2023-09-29 06:18:48 ET
Summary
- Market turmoil continues in 2023 due to higher interest rates and the Federal Reserve's actions to contain inflation.
- Dividend yields have climbed, particularly in interest rate-sensitive industries, presenting opportunities for income investors.
- Three undervalued high-yield stocks with reasonable valuations are Verizon Communications, Washington Trust Bancorp, and Walgreens Boots Alliance.
The market turmoil continues in 2023 because interest rates have headed higher. The U.S. Federal Reserve has aggressively moved to contain and lower inflation by draining liquidity and raising the Federal Funds rate. As a result, short-term and long-term Treasury yields have soared.
One consequence of the Fed's action is dividend yields have climbed, especially in interest rate-sensitive industries. For example, in aggregate, utility stocks are trading at the lowest valuation and highest yields in many years. Bank stocks are also sporting elevated dividend yields. Granted, some of these stocks carry risks because of industry or company-specific issues. But quality companies exist.
In addition, dividend growth and income investors can find high-yield stocks with reasonable valuation. We discuss three undervalued high-yield stocks that are also dividend growth stocks for long-term income.
Criteria for Selection
To pick the three stocks, we require specific criteria to be met. The bullets below outline what we desire in employing a stock screener in the Portfolio Insight application.
- A minimum dividend yield of 7%.
- At least five years of dividend growth for Dividend Challenger status.
- A payout ratio of not more than 65%.
- Undervaluation based on historical price-to-earnings [P/E] ratio.
The outcome was 18 stocks. We discuss three companies from different industries.
Verizon Communications
Verizon Communications ( VZ ) is in the bargain-basement bin. The company has struggled with poor results in its retail cellular business. Net subscriber growth was negative because of poor operational execution and competition from T-Mobile ( TMUS ) and AT&T (T). Also, capital spending was elevated because of the 5G rollout, impacting profitability.
The CEO made some changes, replacing the head of the Consumer Group twice in one year. Whether the consumer cellular numbers reverse their losses over time is yet to be determined, but it shows year-over-year improvement. Also, when combined with business cellular growth, Verizon has net additions.
He also lowered capital spending. The move to lower capital spending has improved operating and free cash flow. Total debt is still elevated, but net debt is lower.
In the meantime, Verizon carries an 8%+ dividend yield, the highest in a decade. Moreover, the rate was increased for the 19th consecutive year this month. This Dividend Contender's high yield comes with a non-GAAP payout ratio of 53%. The credit rating agencies give Verizon a BBB+ /Baa1, a lower-medium investment grade, providing confidence about the balance sheet .
Verizon is undervalued trading at a price-to-earnings ratio of only ~6.9X, appreciably less than the range over the past decade. We view Verizon as a long-term buy.
Washington Trust Bancorp
Washington Trust Bancorp ( WASH ) is a regional bank whose share price and valuation have plummeted while its yield has climbed to above 8%. The bank does not have the same exposure to cryptocurrencies and riskier assets that affected several regional banks earlier this year.
The over 200-year-old bank operates in Rhode Island, Connecticut, and Massachusetts. It has 26 branches in Rhode Island, seven residential mortgage offices, four commercial lending offices, and five wealth management offices. Investing in this bank is a play on the New England economy, which is doing well compared to the rest of the United States. The unemployment rate for Rhode Island is 2.7%, for Massachusetts is 2.6%, and Connecticut is 3.6%, all below the national average.
That said, regional banks have exposure to commercial lending like real estate and commercial & industrial [C&I]. A concern is that commercial loans may be under pressure because the interest rates will reset higher. However, most loans have a fixed term followed by a reset after a few years, meaning the risk will impact only a small percentage of loans annually.
The other main risk is office portfolios, which face difficult times because hybrid work reduces income. However, Washington Trust only has ~$306 million of exposure out of a $5.4 billion total loan portfolio or 5.7%. Next, the average loan-to-value is 50%, while the debt-service cover ratio is 1.4+, and $0 non-performing loans. The bottom line is Washington Trust does not have the same exposure as other regional banks.
Since investors were indiscriminately selling all regional bank stocks, it has made bargains of some. Washington Trust now yields about 8.3% with a payout ratio of 65%. The bank has raised the dividend for 13 consecutive years and paid a consistent dividend for over a century.
Furthermore, the earnings multiple is only 10.6X, lower than the 10-year range. We view this bank as a long-term buy.
Walgreens Boots Alliance
The third stock on this list is Walgreens Boots Alliance ( WBA ), the giant pharmacy retailer. The company has been difficult to hold because of a declining share price since 2015, after the merger of Walgreens and Boots. The third quarter of fiscal year 2023 saw lower guidance, and subsequently, the CEO and CFO resigned, further pressuring the share price.
Although the company is seemingly in a rut, it is one of the two market leaders in pharmacy retail nationwide. Walgreens Boots also has a strong presence in the United Kingdom. Additionally, the company is expanding from its core retail into healthcare for growth, leveraging the stores as the center. Along these lines, Walgreens Boots is growing VillageMD (primary care), CareCentrix (post-acute care), Shields Health Solutions (specialty pharmacy), and Walgreens Health.
On the plus side, pharmacy sales are increasing on higher prescription volumes, and Boots is gaining market share. Retail sales for Boots are also climbing but are weaker for the U.S. stores. Nevertheless, the firm has some challenges. First, although growing rapidly, the U.S. Healthcare segment has yet to be profitable. Next, margins are under pressure globally because of inflation, rising wages, lower COVID-19 vaccine demand, and weak consumer sentiment.
Lastly, Walgreens Boots has a complex footprint. However, the firm is selling its AmerisourceBergen stake, exited Option Care Health, sold its stake in Guangzhou Pharmaceuticals, and announced the sale of retail pharmacies in Chile. The company uses the proceeds to invest in the business, strategic M&A, pay down debt, and dividend and share repurchases.
The company has a storied history as a dividend growth stock with a 48-year streak and 91 years of never missing a payment. The firm is a Dividend Aristocrat and will probably become a Dividend King. The forward dividend yield is 9%+, supported by a moderate payout ratio of approximately 47%. However, debt is higher because of M&A and operating lease obligations on the balance sheet. The leverage ratio is about 2.0X, including only short-term, current, long-term, and long-term debt.
Walgreens Boots is in a weaker position than a few years ago, and a lot has to do with complexity, strategy, and more debt. However, slimming the corporate structure and cost-cutting initiatives should help margins and profitability. In the meantime, the stock is undervalued at a P/E ratio of only ~5.2X, and investors are paid to wait.
For further details see:
3 High Yield Stocks For Dividend Growth And Income