the economy remains strong. In that case, the Fed may have to raise rates higher and for longer than the market currently anticipates.

There also might be another shoe to drop on this economy. Historically, it takes more than a year for the negative effects of Fed rate hikes to ripple through the economy. The damage already inflicted may not be realized until later this year. There may be a steeper economic downturn in the works than the market is currently pricing into stocks. It’s still premature to declare a “soft landing.”

What to do now

I hate to be a negative Ned. Through the years, the U.S. economy has consistently proved stronger and more resilient than most pundits give it credit for. The market has consistently proved naysayers wrong as well. The pain may be over, and we could be off to the races.

But historically, inflation and rising interest rates have proved to be a tough nut, even for the strong and resilient U.S. economy. In addition, the unprecedented pandemic crash and recovery may be skewing the economic numbers at this point. It’s difficult to say to what extent this economy is still running on stimulus juice that won’t last.

It is certainly possible that we could get through this cycle soon and without a recession. The market could rally to new highs without much more trouble. In that case, there should be more of what we have already seen so far this year where cyclical and growth stocks rally and defensive stocks lag.

On the other hand, a more hawkish Fed or deeper economic downturn than currently anticipated could have the opposite effect, where growth and cyclical stocks take another drubbing and defensive stocks outperform.

This portfolio is erring on the side of caution. Most of the stocks in the portfolio and all of the current BUY rated stocks are defensive oriented. There are some more cyclical and growth-oriented stocks in the three technology stocks and Visa (V) in case this market does recover sooner. But on balance, the portfolio is taking a defensive posture.

But what do you do with new money? You could just bet on one scenario and hope for the best. But there might be a better way to navigate these waters. Instead of gambling on a certain outcome, we can buy stocks that should thrive in both bull and bear markets.

Below I highlight four current portfolio positions that I consider “all-weather” stocks. These stocks should do just fine if the market takes off and doesn’t look back in a soft landing. But they should also perform relatively well in case one of the other more ugly scenarios unfolds. They should be solid in almost any kind of market environment and pay you a great income in the meantime.

Featured Action:

Buy NextEra Energy, Inc. (NEE) Yield: 2.3%

Utility stocks fill a great niche in any investment portfolio, especially in a bear market. The sector is the most defensive on the market as earnings are virtually immune to economic cycles. Stocks also pay high dividends and typically hold up very well in down markets.

NextEra Energy provides all those advantages plus exposure to the fast-growing and highly sought-after alternative energy market.

NextEra Energy is the world’s largest utility. It’s a monster with about $20 billion in annual revenue and a $167 billion market capitalization. Ordinarily, when you think of a huge utility you probably think it has lackluster growth and a stable dividend. But that’s not true in this case. Earnings growth and stock returns have well exceeded what is normally expected of a utility.

Amazing track record

NEE has not only vastly outperformed the Utility Index, it has also blown away the returns of the overall market. NEE has well exceeded the returns of the S&P 500 over the last five- and 10-year periods, with returns of 119% and 446% respectively (with dividends reinvested). And the stock achieved these returns with a beta of just 0.49, meaning it was less than half as volatile as the overall market.

How can that be? It’s because it isn’t a regular utility. NEE is two companies in one. It owns Florida Power and Light Company, which is one of the very best regulated utilities in the country, accounting for about 55% of revenues. It also owns NextEra Energy Resources, the world’s largest generator of renewable energy from wind and solar and a world leader in battery storage. It accounts for about 45% of earnings and provides a higher level of growth.

Investors love it because they get the safety and income of a utility and still get growth and capital appreciation. It’s the best of both worlds.

Stability with growth

Florida Power and Light is the largest regulated utility in the U.S. It has about 6 million customers in Florida. It is one of the very best electrical utilities in the country. There are a few good reasons why Florida is a great place to operate a utility.

The state has a growing population. Utilities have a limited geographical range, and a stagnant population can make it tough to grow. Plus, it is one of the most regulator-friendly areas in the country. That’s huge for getting approvals for periodic expansions and price hikes. It also doesn’t hurt that Floridians run their air conditioners like crazy, and just about all year long.

The alternative energy company, NextEra Energy Resources, is the world’s largest generator of renewable energy from wind and solar. Alternative energy is the future, and this company is the top of the heap. The government and regulators love them for it. It’s also a huge benefit that the cost of clean energy generation constantly gets cheaper as technology advances.

