2023-04-21 08:00:00 ET
Summary
- For the most part, dividend stocks have outperformed growth stocks over the past two and a half years.
- But there are some notable exceptions.
- In this article, we look at two high-yield, high-growth dividend growth stocks whose stocks have dipped hard recently and are now looking way too cheap to ignore.
For the most part, dividend stocks have outperformed growth stocks over the past two and a half years. Since launching our portfolio at High Yield Investor on December 3rd, 2020, we have generated a total return of over 55%, whereas popular dividend funds such as the Schwab U.S. Dividend Equity ETF ( SCHD ) and the Global X SuperDividend U.S. ETF ( DIV ) have generated total returns of 24.15% and 18.66%, respectively.
In contrast, the technology mega-cap heavy S&P 500 ( SPY ) has generated a total return of just 16.6% and tech plays Invesco QQQ Trust ( QQQ ) and ARK Innovation ETF ( ARKK ) have returned just 5.59% and -66.45% respectively over that period:
This is not surprising due to the unwinding of three major catalysts for tech stocks that have hit in recent years:
- Technology stocks had been on a run of massive outperformance for years due in large part to the explosive adaptation of the internet as well as the historically low interest rates, which resulted in a premium on longer-dated cash flows from growth businesses. With interest rates now rising in response to runaway inflation, the reverse effect is taking place, with technology stock valuations deflating rapidly.
- The COVID-19 lockdowns provided a strong tailwind to internet/tech businesses at the expense of traditional, slower growth businesses that tend to pay dividends more often and at higher percentages of earnings than do the high growth technology companies. Now that the economy has re-opened, people are flooding back to traditional businesses and resuming their former consumer behaviors at the expense of the growthier tech companies.
- The meme-stock craze that took hold during the COVID-19 lockdowns drove a lot of retail investor demand for high growth, unprofitable businesses. With the government subsidies gone and inflation eating into consumer purchasing power, meme stocks have lost a lot of their luster.
That said, not all dividend stocks have participated in this period of outperformance. In this article, we look at two high-yield, high-growth dividend growth stocks that we believe are being unfairly overlooked by Mr. Market: Alexandria Real Estate Equities ( ARE ) and NextEra Energy Partners ( NEP ).
As you can see in the chart below, since the launch of our portfolio, both NEP and ARE have underperformed SPY's 16.6% total return over that period, with particularly hard pullbacks in recent months:
In the rest of this article, we will discuss why we believe that will change moving forward.
Why Alexandria Real Estate Equities Stock Is A Compelling Buy
ARE - a leading life sciences REIT - is one of our top picks right now for the following reasons:
- ARE Owns High Quality Assets: Life science buildings can be attractive investment opportunities due to rapidly growing demand for space in research, limited supply, and high barriers to entry, resulting in rapid rent growth and high occupancy rates. Moreover, tenant relocations are rare due to the impracticality of moving equipment. Additionally, the credit quality of tenants is strong, with many being investment-grade rated or public companies. Last but not least, rents are currently below market, providing a margin of safety and potential for future growth. For example, ARE retained over 80% of its existing tenants and was able to push for large rent hikes in most cases over the past 5 years. As the picture below illustrates, ARE owns beautifully designed, mission-critical, trophy assets that are in competitively positioned, hard-to-replicate locations:
- ARE Has A Fortress Balance Sheet: Alexandria has a strong balance sheet in the REIT sector with low leverage of 25% LTV (incl. preferred equity), 99% fixed rate debt, and a long average term of 13.2 years with no maturities until 2025. It has over $5 billion of liquidity available for future maturities and retains cash flow with a low 52% payout ratio. Alexandria has a BBB+ credit rating and its leverage is at an all-time low, making it likely to earn an A- credit rating in the future.
