XMLV - REGL: Can This Mid-Cap Dividend Aristocrats ETF Bounce Back?

2023-08-31 13:40:26 ET

Summary

• REGL holds 49 mid-cap stocks that have raised dividends for at least 15 consecutive years. Its expense ratio is 0.40%, and the ETF yields 2.36% with $1.57 billion in assets.
• Despite the suggestion of safety, REGL is the third-worst-performing mid-cap ETF in 2023. My analysis reveals a high concentration in Regional Banks and Gas Utilities is to blame.
• Unfortunately, Wall Street analysts continue to be bearish on these industries. REGL has a 4.95/10 EPS Revision Score and many constituents missed sales and earnings expectations last quarter.
• Since I don't find REGL's yield compelling, I think mid-cap investors should turn their focus to quality instead. This article compares REGL with four other ETFs you can consider depending on your income needs.

Investment Thesis

I last covered the ProShares S&P Midcap 400 Dividend Aristocrats ETF ( REGL ) in October 2022, concluding that although it's historically a solid performer in the mid-cap space, weak profitability meant investors should consider other alternatives in other categories. While it has performed relatively poorly since, I'm surprised at the extent. Among 56 mid-cap ETFs, REGL is the third-worst-performing in 2023, and this considerable underperformance is why I'd like to evaluate the fund from a value perspective in today's article. Below, you'll find a detailed industry-level fundamental analysis, with comparisons with the WisdomTree US Midcap Dividend Fund ( DON ), which yields 2.75% to REGL's 2.36%. Also, I'll highlight a top-performing mid-cap fund this year and explain why it's been so successful. I hope you enjoy the read.

REGL Overview

Strategy and Dividends

REGL selects U.S. mid-cap companies with at least 15 consecutive years of dividend increases. Like its large-cap counterpart, the ProShares S&P 500 Dividend Aristocrats ETF ( NOBL ), REGL is an equal-weight fund, and 49 companies currently qualify. Strict criteria mean relatively low turnover, which benefits ETF investors who like to know what they own. As shown in the last column of the table below, turnover is consistently around 30%, most of which is due to the fund's quarterly rebalances.

REGL's 2.36% dividend yield may be too low for a dividend fund. Also shown above is a declining distribution for the fiscal year ending May 31: $1.67/share in 2023 vs. $1.89 in 2022. Seeking Alpha provides a more up-to-date metric on REGL's Dividend Scorecard , highlighting a -6.62% dividend growth rate over the last year. In the previous five years, the compound annual dividend growth rate was much stronger at 10.83%, but the ten-year figure is unavailable since REGL only launched in February 2015.

Frankly, there aren't many high-yielding alternatives in the mid-cap space, so I believe REGL is best used to diversify by size. Still, WisdomTree's DON may be more attractive to income investors. It yields 2.75% and has a better "B+" overall dividend grade.

Performance Analysis

Despite a lower dividend yield, REGL has outperformed DON since its February 2015 launch. I also included the Invesco S&P MidCap Low Volatility ETF ( XMLV ) in the graph below. XMLV doesn't have a dividend focus, but its 2.43% dividend yield is similar to REGL's, as is its portfolio's current 0.86 five-year beta. They're most suitable for defensive investors in a fairly volatile mid-cap category.

REGL has gained an annualized 8.76% compared to 7.56% and 7.12% for DON and XMLV. Due to its low standard deviation, it also has the best Sharpe Ratio, a measure of risk-adjusted returns. Finally, its 24.53% maximum drawdown in Q1 2020 was substantially better than DON's 35.96%. In short, there's good evidence that REGL holds a reasonably safe group of stocks.

Nevertheless, investors shouldn't fall into the trap of assuming past performance will continue. Since my October 2022 review, REGL has gained 5.91% compared to DON's 10.71%. In that article, I suggested investors go with WisdomTree's DGRW and DHS instead, as equally weighting these two ETFs would result in higher profitability, lower fees, and superior yield, growth, and diversification. This proposed portfolio would have delivered a 13.22% return over this period, a 7.31% improvement over REGL.

In fairness, DGRW and DHS are large-cap ETFs, so it's not an apples-to-apples comparison. However, my objective was to help readers understand the importance of investing in high-quality companies over the long run, and surprisingly, REGL doesn't fit the bill. Let's look at its composition closer to understand this crucial weakness better.

REGL Analysis

Sector Exposures and Top Holdings

The following table highlights REGL's sector exposures under Global Industry Classification Standards, or GICS. Also included are sector exposures for DON, XMLV, the SPDR S&P MidCap 400 ETF ( MDY ), and the SPDR S&P 400 Mid Cap Value ETF ( MDYV ). REGL's selection universe isn't constrained by style, but its holdings tend to be more value-like, so MDVY could be a good alternative. It currently yields 1.77%.

What stands out is REGL's high concentration to Financials, Industrials, and Utilities, together totaling 69% of the portfolio. While its equal-weighting scheme assists in diversifying away company-specific risk, there's still risk if these sectors fall out of favor. Given REGL's low turnover rate, I expect this will continue. Furthermore, an industry-level analysis reveals REGL is 11.98% Gas Utilities and 11.67% Regional Banks. The broader Utilities sector is the worst-performing one this year. Meanwhile, an investment in Regional Banks is still a deep-value play. Although REGL's holdings in this industry yield an attractive 3.43%, the virtual zero earnings growth expected over the next year will likely hamper dividend growth. On performance year-to-date, IAT, KBWR, and KRE, three ETFs tracking the industry, are down 23.87%, 16.57%, and 22.58%, respectively. REGL is down 1.40%.