There is also a huge runway for growth projects. NextEra has deployed about $55 billion between 2019 and 2022 on growth expansions and acquisitions. The company is expecting an increase in investments of 1.5 times from year-end 2019 levels between 2021 and 2024.

Buy Brookfield Infrastructure Partners (BIP) Yield: 4.1%

Brookfield Infrastructure Partners (BIP) is a Bermuda-based Master Limited Partnership (MLP) that focuses on high quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.

Infrastructure is defined as the basic physical structures and facilities needed for the operation of a society or enterprise. It includes things like roads, power supplies and water facilities. Not only are these some of the most defensive and reliable income generating assets on the planet but infrastructure is rapidly becoming a more timely and popular subsector.

As one of the very few tested and tried hands, Brookfield is right there. It’s been successfully acquiring and managing these properties for more than a decade in a way that delivers for shareholders. Since its IPO in 2008, BIP has provided a total return of 773% (with dividends reinvested), more than double the return of 300% for the S&P 500 over the same period. And those returns came with less risk and volatility than the overall market.

Brookfield operates a current portfolio of over 1,000 properties in more than 30 countries on five continents. The company operates four segments: Utilities (30%), Transport (30%), Midstream (30%) and Data (10%).

Assets include:

• Toll roads in South America
• Telecom towers in India and France
• Railroads in Australia and North America
• Utilities in Brazil
• Natural gas pipelines in North America
• Ports in Europe, Australia and North America
• Data centers on five continents

The dividend is rock solid with a low 70% payout ratio and a history of steady growth. The payout has grown by a CAGR (compound annual growth rate) of 10% per year since 2009 and the company is targeting 5% to 9% annual growth going forward.

BIP is a good long-term investment anytime, as the above numbers illustrate. But it is particularly attractive now because it’s cheap (currently selling more than 20% below the 52-week high) and can well navigate both inflation and recession.

Also, 85% of revenues are hedged to inflation with automatic adjustments built into its long-term contracts and its crucial service assets should be extremely resilient in any economy, and earnings should remain strong even if there is a deeper recession than currently expected.

Buy Williams Companies Inc. (WMB) Yield: 5.28%

The most resilient and higher growth midstream companies tend to deal in natural gas and natural gas liquids (NGLs). Natural gas in by far the cleanest burning and fastest growing fossil fuel source in the world, and the U.S. is the world’s largest producer. It is also viewed more favorably by regulators because it is so much cleaner than oil and coal.

Given the current inflation and energy shortages, even some of the more hardcore climate change activists are increasingly seeing natural gas as the bridge to a lower carbon future. The U.S. and the world currently use fossil fuels for more than 80% of energy needs. It’s unrealistic to expect clean energy sources to replace them any time soon. In the meantime, the U.S. has dramatically lowered its carbon footprint by transitioning to natural gas from coal and oil and will continue to do.

It’s a similar situation in the rest of the world. The U.S. still has more natural gas than it can use, and other parts of the world are desperate for the stuff. Massive natural gas export facilities have been built in recent years that liquify gas and ship it overseas. That market should remain red hot, especially with Europe looking for other sources after their fallout with Russia.

Williams is an American midstream energy company involved in the transmission, gathering, processing and storage of natural gas. It operates the large Transco and Northwest pipeline systems that transport gas in densely populated areas from the Gulf to the East Coast. Roughly 30% of the natural gas in the U.S. moves through its systems.

The bulk of adjusted EBITDA comes from pipeline transmissions plus a smaller deep-water presence in the Gulf of Mexico (47%) and gathering and processing facilities (38%). The rest is from marketing and NGL (natural gas liquids) services, exploration and production joint ventures, and oil gathering and processing. The company has minimal commodity price exposure, as most revenues are fee-based and secured under long-term contracts with inflation adjustments.

It’s also well worth noting that the company acquired the remaining 26% ownership from its limited partner and is now a regular corporation (not a Master limited Partnership). Therefore, dividends are taxed at the maximum 15% rate (or 20% in some cases) and the investment doesn’t generate a K-1 form at tax time.

