Saturday, August 11, 2012

Twelve High Yield Stocks

As the world sits and waits for a resolution to the Greek drama, I though it would be interesting to look at some high dividend large cap plays. The idea is that if we are headed towards a protracted slow down in the global economy then these kind of stocks will be more attractive as a proxy for very low yielding Government debt.

Now I know what you are thinking. But you would be wrong!  This isn’t going to be another of those monotonous articles whereby a screen of high dividend plays is listed. I want to qualitatively discuss reasons why some of these stocks are attractive. But first, some definitions of what I am investigating.
  1. S & P 500 Constituent
  2. Yield above 3%
  3. The stock price is up over the last 30 days
  4. No Utilities!
I’m not including utilities, even though there were 14 of them that qualified for the list. The reason for this is that, I view their outperformance as purely a flight of capital towards safety. There is nothing wrong with this -on the contrary this is the point of the article- however, I think that investors would do better just to buy a utility ETF and diversify the stock specific risk. If the drivers for each individual stock are the same, then you are better off holding the sector in order to protect yourself against any stock specific downside risk.

Having excluded utilities, here is the list.



It is an interesting bunch containing the usual defensive high yielding suspects, but within it, there are a few restructuring stories. I find the restructuring stocks interesting because their profit drivers will be dictated more by their internal execution rather than the market’s direction.


High Dividend Stocks

Kraft Foods is splitting into a global snacks business and a North American food business. Similarly, Abbott Labs $ABT will split into two separate companies. Its plan is to separate into a research pharmaceutical company and a diversified medical products company. The rationale behind corporations splitting is that the management can release the value in the companies by managing them separately. It tends to work! At least, the market thinks so because both these stocks were rewarded after the split was announced.

The Abbott split is interesting because it will split branded generics, nutritionals, medical products and diagnostics (Abbot Labs) from pharma and biologics (Abbvie). This is distinct from the a company like Novartis which has generics (Sandoz) and pharmaceuticals in one company. Similarly, generics companies like Teva or Waston are expanding into branded drugs. So Abbott is somewhat bucking the trend. In addition, it will allow investors to invest in the new ‘Abbot Labs’ without carrying the greater risk inherent in drug development or the Humira patent expiry.


Deffensive Large Cap Stocks

However, it is not only about splits.  Pfizer $PFE is a company engaging in substantive restructuring and divestitures, not least with the recent sale of its baby foods division to Nestle. It also wants to sell its nutritional and animal health divisions. Research and development expenditure has been cut and, the Wyeth acquisition has diversified its product offering into more biologics and vaccines. The company does have to deal with patent expiries this year, but that should be in the price by now. Furthermore, there is upside potential from some key trials and potential approvals.

Turning to Johnson & Johnson $JNJ  this company’s future prospects are really guided by its execution. It needs to integrate the acquired Synthes (skeletal fixation) business, fix its manufacturing problems that kept some of its products off the shelves and, successfully launch some new drugs. The market hates this stock, but that is what makes it a good value. Its cash flow generation is huge, and it has the market position to sort out its problems. If it does so, then the stock could appreciate from here.
Unlike other cash rich behemoths like Cisco or Intel, its end market demand is not dependent on cyclical forces. This makes it attractive for those concerned with the global economic outlook. There is a more detailed article on the stock linked here.


Best Dividend Paying Stocks

One company that is not splitting in the near future is Pepsico (NYSE: PEP). In contrast to Kraft, Pepsico is actually restructuring to closer integrate the snacks and beverage business, under Indra Nooyi’s ‘Power of One’ strategy. The idea being that the scale of the combined business strengthens customer relationships. An example of this line of thinking came when Pepsico bought its bottlers in order to generate supply chain efficiencies.

Nooyi’s strategy is not short of critics. Many of whom think that both divisions are not performing to their potential. Essentially, many analysts are looking at the beverage division’s underperformance vs. Coca Cola in North America and, then the global growth prospects of snacks (particularly in emerging markets) and concluding that Pepsico needs to split. Management would then be allowed to focus efforts in the different challenges and opportunities that these business are faced with. I’m sympathetic to the argument, but I think that there is little certainty that Nooyi will change tack, despite the investor pressure. Nevertheless, as a stock with prospects outside of the wider economy, Pepsico is worth a close look.


Top High Yield Stocks

The telcos are prevalent in this list as AT & T $T, CenturyLink and Verizon  $VZare all high yielding stocks, but are they really safe? Competition is coming from all angles and, the core business of land line telephony is under pressure. Technological developments have eroded their traditional markets and as data takes over from voice in growth, increasingly, cable and satellite operators are encroaching on the data market. Ultimately, an investment in the telcos must contain an appraisal of how they can deal with potential erosion in their end demand.

It is a similar conclusion with the tobacco companies like Altria, even though its investment thesis is one of emerging market growth supplanting declining traditional markets. As for Heinz $HNZ, it is striking how food companies like General Mills $GIS and Treehouse have been reporting that consumers are trading down to shop for groceries in dollar stores, where store private label brands are likely to pressure their margins.

In all of stocks, the principle of some sort of structural challenge to their core earnings is present. This makes them an investment that needs a certain amount of circumspection.


Manifesto

Of the stocks on this list, I like Pfizer, Johnson and Johnson and Abbott Labs. I’m a bit concerned by the high levels of debt at Kraft. As for Kimberly-Clark, it paid out 83% of its free cash flow in dividend last year and earnings growth is forecast in single digits, so I see little opportunity for dividend growth with the stock. Pepsico is the most intriguing, but should an investor buy a stock because he/she is hoping its management will change direction from its stated course? I’m not so sure.