MUSA - Treasuries Or Murphy USA Which Will Provide The Better Return?

2023-11-02 09:22:26 ET

Summary

• Murphy USA stock has climbed 28.4% in the past five months, outperforming the S&P 500.
• The company's financial performance is not strong, with revenue and net income down compared to the previous year.
• The dividend yield of the stock would need to grow by 48.65% over the next decade to match the cash flows of a risk-free Treasury investment.

It's been just under five months since I put out yet another cautious piece on Murphy USA Inc. ( MUSA ), and in that time, the shares have climbed even higher, up another 28.4% against a loss of about 1.5% for the S&P 500. It's frustrating when your caution costs you gains, but I'll try to ignore that emotion and decide whether or not it makes sense to buy the stock at current levels. I'll make that determination by reviewing the latest financial results, and by comparing those to the valuation. Additionally, since we're in a world where "TINA doesn't live here anymore", I want to compare the current dividend yield to the risk-free rate.

I think my writing is an acquired taste at best, and for that reason, I offer my readers an "out." I give them the chance to get in, get the gist of what I'm writing, and then get out again before they're exposed to too much "Doyle mojo." You're welcome. Although Murphy USA stock is not itself egregiously expensive, the company is not performing well financially in my view. More importantly, investors are taking on a great deal of relative risk here, given that they can earn a much higher rate of return from the risk-free 10-Year Treasury Note. Given that, I think we should be seeking "risk-adjusted returns" and not simply "returns", I think we should continue to eschew this name in favour of the reasonable returns on offer in the Treasury market.

Financial Snapshot

The financial trends that disturbed me so much in my previous article persist, with revenue and net income during the first six months of 2023 down by 10.3% and 29%, respectively, when compared to the same period a year ago. Additionally, the capital structure is also worse in my view. Long-term debt is basically the same as it was in 2022, but cash has dropped by about $147.5 million, or 61%. Things look much better when we compare the current financial results to the same period in 2019, given that revenue and net income are now higher by 54% and an eye-watering 530%, respectively. That written, I remain of the view that the financials are trending in the wrong direction, and so I remain troubled.

As we've seen over the past several months, though, the fact that I'm clutching my pearls about deteriorating financials seems to have little bearing on the performance of the stock. For that reason, I'm willing to consider buying the stock if the valuation is reasonable.

Dividend Yield vs Risk Free Rate

I'm going to state some of my assumptions before getting into the "gist" of this part of the analysis. First, I assume that all investors care about risk. They want to alleviate it as much as possible for the simple reason that losses are more emotionally painful than gains of the same magnitude are pleasurable. Second, I'm of the view that investors are relatively indifferent about the source of their returns. It doesn't matter to investors if those returns come from dividends, interest, or capital gains, but they're always seeking the highest risk-adjusted returns. Finally, I'm assuming that investors are unwilling to earn less on a risky investment than they can from a risk-free investment. Different investors impose different risk premia, but I insist on a 3% extra level of return potential from stocks.

With all that out of the way, I want to draw a comparison between the dividend yield here and the 10-Year Treasury Note. We all know that the 10-Year Treasury is currently yielding about 4.78 % and that the dividend yield is just under 0.5%. If you were wondering the exact rate at which the dividend will need to grow for the stock investor to receive the same cash flows as the Treasury investor, then wonder no further for I have the answer. The answer is that the dividend will need to grow from its current levels at a rate of 48.65% over the next decade in order for the stockholder to receive the same cash flows as the Treasury holder. I've compiled the math for your convenience in the table below. In my view, 48.65% is a ludicrously high bar, and I think it's inevitable that the Treasury Note buyer will receive more cash on their capital than will the stockholder. That means that stock capital gains need to generate the vast majority of returns here, and that adds a great deal of risk, in my view.

While I'll admit that the stock is not egregiously expensive at the moment, per the chart below, I think I think it's worth remembering that we should always expect more cash flows from our stocks than from risk-free instruments. Thus, the 48% CAGR required of the dividend should barely qualify this for investment in my view. I think the stock should offer a return of about 3% over the risk-free rate to compensate for the inevitable risks. This widens the spread of relative attractiveness further, so I think Treasuries are the proverbial "no-brainer" at the moment.

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