Stock Performance

WMB returned more than 30% in 2022 while the market was down more than 19% for the year. It has averaged better than a 20% per year return over the last three years. Yet WMB is still priced over 45% below the all-time high despite having much higher earnings now.

Recent returns are far better than the midstream energy group and only a little below the performance of the overall energy sector. Williams has been able to achieve a higher level of earnings growth than the group because it is reaping the reward of $8 billion invested in new projects between 2018 and 2021.

Net income per share was up 54% in the first nine months of 2022 versus the same period last year. The recently reported quarter featured a whopping earnings per share spike of nearly 300% over last year’s quarter. Williams also increased 2022 earnings guidance.

A huge tailwind is that there is a rise in natural gas demand in all its sectors. There continues to be a growing need for secure and reliable supplies amid geopolitical volatility and climate concerns. In fact, Williams’ earnings continued to rise right through the heart of the pandemic lockdowns, one of the worst periods for the industry ever.

The Dividend

Williams currently pays out $0.4475 per share quarterly, or $1.79 annually, after raising the latest payout by 5.1%, which translates to a current yield of 5.62%. While the company has paid a quarterly dividend since 1974, it hasn’t always raised or maintained the payout. The company slashed the dividend in the aftermath of the 2014 oil price crash. But it has since restructured in a way that makes the current dividend far safer.

Williams restructured to a regular corporation in 2018. It has since reduced its net debt-to-EBITDA by 21% while investing $8 billion in new projects with an 18.8% return on capital between 2018 and 2021. Operating margins have increased from 57% in 2015 to 70% in 2021. And adjusted earnings per share have increased at a CAGR of 18% since 2018.

The Future

As I mentioned above, the prospects for natural gas volumes going forward are tremendous. And Williams also has the advantage of having a large and well-established network. Regulators tend to be much more lenient for expansions than new projects, favoring established players. Williams has a well-positioned network that allows it to invest in high-return growth projects with minimal regulatory hurdles.

The company currently has $1.5 billion invested in six projects that will boost the bottom line over the next several years. That should keep the growth pump primed.

Despite the high returns last year, the stock still sells at just 8.5 times cash flow, a very reasonable valuation for a company with such solid earnings growth and a high and safe dividend.

Buy ONEOK, Inc. (OKE) Yield: 5.6%

ONEOK is a large U.S. midstream energy company specializing in natural gas. It owns one of the nation’s premier natural gas liquids (NGLs) systems connecting NGL supply in the Rocky Mountains, midcontinent, and Permian regions in key market centers, and also has an extensive network of natural gas gathering, processing, storage and transportation assets. A whopping 10% of U.S. natural gas production uses ONEOK’s infrastructure.

Here are some things to like about the company and stock:

• Investment grade rated debt
• 85% of earnings fee-based
• 26 years of stable and growing dividends
• C corporation structure (generate a 1099 and not a K1)

Earnings are resilient because ONEOK operates in the best segments and is well positioned in the high-growth shale regions. Natural gas is a rapidly growing fuel source that is much cleaner to burn than oil or coal. NGL is by far the fastest growing fossil fuel source. During the pandemic, in one of the worst years ever for the energy industry, ONEOK’s NGL and dry natural gas volumes both continued to grow anyway.

The Dividend

OKE pays a stellar 5.6% yield. That’s not too good to be true, for several reasons. The company has grown or maintained the payout for 26 straight years that include recession and terrible energy environments. It has also grown the dividend at a better than 8% average annual clip for the last five years.

The Timing

Why buy it now?

OKE returned a solid 16.46% in 2022. That was about on par with the rest of the midstream energy subsector. But performance had been much better than its peers. The stock returned a stellar 68% in 2021. The lower relative performance last year was for two reasons. One, after the huge 2021 performance, it didn’t have as much ground to make up. Two, earnings didn’t grow as strongly as much of the sector last year because they never decreased very much during the pandemic.

But despite higher earnings and better prospects, OKE still sells below the pre-pandemic high. Demand for natural gas is steady and solidly growing and is resilient in any economy. OKE is a safe stock in a rough market that should continue to perform well while paying a high and safe income.

