At a new all-time high, this is a tough market to navigate. Sure, the market could stay good for a while. But at this late-stage of the bull market and recovery, how much is left in the tank?
It’s hard to muster the enthusiasm to take on risk to get the last drop of this late stage bull market before the next downturn. While defensive stocks make a lot of sense here, most are very expensive. But there is one place where stock prices are still cheap, value stocks.
Investors have been rotating toward the long-neglected value stocks and they are starting to perk up. These stocks represent a way to get bargains in an expensive market as well as protection from the next downturn. And some stocks even have momentum.
In this issue, I highlight a stock that is one of the best healthcare companies in the world that is perfectly positioned ahead of the world’s most pronounced megatrend. It also offers great value in an expensive market and has recently found upward momentum.
Cabot Dividend Investor 1019
This High Priced Market Still Offers Great Value
Here we are with the market at fresh new all-time highs. It’s already the longest running recovery and bull market in history. Meanwhile, the global economy stinks and might be getting worse and we are on the precipice of what promises to be a divisive and rancorous Presidential election.
Sure, stocks could continue to forger higher for now, but how much gas is left in the tank?
It’s true that the economy is solid and showing no real signs of an impending recession at this point. It’s also a fact that the S&P 500 is less than 6% higher now than it was almost two years ago in January of 2018. Stocks have hardly run away on the upside. It’s very possible that the market continues to trend higher for a while. Markets can always move 10% or so higher. But then what?
It’s hard to see how the market runs 30% or 40% higher from here before the next bear market. And it’s difficult to muster the enthusiasm necessary to take on risk in order to eke out the last drops of this late-stage bull market. Then again, you may not want to be on the sidelines earning practically nothing while the market could be fine for a couple more years.
Under the circumstances, investors have been opting for the safer plays with dividend stocks in defensive businesses. That’s why REITs and Utilities have been the best performing market sectors over the past couple of years. You get a good return for now and if the market turns south they should hold up relatively well. But investors have been doing this for a while, and many of those stocks have gotten overpriced. Defense isn’t all that defensive if you have to pay through the nose for it.
It’s a tricky time to invest. During times like this it always helps to go back to the basics. There are time-tested principles for investing successfully in any market. Two of them are as follows; buy good companies cheap and invest in front of a megatrend.
A megatrend is defined as a set of changes in the world that are enormous in impact, unprecedented in magnitude and unstoppable in their march. A current megatrend is the aging of the population. Because of longer life spans and lower fertility rates the populations in the U.S. and the world are older than ever before and getting still older at breakneck speed.
It is a transformation of the human race that will profoundly affect markets for a long time to come (see the January 2019 issue). A clear beneficiary of the trend is healthcare, as older people inevitably demand more of it.
Buying good companies cheap is probably the most important investment adage of all. The best companies always perform over time, but it also matters when you buy them. Returns tend to be much higher when you buy them on sale, rather than at a premium. And, although the overall market may be expensive, many stocks are still selling at discount prices.
Value stocks, those stocks selling at historically low valuations, have been neglected by the market for years. But things have started to turn around. Many of these cheap stocks have recently found momentum as investors go bargain hunting.
In this issue I will highlight a stock that is one of the best healthcare companies in the world that is perfectly positioned ahead of the world’s most pronounced megatrend. It also offers great value in an expensive market and has recently found upward momentum.
The stock is already a “BUY” rated portfolio position. But, under the current circumstances, it still offers a better opportunity than anything else I found in the market.
[highlight_box]What To Do Now:
The current portfolio is in large part in two different groups; defensive companies that have been performing well for a long time and continue to do so, and cheaply priced value stocks that offer bargains but not great momentum.
I like have both types well represented in the portfolio.
The REITs and Utilities in the portfolio continue to ride great technical momentum despite having gotten high priced for the most part. I did pull the trigger this month and sold the position in McCormick (MKC), half the position in NextEra Energy (NEE), and a third of the position in Community Healthcare Trust (CHCT).
They weren’t sold because of bad news or any kind of technical breakdown in their charts, though. I sold them because valuations had gotten to nose-bleed levels, and I thought it prudent to sober up before the market does. There are still partial positions maintained in CHCT and NEE because the momentum is still solid. It seemed silly not to protect profits and sell at least part of the positions at such high price levels. I don’t want to look back after not selling it and say, what was I thinking? How could I have been so foolishly greedy?
I also sold the position in American Express (AXP). The stock has a lot of international exposure, and I don’t trust the global economy. As well, the stock had broken down technically after its second quarter earnings report.
The big story in the portfolio has been the resurgence of the value stocks. Valero (VLO), AbbVie (ABBV) and Altria (MO) have all had a fantastic month as investors have begun to shift into value. These stocks still offer great value, but now they have some momentum as well. Enterprise Product Partners (EPD) has not participated in the value upswing but still offers fantastic value and should gain traction if the trend toward value continues.