- ARE Stock Is Heavily Discounted: Despite historically trading in line with NAV, shares of Alexandria are currently priced at a ~35% discount to its net asset value. Its P/FFO is currently 13.2x, which is lower than its five-year average P/FFO multiple of 20.7x. With a strong balance sheet, resilient properties, and predictable growth prospects, we think it should trade closer to 20x FFO, which would bring its share price closer to $200 per share. The current price is just ~$120 per share, which is discounted due to being included in the "office" peer group, despite having different fundamentals from traditional offices.
- ARE Stock Has A Rapidly Growing Dividend: Alexandria has a respectable dividend yield of 4.2% with a low payout ratio of 55%, and the company's cash flow is growing rapidly. Over the past 5 years, the average annual dividend hike has been 6.5%, and this could accelerate in the future as they increase their payout ratio and sustain FFO per share growth rates in the high single digits.
- ARE Stock Has An Impressive Total Return Track Record: Alexandria creates additional value by developing its own properties at a 6-7% stabilized yield, which can then be sold at a 4-4.5% cap rate, creating value for shareholders. It also has a venture capital arm, buying equity stakes in some of its tenants, which has been successful due to its competitive advantage as the biggest landlord in the life science space. This has resulted in market-beating returns since going public, outperforming even Berkshire Hathaway ( BRK.A ) ( BRK.B ) and Walmart ( WMT ) over time:
You can read our full investment thesis on ARE here .
Why NextEra Energy Partners Stock Is A Compelling Buy
NEP - a leading renewable energy infrastructure business - is a very attractive buy at the moment because:
- NEP Has A Well-Diversified Portfolio: With long-term contracts that generate stable, defensive cash flows, NEP has a very predictable cash flow profile for the foreseeable future. Moreover, its concentration in the United States reduces geopolitical and Forex risks.
- NEP's Balance Sheet Is Well-Positioned To Fuel Further Growth: NEP has plenty of liquidity and is backed by its A- rated parent NextEra Energy ( NEE ). Management provided the following commentary on NEP's financial positioning on its latest earnings call, indicating that they are well-positioned to continue investing aggressively in growth:
During the fourth quarter, NextEra Energy Partners entered into a new convertible equity portfolio financing for approximately $900 million, with a low implied cash coupon of roughly 2.8% for up to 10 years to be funded by the investors' share of ongoing portfolio cash flows.
In December, NextEra Energy Partners raised approximately $500 million in new convertible notes with a 2.5% coupon which, along with a cap call entered into at the time of the financing, provides unitholders with dilution protection for up to 50% accretion versus the net unit price at the time of issuance...
In May 2022, NextEra Energy Partners increased the size of its revolving credit facility to approximately $2.5 billion, nearly all of which is currently available. With this available revolving credit capacity and the final funding of approximately $180 million expected from the 2022 convertible equity portfolio financing, NextEra Energy Partners enters 2023 with significant financing capacity to fund future growth.
Additionally, NextEra Energy Partners still has $6 billion of forward starting interest rate swaps, which is more than enough to cover its corporate maturities through 2027 and will help mitigate the impact of higher interest rates on future debt issuance, whether for maturities or net new issuances.
- NEP Stock Has Robust Distribution Growth Potential: Management expects that its distribution per unit will grow at a 12-15% CAGR through 2026. At the current unit price, the 2026 year-end distribution yield on cost is expected to be ~9% at the midpoint of guidance. For an above-average growth business that also boasts defensive cash flows, that is a phenomenal yield that implies substantial upside potential for units in the coming years. Management reiterated its confidence in the growth profile on their latest earnings call, stating:
The significant tailwinds provided by the IRA and Energy Resources' future renewables outlook, combined with NextEra Energy Partners' third-party M&A and organic growth opportunities and continued ability to raise low-cost capital even in a challenging capital markets environment, provide us with long-term growth visibility.
As a result, today, we are pleased to announce that we are extending our financial expectations for NextEra Energy Partners by another year. We now see 12% to 15% per year growth in per unit distributions as a reasonable range of expectations through at least 2026.
For further details see:
Buy The Dip: 2 High-Growth, High-Yield Stocks Getting Too Cheap