Recent Activity

January 11
Purchased Vanguard Long-Term Corp. Bond Fund (VCLT) - $80.35

January 25
Medical Properties Trust (MPW) – Rating change “HOLD” to “BUY”
Xcel Energy (XEL) – Rating change “BUY” to “HOLD”

Current Allocation

Stocks 32.5%

Fixed Income 20%

Cash 47.5%

Portfolio Recap

Enterprise Product Partners (EPD – yield 7.6%) – It’s another good year so far for the midstream energy partnership. It’s up over 9% YTD after returning a market-shellacking 18.4% in 2022. Of course, it hasn’t been lighting the world on fire but it doesn’t have to while paying you a whopping 7.6% per year just to hold it. EPD is also well positioned for possible perils ahead in 2023 as it can continue to generate solid profits in recession and/or inflation. (This security generates a K-1 form at tax time). BUY

Enterprise Product Partners (EPD)
Next ex-div date: April 28, 2023, est.

ONEOK Inc. (OKE – yield 5.6%) – This midstream energy company has returned a mediocre 5.26% YTD while the overall market is up more. But that is because cyclical stocks have rallied and safer stocks have lagged so far. OKE delivered a return of 16.46% last year in a bear market and a whopping 69% in 2021. Yet the stock still remains below the pre-pandemic high with much higher earnings now. OKE is also well positioned to weather a possible recession. BUY

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

Realty Income (O – yield 4.4%) – After selling off this past fall, the legendary income REIT has resumed its slow uptrend. O recently broke out to the highest price level since the summer. I also like the way it is positioned ahead of a possible recession. Also, it’s a retail REIT, and its portfolio consists of mostly consumer staple properties like super markets and drug stores and should have no problem generating consistent revenue in an economic downturn. Plus, it pays dividends every single month. BUY

Realty Income (O)
Next ex-div date: February 28, 2023, est.

The Williams Companies, Inc. (WMB – yield 5.6%) – WMB has been lagging the other midstream companies of late. It held up much better than its peers when the sector took a hit in the fall. But it has foundered in recent months. The market seems to like its defensive characteristics best and it tends to rally with the more defensive plays. And defensive stocks may come back again in a big way before long. Prospects for midstream companies and stocks this year remain excellent. Natural gas demand should remain resilient even if the economy hits the skids. BUY

Williams Companies, Inc. (WMB)
Next ex-div date: March 10, 2023

Medical Properties Trust, Inc. (MPW – yield 9.3%) – This high paying and recession-resistant hospital REIT has been very bouncy lately. It broke out to a higher level and then pulled back somewhat. But it is still in an uptrend since the October low and probably has already bottomed out. This stock got ridiculously cheap and still had strong earnings and a safe dividend. It should be in for much better returns this year and its properties are very defensive in a recession. BUY

Medical Properties Trust, Inc. (MPW)
Next ex-div date: March 7, 2023, est.

AbbVie (ABBV – yield 4.1%) – This innovative health care company has hit another rough patch. It sold off in the spring and then recovered. Now, it has been selling down so far this year as health care and other defensive stocks have lagged in the recent rally. But ABBV returned 24% while the market fell 19.4% last year. Sure, it doesn’t go straight up, but it has been pretty good over time. There is an issue this year as blockbuster drug Humira loses its American patent. But the company has been planning for this for years and has new drugs that should pick up the slack over time. HOLD

AbbVie Inc. (ABBV)
Next ex-div date: April 12, 2023, est.

Broadcom Inc. (AVGO – yield 3.1%) – Sure, technology stocks have performed much better lately. But this software and chip company goliath has been trending sharply higher since October. It’s made a very big move and is up over 40% from the low. Its fortunes are tied to the technology sector, but it has done a lot better than its peers in the tough market. That could be because Broadcom’s business is more resilient than most as it reported a 34% earnings increase in the last quarter. It’s held tough in dark days for technology and should take off when the sector recovers. HOLD

Broadcom Inc. (AVGO)
Next ex-div date: March 19, 2023, est.

Brookfield Infrastructure Partners (BIP – yield 4.1%) – The infrastructure juggernaut has behaved oddly over the past several months. It lagged when other defensive stocks soared late last year. But it has been moving higher YTD while other defensive stocks have been struggling. The reason is the U.S. dollar. Brookfield generates a lot of its revenue overseas. The soaring dollar late last year put a crimp in returns. But the dollar has pulled back sharply and BIP has reawakened. It should be solid in a possible recession with its portfolio of crucial assets. (This security generates a K-1 form at tax time.) BUY

Brookfield Infrastructure Partners (BIP)
Next ex-div date: February 28, 2023, est.

