Darren McKiernan says it’s tough to find high quality, dividend-paying companies trading at reasonable valuations.
The global developed equity market has done exceptionally well over the last 12 months and “many of the bigger-cap, brand-name companies that pay dividends are expensive,” says McKiernan, vice-president and global portfolio manager at Invesco Canada Ltd, who is a value manager focused on dividend-paying stocks.
The recent rise in interest rates has provided a headwind for some dividend-paying stocks, particularly those “classic” dividend-payers, says McKiernan. In this category, he includes pipelines, utilities, telecommunications services and real estate investment trusts, “all of which have been favoured by investors for some time.”
These entities, he says, pay large dividends, have high dividend-payout ratios and their valuations, in the context of dividend-paying companies, had become extremely stretched. “Even though these stocks have retreated, they are still expensive,” he says.
McKiernan reports that he has avoided these stocks over the last couple of years, despite their popularity, in favour of dividend-growers in other sectors. Select companies in, for example, information technology and consumer staples, “have offered good dividend yields to investors and have much greater scope to raise their dividends.”
These companies are strong free-cash-flow generators and have lower dividend-payout ratios. They also remain relatively less expensive than the classic dividend-payers, although their valuations have increased, he says.
At Invesco Canada, McKiernan is a member of the Trimark global equity team. He is lead manager of Trimark Global Dividend Class Fund and co-lead manager of Trimark Global Fundamental Equity Fund and Trimark Global Fundamental Equity Class Fund.
Trimark Global Dividend Class Fund, which has 48 names, currently has 43.4%of its assets under management (AUM) in U.S. equities. European weightings include 7.6% in Switzerland and 6.9% in the U.K. Cash and cash equivalents constitute 20.1% of the fund’s AUM.
“The high cash holding in this fund speaks to the challenge of finding quality dividend-payers at a reasonable valuation,” says McKiernan. “I have a conservative mandate and I will not dilute the quality of the existing holdings in the fund, by buying lesser quality stocks simply because they appear to be cheap.” McKiernan adds that he is “a patient investor with a longer-term investment horizon and I am willing to wait.”
Consumer-staples stocks are by far the largest weighting in Trimark Global Dividend Fund at 23.2% of AUM , followed by information technology at 11.1%. Industrials represent some 10.3% of the fund’s AUM, followed by consumer discretionary at 9.9% and health care at 9.7%.
A participant in Morningstar’s U.S. Equity Roundtable last December, McKiernan noted at the time that the U.S. technology sector was “cheap.” That’s still the case, he says, and “there are opportunities.” Meanwhile, consumer-staples stocks in the portfolio “are generally more expensive than when I bought them, but there are still a few opportunities globally.”
Apple Inc. (Nasdaq:AAPL) is a top-10 holding in Trimark Global Dividend Class Fund. McKiernan has held the stock in this fund for about two years. Although the information-technology industry as a whole is a mature one, Apple “continues to be a growth company,” says McKiernan. It has “considerable scope” to grow its smartphone sales, he says.
For example, he says, Apple is expected to launch a lower-priced smartphone. “This should do particularly well in emerging markets, which are generally an important source of growth for the company going forward.”
In the developed markets, Apple dominates the tablet segment, says McKiernan, and “tablets are steadily replacing personal computers.” Apple’s stock pulled back sharply over the past year, he notes. “I added to it when it was below US$400 a share.” The stock’s dividend yield is 2.7%.
Another technology holding in the fund is Microsoft Corp. (Nasdaq:MSFT). McKiernan reports that he continues to like this stock. “It is undervalued; the company’s assets, which go well beyond its Windows franchise, are under-appreciated.”
Based on valuation, McKiernan has sold down his holding in the dominant credit-card issuer, Visa Inc. (NYSE:V) , which also falls within the technology sector. He continues to like the company and “would add to my holding on weakness.”
Visa is “an excellent business,” with huge growth prospects outside North America. But the stock, says McKiernan, “is approaching full value at a price-earnings multiple of 25 times earnings per share.”
In consumer staples, a top-10 holding in the fund is Henkel AG & Co. KGaA, which is based in Germany. This company has two principal divisions, says McKiernan, one of which is home care and personal-care consumer products. The other is adhesives for both consumer and industrial purposes.
Henkel, says McKiernan, has developed some global consumer brands, such as Purex laundry detergent and Dial soap, and has made strong inroads in emerging economies. There is also a growing use of its adhesive technologies in a wide range of products, he says, including in packaging and smartphones.
Shares of Henkel trade at around 15 times 2013 earnings-per-share estimates and 14 times 2014 estimates. “The company has a low dividend-payout ratio relative to other major consumer-staples companies,” he notes. The stock has a dividend yield of 1.8%.
Another prominent global consumer-staples company that is in the portfolio is Mondelez International Inc. (Nasdaq:MDLZ) , which makes a wide range of brand-name food and beverage items including Cadbury chocolates, Oreo cookies and Trident gum. Formerly part of Kraft Foods Inc., the company was spun out in October of last year.
“It is currently restructuring some of its operations,” says McKiernan. “Looking ahead, the restructuring, better leveraging of its size, its long-established brands and expansion into emerging markets, augurs well for the stock over the next three to four years.”
A dominant player in medical technology and hospital supplies that has “good scope to continue to increase its dividend” is Becton, Dickinson & Co. (NYSE:BDX) , says McKiernan.
A top-10 holding, this health care company “has increased its dividend every year for the past 30 years and has increased earnings every year, bar one,” says McKiernan. Its products are a play on both the aging population in developed economies and the demand for better medical treatment in emerging economies, he says.
The stock, he says, trades at 16 times earnings-per-share estimates for the next 12 months and a dividend yield of 2%. Furthermore, he says, the company’s dividend payout ratio is relatively low at 35%.
July. 22 close
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*As of July. 22, 2013. All figures in US$