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Saturday, June 11, 2016

[fm]: Top 5 Stock Picks: Bargain Dividend Stocks


Just because a stock offers a healthy dividend yield doesn’t mean it’s a buy.
“People used to associate dividend stocks with value,” says John Bailer manager of the $1.1 billion BNY Mellon Income Stock fund (ticker: MIISX ), “A lot of my competitors are buying bond-proxy oriented stocks, blue-chip, high quality, never sell ‘em stocks, which are, unfortunately, very expensive.”
Dividend aristocrats, companies that have raised dividends for 20 years or more, can be attractive and stable sources of income. Coca-Cola ( KO ), Procter & Gamble ( PG ) and ExxonMobil ( XOM ), for example, all sport dividend yields above the Standard & Poor’s 500’s 2% and investment-grade credit ratings to boot. They also trade at a premium to the market. 
Bailer, 46, looks for companies that can afford to grow their dividends but he also wants to buy their stocks at a discount. Bailer seeks “cheap free cash flow” be it on a historical basis or relative to sector peers. The average forward price/earnings multiple of the fund’s holdings is just shy of 16, compared with the Standard & Poor’s 500 at 19.
The concentrated 41-stock fund holds NRG Yield ( NYLD ), a “yieldco”—an MLP-like financial vehicle for renewable energy companies—of parent power producer NRG Energy ( NRG ), mid-sized real-estate investment trust Lamar Advertising (LAMR ), ConocoPhillips’ ( COP ) spun-off downstream unit Phillips 66 ( PSX ), insurer Prudential Financial ( PRU ) and mega-cap technology company Cisco Systems ( CSCO ). All come with juicy dividend yields of 3% or more and based on Bailer’s estimates, trade at a discount.
The fund’s gross yield of 3.4% is about 1.5 times more than S&P’s—Bailer’s aim—but it shrinks to around 2% net of fees. To be sure, some dividend exchange-traded funds have higher yields and charge lower fees. But many don’t consider valuation. And the cheapest among them, such as the Schwab U.S. Dividend Equity ETF ( SCHD ), which charges an incredibly low $7 per $10,000 invested, has a three-year annualized return of 10.1%—below the BNY fund’s 10.7% return. Over that time period the fund also beat the average large-cap value fund’s 7.8% return. Barrons.com caught up with Bailer to get his take on his top five stock picks.

NRG Yield: Created by NRG Energy to buy and hold solar and wind assets in July 2013, NRG Yield is the original yieldco. At the time, Wall Street analysts hailed the creation as being transformative. Of course, SunEdison’s spectacular flameout, and its yieldco TerraForm Global’s (GLBL) 80% decline in under a year to a recent $2.58, has given the usually safe investments a bad rap. Bailer says NRG 
Yield is misunderstood and underappreciated. At a glance NRG Yield’s debt of some $4.7 billion, nearly triple its $1.6 billion market value, looks alarming. “The difference between NRG Yield and other yieldcos is that NRG has self-amortizing debt,” says Bailer, which he likens to a mortgage. 
“This debt does not need to be refinanced,” he says. “They also have strong counterparties with regulated utilities.” Bailer sees its dividend rising 30% to $1.20 by 2018 and has a target price of $27. Shares recently at $16.38 have a juicy yield of 5.8%.

Lamar Advertising: The Baton Rouge, La.-based company owns and operates some 144,000 billboards in 44 states, Canada and Puerto Rico. Formerly a C corporation, Lamar converted into a REIT in November 2014. Local advertisers from lawyers to plumbers who used to buy advertisements in the yellow pages are beginning to use outdoor ads like billboards, says Bailer. 
The upcoming election could also give a boost to Lamar by way of political advertisement dollars. At a recent $64, shares trade for just 11 times Bailer’s 2017 estimate of AFFO or adjusted funds from operations, a P/E proxy for REITs. He thinks it should trade closer to 14 times or about $80. Lamar stock yields 4.6%.

Phillips 66: Since the midstream and downstream energy unit of ConocoPhillips was spun off in 2012, Phillips 66 hiked its dividend 33% annually and repurchased about 14% of its stock. The oil rout put pressure on the company, but Bailer sees the supply/demand picture becoming more favorable. The price of crude hit $50 per barrel late May, up 85% from $27 in January. “We’re going to need more supply a couple quarters from now and we’ll go back to shale,” says Bailer. “Production growth will come in 2017 and Phillips 66 will be a prime beneficiary.” 
While Phillips’ future is dependent on the price of crude, one could find solace in Berkshire Hathaway’s 14.5% stake. Shares at a recent $81 trade at under 12 times 2017 consensus earnings estimates of $6.92. Bailer says the company can generate as much as $9 in earnings and sees 35% upside to the stock. Its dividend yields 3.1%.

Prudential Financial: The second-largest life insurance company in the U.S. paid dearly during the 2008 financial crisis after aggressively pushing equity-linked products such as annuities. Prudential has since made changes and its return on equity, which was negative seven years ago, is now around 9.5%, just below its 10-year median of 10%. Historically, shares of life insurers have been correlated to interest rates. And investors have been concerned about Prudential’s prospects given the low interest-rate environment, says Bailer. 
However, he thinks that rising oil prices will create a little bit of inflation and incentivize the Federal Reserve to raise rates. Bailer expects a rate increase by July and thinks Prudential will “benefit meaningfully.” The company also raised the dividend by 21% last year; with shares at a recent $75, yield is 3.6%. Valuation-wise, Bailer says Prudential is “incredibly cheap” trading for 7.5 times his 2017 earnings-per-share estimate, below its 10-year median P/E of nine times. It also trades at under tangible book value of $105.

Cisco Systems: The tech giant hasn’t meaningfully grown revenue for years, but considering it generates significant cash and has a history of raising its dividend, Cisco Systems looks like a winner. Bailer says there’s no doubt that the company is selling less hardware, but argues the company just needs time. Recent quarterly earnings supported that sentiment. The company’s fiscal third-quarter sales and profits beat expectations. 
Through April, Cisco reported revenue of $12 billion and GAAP net income of $2.3 billion. What surprised Bailer, however, was that the company raised guidance for the new quarter despite suffering from some hardware product softness. “You get beats from Cisco, but you don’t get raises,” says Bailer. Cisco expects to earn between 59 cents a share and 61 cents a share in its current quarter -- above Wall Street’s 58 cents a share estimate. 
At a recent $29, shares have an unlevered free cash flow yield of 11% per Bailer’s estimates. He thinks it should trade at around $35 and sees the company earning $2.50 in the near-term compared with 2017 consensus earnings-per-share estimate of $2.44. Shares yield 3.6%.

By: Crystal Kim (Barrons). 
Photo: Daily Stock Advisor. 
Review: Emerging Market Formulations & Research Unit, FLAGSHIP RECORDS.
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