At this point, I would buy ABBV, VLO and EPD first if I was new to the portfolio. Although the overall market may be expensive, it’s like 2010 all over again with these stocks.
AbbVie Inc. (ABBV)
AbbVie Inc. (ABBV) is a cutting-edge U.S. based biopharmaceutical company specializing in drugs and treatments that incorporate biotechnology as a solution to human diseases. The company came into existence in 2013 when it was spun off from Abbott Laboratories (ABT). Since then, it’s gotten big. Abbvie is now the 8th largest pharmaceutical company in the world and the fifth largest biopharmaceutical company.
The company got so big so fast because of the success of its blockbuster autoimmune drug Humira, which is by far the world’s best selling drug with nearly $20 billion in annual revenues. It is precisely this success that has been plaguing the company of late.
The stock had been very successful. From the IPO in January of 2013 to January of 2018, the stock returned 265% (with dividends reinvested) compared to a return of 120% for the S&P 500 over the same period. But the company had a drawback. It had too many eggs in one basket. Humira still accounts for most of the firm’s revenues. As with all drugs, one day Humira will lose patent protection, and that day is fast approaching.
Humira is already facing generic competition (in the form of biosimilars) in Europe and will face competition in the U.S. (which accounts for three quarters of revenue) in 2023. The market is worried that AbbVie won’t be able to replace the lost revenue on such an important revenue source. As a result, the stock fell about 50% from January 2018 until its low in mid August.
However, I believe the concerns are overblown for several reasons.
It’s important to note that AbbVie has long planned for this eventuality. For years, the company has made acquisitions and invested heavily in R&D to build what EvaluatePharma has called the second best pipeline in the business, with many promising drugs in late stage trials before FDA approval.
The pipeline is already paying off in a big way. Recently launched blood cancer drugs Imbruvica and Venclexta have impressive growth and appear on the way to being multibillion dollar blockbusters. Endometriosis drug Orilissa (launched late last year) will also be a blockbuster drug. As well, Rinvoq and Skyrozo both received FDA approval this year, and are ranked as two of EvaluatePharma’s top three new drug launches for 2019. By some estimates, those two drugs could combine for annual sales of more than $10 billion.
In addition, AbbVie announced plans to acquire Ireland-based specialty pharmaceutical company Allergan (AGN) in June for $63 billion. About half the size of AbbVie, the company specializes in aesthetics, ophthalmology, women’s health, gastrointestinal, and nervous system products. Its most notable drug is facial rejuvenation treatment Botox, which brings in $3 to $4 billion per year of revenue.
Wall Street did not initially like the deal but has since been warming up to it. The acquisition (expected to close in early 2020) will boost earnings and further diversify AbbVie away from Humira. AbbVie will likely be able to quickly pay down the debt it floated to fund the buyout, and it shouldn’t disturb the dividend, which currently yields a whopping 5.46%.
Also consider this. While Humira sales (which currently account for more than 50% of revenues) will decline, they won’t fall off a cliff. Biologic drugs aren’t that easy to duplicate. EvaluatePharm estimates that Humira will still be the world’s top selling drug by the middle of next decade with estimated sales of $15 billion per year. AbbVie has more than enough firepower to overcome that.
Patent expirations are commonplace with pharmaceutical companies. The panic with AbbVie is particularly dramatic because it is so dependent on the one drug. But the company’s ability to overcome the problem is also special. Meanwhile, the bigger picture is spectacular. Abbvie is one of the world’s best and most innovative biopharmacuetical companies on the cusp of a pronounced demand explosion from the aging population.
There may be continued uncertainty in the near term. But this isn’t a stock sitting on the bottom of the ocean waiting for good news. Many analysts have upgraded it recently and insiders are buying. The stock still sells at ridiculously cheap valuations (just 8 times forward earnings) that seemingly price in a worst case scenario on several fronts.
The stock is on the move already. It’s up 25% from the lows of August and over 7% in October. It not only offers value, but value with momentum.
As a note, AbbVie will announce third quarter earnings tomorrow, October 31st. Earnings are tricky and you never know what any given quarter will bring. If you don’t own it already you may want to err on the side caution and wait until after the announcement to buy it.
Portfolio at a Glance
Closing Prices on October 29, 2019
High Yield Tier
The investments in our High Yield tier have been chosen for their high current payouts. These ?investments will often be riskier or have less capital appreciation potential than those in our other ?two tiers, but they’re appropriate for investors who want to generate maximum income from their? portfolios right now.
