VSDA - VSDA Is Still Only A Hold Due To Valuation Nuances Despite Robust Quality

2023-10-25 17:14:40 ET

Summary

• Passively managed VSDA capitalizes on promising U.S. dividend growth stories.
• It offers exposure to 75 dividend stocks, predominantly from the industrial (25.5%), consumer staples (25%), and financial (10.8%) sectors.
• The portfolio has a weighted-average EY of about 5.1% and a market cap of $173 billion. VSDA's valuation overall does not appeal to me, while I like its quality.
• All in all, unfortunately, I see little justification for a more optimistic outlook, so the Hold rating is maintained.

In my previous note on the VictoryShares Dividend Accelerator ETF ( VSDA ) published in May 2022, I stopped short of a Buy rating due to its lofty valuation, even despite the overall promising strategy. It is worth quoting the article at some length:

...given elevated uncertainty as the market faces a few interest rate hikes coupled with a stagflation risk in case fighting inflation results in borrowing costs climbing too high and too fast, hence, suppressing economic growth, exposure to premium multiples is exceedingly risky now.

Since then, VSDA has drastically underperformed the S&P 500 index.

Today, I would like to offer an overview of the fund's current factor exposure and discuss its performance to decide whether it deserves a rating upgrade or not.

Recapping the strategy

VSDA was incepted in April 2017. According to its website , the fund

...offers exposure to large-cap U.S. stocks that feature not only a history of increasing dividends, but that also possess the highest probability of future dividend growth. It seeks to provide exposure to dividend growth, rather than yielding, offering a potential diversification benefit to high dividend yielding alternatives, particularly in a rising rate environment.

The Nasdaq Victory Dividend Accelerator Index is at the crux of the strategy. The fact sheet says this annually reconstituted and quarterly rebalanced index

...selects 75 securities from the Nasdaq US Large Mid Cap Index based on factors such as dividend growth, return-on-equity and earnings stability.

Valuation: still mostly suboptimal

As of October 23, there were 75 stocks in VSDA's portfolio. We still see a sizable share of assets allocated to the top ten names, which have had more than a 25% combined weight. The presence of 17 mega-caps is one of the factors that contributed to its $173.3 billion weighted-average market cap.

Even though almost 39% of its portfolio has been replaced since May 2022, I believe it is still valued imperfectly. It seems bond yields have stabilized (there is certainly no guarantee another sell-off is not around the corner), but I see little justification for a value-agnostic market rally to return soon. Thus, the ETF trading with a weighted-average earnings yield just slightly ahead of the EY of the iShares Core S&P 500 ETF ( IVV ) (5.1% vs. 4.6%) looks unattractive.

Calculated by the author using data from Seeking Alpha and VSDA; EV/S, EV/EBITDA, and CY were computed for non-financials only

There are other considerations. For instance, both EV/EBITDA and the cash yield (Net CFFO/Price) look adequate. But I would still say that EV/Sales and P/Sales are rather elevated nonetheless. Besides, just 14.7% of the holdings have a B- Quant Valuation grade or higher.

Growth characteristics are not spectacular

Alas, VSDA cannot boast sizable exposure to the growth factor.

More specifically, my analysis revealed that about 18.6% of its current holdings will have to address revenue declines going forward, according to pundits' consensus estimates. And even though there are a few spectacular sales growth stories like the one of Noble Corporation ( NE ), which is forecast to deliver an almost 51% improvement , the WA figure is just 3.9%. Earnings growth is slightly better, though I would not call a 4.1% forward EPS growth rate 'strong' or 'robust.' Here, it is also worth clarifying that the reason why the rate is so low is that 25% of the companies are forecast to deliver lower EPS. And solid profit growth stories like the one of Carlisle Companies ( CSL ) and the already-mentioned NE, etc., only slightly offset their impact on the weighted-average metric.

Top 5 contributors to the Fwd EPS growth rate. Data from Seeking Alpha and the fund

Top 5 detractors

Dividends: solid growth, bleak yield

VSDA has a mostly solid dividend growth story under the hood. For example, my calculations show that its weighted-average 3-year dividend CAGR stands at 6.9%, while the 5-year rate is even stronger at 7.9%. I have compiled the key contributors in the tables below:

Data from Seeking Alpha and the fund

Yet, as it frequently happens with high-quality vehicles, its weighted-average dividend yield of 2.7% is rather bleak, especially compared to the 10-year Treasury yield ( US10Y ) of 4.89% as of writing the note. This is hardly a coincidence that just 35.6% of the holdings have a B- Yield score or higher, like LEG. The ETF itself is yielding only 2.12%.

Quality

VSDA's portfolio has quality characteristics that are nothing short of robust. First and foremost, none of the holdings has a Quant Profitability rating of D+ or lower, while those in the A league (+/-) account for over 71% of the net assets. Next, just two companies are unprofitable, namely Walgreens Boots Alliance ( WBA ) and 3M ( MMM ). Together, they account for only 4.1%. Next, almost all companies delivered positive net operating cash flow in the last twelve months, with the exception being V.F. Corporation ( VFC ). Speaking of capital efficiency, a weighted-average Return on Equity of 43.4% and Return on Assets of 9.5% is more than healthy; at the same time, as I frequently mention in my articles, ROE is less reliable as it was skewed by debt-heavy names like Colgate-Palmolive ( CL ) and Kimberly-Clark ( KMB ).

Performance

VSDA's performance since the May 2022 note has been utterly lackluster as it delivered a negative total return of 2.6% while the S&P 500 has advanced by 5.85%.

For better context, VSDA eked out a gain of 99 bps in June-December 2022, but the issue is that it was unable to benefit from the market rally earlier this year, delivering a negative total return of 1.61% while IVV rose by 13.11% in January-September 2023.

However, it still should be noted that longer-term returns look much stronger. For example, during the May 2017-September 2023 period, VSDA outperformed the following funds focused on dividend growth:

• ProShares S&P 500 Dividend Aristocrats ETF ( NOBL ),
• ProShares S&P MidCap 400 Dividend Aristocrats ETF ( REGL ),
• iShares Core Dividend Growth ETF ( DGRO ).

Data from Portfolio Visualizer

However, it was unable to deliver a stronger annualized return than the Vanguard Dividend Appreciation ETF ( VIG ) and IVV.

Conclusion

In sum, VSDA capitalizes on promising U.S. dividend growth stories. In the current version, it offers exposure to 75 dividend stocks, predominantly from the industrial (25.5%), consumer staples (25%), and financial (10.8%) sectors. The portfolio has a weighted-average EY of about 5.1% and a market cap of $173 billion. VSDA's valuation overall does not appeal to me, while I like its quality.

All in all, unfortunately, I see little justification for a more optimistic outlook, so the Hold rating is maintained.

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