Eli Lilly and Company (LLY – yield 1.3%) – LLY is down over 7% YTD after a stellar 2022 where it returned 34% in a bear market. Health care stocks have lagged. Earnings disappointed. And Lilly failed to get fast-track approval for its Alzheimer’s drug. But those are a lot of negatives for the stock to only be down 7%, especially after such a strong year. That’s because beyond the near-term smoke this company is expected to grow earnings by 19% on average over the next five years and it has two potential mega-blockbuster drugs that could be approved in the next year or so. HOLD

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

Intel Corporation (INTC – yield 4.8%) – The recent bad news suggests that the stock has already bottomed out. Earnings were once again hideous. Revenues plunged 32% for the quarter versus the prior year and demand for PC and server chips is falling. Global PC (personal computer) shipments fell 28.5% in the quarter. Intel also said next quarter will be worse. But the stock is at the same level as before the bad earnings. It suggests that the market already priced in a rotten first half. The company is employing a massive cost-cutting program and new products should also help the bottom line in the second half of this year. HOLD

Intel Corporation (INTC)
Next ex-div date: February 6, 2023

Qualcomm Inc. (QCOM – yield 2.2%) – Qualcomm reported earnings earlier this week. And they were bad. Net income fell 33% and revenue was down 12% from the same quarter last year. It also appears that next quarter won’t be much better as smartphone sales continue to plummet in this economy. But the stock has moved higher since the report. That suggests that this news was already factored into the stock and the market is looking towards improvement in the second half of the year. QCOM is up over 22% YTD. It has also cracked the 130 per share level for the first time since September. HOLD

Qualcomm Inc. (QCOM)
Next ex-div date: March 1, 2023

Visa Inc. (V – yield 0.8%) – The payments processing company stock has been loving the market rebound. It’s always among the first of its kind to recover when the market situation improves. V is up over 10% YTD and is now at the highest level since early April. V held up remarkably well last year with a -3.4% return and should thrive in the likely rebound this year. HOLD

Visa Inc. (V)
Next ex-div date: February 9, 2023

NextEra Energy (NEE – yield 2.1%) – Utilities were riding high in the market tumult. But now the sector is taking a back seat in the recent rally as last year’s downtrodden stocks have come alive. The latest rally has been one in which defensive stocks and last year’s winners are out, and the losers are back in. But that dynamic is unlikely to be sustained as the economy continues to slow and investors realize it might be a longer slog to the next true recovery. The recent downturn provides a good entry point for NEE ahead of a period of historic outperformance for utility stocks. BUY

NextEra Energy Inc. (NEE)
Next ex-div date: February 23, 2023, est.

Xcel Energy (XEL – yield 2.8%) – This clean energy utility stock had been a superstar when the sector was hot. It is now understandably cooling off. It has pulled back over 7% from the January high after rallying sharply late last year. This stock tends to be bouncy and it would be very much in character for it to fall further on the current down move. For that reason, it was downgraded to HOLD. I still like XEL over the rest of the year and will likely upgrade the rating when the stock breaks the downward trend. HOLD

Xcel Energy Inc. (XEL)
Next ed-div date: March 28, 2023, est.

USB Depository Shares (USB-PS – yield 5.3%) – So far, it has been a great move to lock in this high fixed rate yield when rates were near the high. The price has appreciated, and the position has returned 13% in the past couple of months. Locking in the high rates may turn out to be a good longer-term move as well. BUY

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

Invesco Preferred ETF (PGX – yield 6.3%) – Ditto what I said about USB-PS. Longer-term rates are coming down as the economy slows. Many economists are predicting a recession later this year and investors have been flocking toward fixed income. This provides diversification from stocks with a high income ahead of a period when interest rates could fall back further. BUY

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

Vanguard Long-Term Corp. Bond Index Fund (VCLT – yield 4.4) – The same interest rate story for the last two positions above applies here. The timing is probably good to lock in higher rates on investment grade bonds in an economy that is slowing while longer-term rates are falling. BUY

Vanguard Long-Term Corp. Bd. Index Fd. (VCLT)
Next ex-div date: March 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 March 8, 2023.