Brookfield Infrastructure Partners (BIP 50 – yield 4.0%) – The stock looks great. It just set a new all time high. This owner of infrastructure assets across the globe has returned over 50% so far this year. But it is still reasonably valued because of a rare bad year in 2018. Defense is in vogue. Infrastructure is up and coming. The stock could run for a while. However, it does announce earnings next week where newly acquired assets should help boost the bottom line. That having been said, after the big up move this year and this past month, it is getting a little too pricey to continue to acquire at this price. I’m reducing the rating to HOLD and will consider raising it again if the stock pulls back into the mid 40s. Rating change BUY to HOLD.
Next ex-div date: November 29, 2019 est.
Community Health Trust (CHCT 48 – yield 3.5%) – This small healthcare REIT has been spectacular. This little-REIT-that-could has returned 68% so far this year. That’s breathtaking performance for a high yielding REIT, even a smaller and promising one like this. I say the same thing every week and month, the stock is definitely overvalued at this point. However, it’s still technically strong and looks like it wants to go higher. And then it continues to go higher. But with earnings coming up on November 6th, I think it is prudent to take some of the obscene profits off the table and protect them. I am selling another one-third of the position and will let the remaining third ride. Rating change HOLD to SELL 1/3.
Next ex-div date: November 21, 2019 est.
Enterprise Product Partners (EPD 26 – yield 6.6%) – This energy company continues to lag in an otherwise friendly market for undervalued stocks. The company missed on earnings last week with profits of $0.50 per unit versus an estimated $0.53, and also a miss edon revenues. The company had exceeded estimates for the last four quarters by an average of 14%. The miss resulted from one time write offs as well as an earnings decrease in the small part of the business that is exposed to commodity prices. But volumes were higher in just about every facet of the business, which will ultimately deliver higher profits for the fee-based business. The company has $9.1 billion in projects under construction and $3 billion coming on line in the next six months. It’s a good opportunity to get in cheap. BUY.
Next ex-div date: October 30, 2019
STAG Industrial (STAG 31 – 4.6%) – This monthly dividend payer announces earnings today. There is high demand for industrial properties as online shopping increases the need for warehouse space, and STAG should continue to produce steady profits. The performance of this REIT has not been lighting the world on fire but it has held very steady in down markets. I’m not going to pare back the position ahead of earnings on this one because it isn’t as overextended. Hopefully the earnings will give it a bump. HOLD.
Next ex-div date: November 27, 2019
Dividend Growth Tier
To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.
AbbVie (ABBV 79 – 5.5%) – I covered the situation in the “FeatureD Buy” section above. Earnings will be announced tomorrow and I’ll review the report in the update next Wednesday. BUY.
Next ex-div date: January 11, 2020 est.
Altria (MO 46 – 7.3%) – The cigarette maker reports third quarter earnings tomorrow, October 31st. Flat revenues are expected with slightly higher earnings (5% to 6% year over year) as Altria compensates for lower cigarette volumes with higher prices and fewer outstanding shares. The recent 35% acquisition of JUUL continues to bleed. The E-cigarette maker just announced a 10% to 15% reduction in its workforce to adjust to lower sales of its flavored E-cigarettes. But as JUUL faces an avalanche of regulatory scrutiny and the new investment looks like a bad idea, there is a benefit. It is very possible that Altria gets a lift from a less than expected drop in cigarette volumes as the E-cigarette alternative sours. The stock has likely bottomed with the consensus target price currently north of 52. And that’s with a safe 7.4% dividend payout. HOLD.
Next ex-div date: December 13, 2019 est.
Cheniere Energy Partners (CQP 45 – yield 5.5%) – The LNG terminal operator has been a rare bright star in the energy sector, up 58% over the past two years. The company reports third quarter earnings on Friday. The stock should be strong as revenues should continue to soar amidst the LNG export explosion. The company is in the right place and I believe the market is likely to keep rewarding the stock. In the meantime you get a fantastic 5.5% yield. CQP just raised the dividend again slightly (up a penny to 62 cents per share), which is payable on November 14th. BUY.
Next ex-div date: November 6, 2019
Crown Castle International (CCI 140 – yield 3.4%) – The 5G infrastructure REIT reported earnings a couple of weeks ago that beat expectations with funds from operations (FFO) growth of 12% and revenue growth of over 10% compared to a year ago. The company cited high demand for its cell towers amidst the 5G build out, go figure. The stock was up over 3% the day of the announcement and almost 6% for the week. The good news is partially offset by an SEC probe into its business practices. But the market isn’t too worried about it and the strong earnings growth is likely to continue in the quarters and years ahead. As well, CCI also announced a 6.7% hike in the quarterly dividend to $1.20 per share, payable at the end of December. BUY.