Finally, I've listed REGL's top ten holdings below. Since it's an equal-weighted fund, these are the top-performing stocks since its Index last rebalanced. They include AptarGroup ( ATR ), Williams-Sonoma ( WSM ), and RPM International ( RPM ). Interestingly, the only Gas Utility listed is National Fuel Gas ( NFG ), and there are no Regional Bank stocks in the top ten. It's another piece of evidence that these industries continue to struggle.

Fundamentals By Industry

The following table highlights selected fundamental metrics for REGL's top 25 industries, totaling 92.52% of the portfolio. I've also included metrics for DON, XMLV, MDYV, and the Invesco S&P MidCap Quality ETF ( XMHQ ). XMHQ isn't a dividend fund, and its 1.13% yield will not interest income investors. However, it's the top-performing mid-cap ETF this year, up 23%, and its focus on quality has resulted in excellent returns since it began tracking a different Index in June 2019.

A few observations:

1. REGL's constituents currently yield 2.78%, and after deducting the fund's 0.40% expense ratio, investors should net approximately 2.38%. Please note that this almost exactly matches its 2.36% trailing dividend yield. Most of this comes from stocks in the Gas Utilities and Regional Banks industries, which yield 4.31% and 3.43%, respectively. In addition, holdings in the Electric and Multi Utilities industries yield 4.56% and 4.75%.

2. DON has a higher gross dividend yield of 3.00% or 2.62% after fees. It's a far more diversified ETF than REGL, as indicated by its percentage of assets in its top 25 industries (59.65% vs. 92.52%), and uses REITs to boost its yield. According to the ETF Research Center, there's only a 14% overlap by weight between the two funds, so dividend investors might want to consider holding them both for efficiency purposes.

3. As mentioned earlier, XMLV has a similar five-year beta as REGL, and its lower 0.25% expense ratio means investors will net approximately 2.30%. Its quality is equally as low, as measured by its 6.46/10 Profitability Score, which I calculated using individual Seeking Alpha Factor Grades. It's also not a coincidence that XMLV is the only one to underperform REGL in 2023, losing 2.34% on total returns.

4. REGL has a more attractive combination of growth and valuation than DON and XMLV, its two main peers. REGL trades at 17.13x forward earnings and 13.22x trailing cash flow while offering 6.10% and 6.59% estimated sales and earnings per share growth. Meanwhile, DON's valuation is similar, but its growth rates are lower, and XMLV trails on both metrics. Given these fundamentals and a poor track record, I don't recommend XMLV.

5. XMHQ is the highest-quality fund, measured by its 8.27/10 Profit Score. It's also the second-best-performing mid-cap fund YTD, up 20.88% in price and slightly below the AdvisorShares Focused Equity ETF ( CWS ). According to its fund page, CWS follows a proprietary strategy and is actually an all-cap fund, with roughly equal allocations to the small-, mid-, and large-cap segments. Therefore, I consider XMHQ the best-performing mid-cap fund this year, and I believe its high profitability is a key reason.

XMHQ also features an excellent 11.83% estimated earnings per share growth rate, nearly twice as high as REGL, though its beta is the highest. XMHQ's 6.53/10 EPS Revision Score is also the best in this peer group, which indicates its holdings have good earnings momentum. In contrast, REGL's 4.95/10 score is the lowest. Let's look at the individual holdings next to see the pressure this ETF faces.

REGL Earnings Season Summary

REGL's constituents delivered a weighted average -3.70% and 1.17% sales and earnings surprise in Q2 2023. For comparison purposes, here is what the other ETFs produced:

• DON: 0.52% / 7.51%
• XMLV: -0.54% / -3.68%
• MDYV: 1.63% / 10.02%
• XMHQ: 1.63% / 10.99%

These numbers help explain REGL and XMLV's poor recent returns. They may be considered safer investments, but their constituents did not deliver big sales and earnings surprises that would cause analysts to revise their expectations upward. In short, there is no apparent short-term catalyst that would support a turnaround.

I want to summarize the Q2 2023 earnings season results for REGL's 49 holdings. I've sorted the tables below by sector and industry, as I want to highlight the poor results of REGL's top industries, particularly Regional Banks and Gas Utilities.

As shown in the above table, many Regional Bank stocks are down by 20% or more YTD, though Bank OZK ( OZK ) is slightly up and has a solid 7.69/10 EPS Revision Score. Cullen/Frost Bankers ( CFR ) is also on Moody Investor Services' review list for a possible downgrade. Also, note the poor EPS Revision Scores of nearly all Gas Utilities holdings in the following table. While the aggregate earnings surprise for large-cap Utilities stocks improved in Q2 to 5.8%, the mid-cap segment stalled at 0.8%, and REGL's holdings averaged -4.4%. The average sales surprise was even worse at -10.1%.

Investment Recommendation

REGL has a strong track record relative to DON and XMLV, two other ETFs with competitive dividend yields. However, I don't recommend an investment today. Though it's underperformed its mid-cap peers substantially YTD, that alone is not a reason to believe a turnaround is imminent. Instead, further declines are possible based on REGL's weak 4.95/10 EPS Revision Score, poor earnings results, and low profitability, which is unusual for an ETF that only holds consistent dividend payers. Since I don't find REGL's 2.36% dividend yield appealing, I recommend that mid-cap investors focus on profitability instead through the XMHQ, a top-performing fund with excellent growth potential and earnings momentum. Thank you for reading, and I look forward to continuing the discussion in the comments section below.

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