Next ex-div date: December 12, 2019
Valero Energy Corp. (VLO 98 – yield 3.6%) – The refiner reported earnings last week that soundly beat consensus for both earnings and revenues, although both were lower on a year-over-year basis. The company also reported that crack spreads are improving in the fourth quarter. It is also apparent that the IMO’s (International Maritime Organization) new requirements for shipping fuels are likely to help refiners in 2020. As more refiners use resources to produce the new fuel, less goes to gasoline and other refined products, reducing supply and likely increasing prices. Things appear to be improving for refining margins for Valero and the stock price is reflecting that fact. The stock is up 40% since late August and 18% in October. As expected, 2020 looks like a very promising year. BUY.
Next ex-div date: November 5, 2019 est.
Safe Income Tier
The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.
Alexandria Real Estate Equities (ARE 159 – yield 2.6%) – The stock reported earnings yesterday and matched estimates with 5.4% year-over-year funds from operations (FFOs) growth and 14.2% revenue growth which exceeded estimates. As well, rental rates increased 11% from last year’s quarter reflecting strong demand for its life science properties. Alexandria also acquired 11 properties as it continues to add to its strong pipeline. This is a very solid REIT in the highly specialized life science and research lab niche that should continue to benefit amidst the search for new medicines and treatments for the aging population. BUY.
Next ex-div date: December 27, 2019 est.
Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 2.3%)
Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.7%)
These bonds remain steady and predictable, just like they should. They just keep rolling on at a steady price paying interest. These short term investment grade rated corporate bond ETFs don’t pay much yield but they come as advertised, with consistent income and virtually zero volatility. It nice to have them in the portfolio when the market gets funky. BUY.
Next ex-div date; November 20, 2019 est.
Invesco Preferred ETF (PGX 15 – yield 5.4%) – This preferred stock ETF is remaining solid. It is a high yielding, safe haven in a low interest rate world and an uncertain market. The lack of correlation to the stock and bond markets makes this a fantastic way to diversify. The falling interest rates make it even more attractive on a relative basis. The monthly payout is icing on the cake. BUY.
Next ex-div date: November 22, 2019 est.
NextEra Energy (NEE 236 – yield 2.2%) – This utility and alternative energy juggernaut announced very positive earnings a couple of weeks ago. NextEra beat estimates with earnings growth of 10.1% year over year. It also reiterated its target of 6% to 8% annual earnings growth through 2021 and dividend growth of 12% to 14% per year through at least 2020. The stock recently made new all time highs, with no signs of a break in upward momentum from a technical standpoint despite lofty valuations. The stock is expensive and I took half of the position off the table a few weeks ago for that reason. But the stock has exactly what the market seems to want right now. So I’ll let the other half ride. HOLD.
Next ex-div date: November 27, 2019
Xcel Energy (XEL 63 – yield 2.6%) – The utility sector has had a bit of pullback over the last week, which is natural as the market forges to new all time highs. But as uncertainty persists I expect the sector to continue to perform well as investors still crave safety. The company missed on earnings and revenue estimates a couple of weeks ago. However, top line growth soared 42% from the same quarter last year based on higher revenue from alternative energy sales. The stock has missed over the last several quarters but the stock continues to show solid technical strength. It’s expensive at the current price but until it starts to show some kinks in the armor I will continue to hold. HOLD.
Next ex-div date: December 12, 2019 est.
Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates estimated.
The Still Strong Economy
It’s tough to invest confidently these days. It seems like all the economic news you read about or hear about is bad. You hear things like ‘we may be sliding into a recession”. “CEO confidence is the lowest since the financial crisis”. “The trade war with China is killing us”. Don’t believe it.
Sure, the U.S. economy is slowing down from last year. The global economy stinks and it is to some degree dragging us down. But growth is still solid and the U.S. economy remains a shining beacon in the developed world. Housing starts are booming, unemployment is at record lows, business and consumer confidence is still solid, and the consumer is still very healthy.
These aren’t things you see at the precipice of a recession.
Much is made of the trade war with China. It is a negative and a risk. News of any escalation roils the market while news of a truce lifts stocks. But the actual economic impact on the overall market and economy is fairly small. I believe much of the economic drag is caused by the desire for a scapegoat. You give companies a built-in excuse for lackluster performance and they’ll run with it every time.
And then there’s the Fed. It is likely that the central bank will again lower the Fed Funds rate by 0.25% today, marking the third such cut this year. Many associate the rate cuts with trying to stimulate a lackluster economy. But much of the reason for the cuts is to reverse the fact that rates were too high compared to the rest of the world. The high rates put the country at a disadvantage and the Fed is correcting that fact.
Many see the bad economic news and the market making new highs as a dichotomy that will soon be corrected. But the fact is that higher prices are somewhat justified with a solid fundamental economic backdrop. Also realize that many pundits will continue to warn of impending recession whether there is one or not. It’s just what they do.
Of course, things can change. But there is no reason for economic gloom at this point. Don’t let the financial press scare you away from a market that knows better.
The next Cabot Dividend Investor issue will be published on November 26, 2019.
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