Image Source: Mike Cohen
By Valuentum Analysts
We are adding five dividend growth gems to fill the ~10% cash allocation in the simulated Dividend Growth Newsletter portfolio that came from removing Intel (INTC) a number of weeks ago. Each gem will be allocated at a 2% weighting. The changes will be reflected in the upcoming December edition of the Dividend Growth Newsletter (see archives), which will be released December 1.
Here are the five additions:
Qualcomm, Inc. – 2% weighting
Qualcomm (QCOM) has revolutionized the mobile phone industry. Through its own R&D and through partnerships with other firms, the company develops breakthrough technology and then licenses it. The firm has one of the strongest Economic Castles in our coverage. We recently raised our fair value estimate of Qualcomm considerably, and it now stands at $164 per share (its share price is trading at ~$145 at the moment).
Qualcomm is a big player in the 5G mobile handset space (the firm designs modems built for smartphones that enable 5G connectivity). In April 2019, Qualcomm and Apple Inc (AAPL) made waves when the duo announced they were dismissing all lawsuits against each other, and that Apple would make a payment to Qualcomm. Additionally, Apple signed a six-year licensing agreement (that included a multi-year chip supply agreement) with Qualcomm that had a two-year extension option.
Recently, Qualcomm signed a licensing deal with Huawei (which also has a large smartphone business) that included Huawei paying Qualcomm royalties owed during the 2019-2020 period (through the first half of this year) under a previous agreement while securing a new licensing agreement (there is also reportedly a cross licensing component included in the new agreement). Qualcomm’s licensing business is performing well as its dominance in the 5G mobile-oriented modem space (and elsewhere) puts it ahead of the competition.
To a very large extent, we continue to prefer large-cap tech companies with pristine balance sheets, quality cash flow profiles, and firms whose growth outlooks are underpinned by secular growth tailwinds. With one of our new additions to the Dividend Growth Newsletter portfolio, Qualcomm fits this profile nicely. The company has a very attractive Dividend Cushion ratio of 3.4 and a dividend yield of ~1.8% at the time of this writing. We expect its payout to continue to grow.
Qualcomm’s 16-page stock report >>
Home Depot – 2% weighting
We’re looking to add exposure to the rebounding housing and home-improvement market in the Dividend Growth Newsletter portfolio, and Home Depot (HD) is one of the best options–without having to take on exposure to the boom and bust cycles of an actual homebuilder, itself. The pandemic has prompted many households, particularly more affluent households in the suburbs, to pursue do-it-yourself (‘DIY’) projects while stuck at home, but we view this as a sustainable trend as the pandemic has all but shown many households they need more living and working space at home.
During Home Depot’s third quarter earnings report for fiscal 2020 (period ended November 1, 2020), Home Depot’s comparable store sales advanced ~24% last fiscal quarter versus year-ago levels, with comparable store sales in the US up almost 25% year-over-year. Rising digital sales have been key of late. The company has significantly improved its e-commerce operations during the past few years, which includes home delivery, in-store/curbside pickup, and in some instances (particularly for professional customers), work-site delivery options.
Beyond improving its fulfillment operations regarding its e-commerce business, Home Depot is also actively improving its digital marketing and overall presentation strategy, which we expect to continue to bear fruit in the coming years. Home Depot also recently announced it would acquire HD Supply Holdings Inc (HDS), a national distributor of maintenance, repair and operations (‘MRO’) products. We see this deal as favorably impacting Home Depot’s business model, though we caution that its balance sheet needs to be closely monitored going forward.
Home Depot had $14.7 billion in cash and cash equivalents on hand as of November 1. Stacked up against $2.5 billion in short-term debt and $32.8 billion in long-term debt, Home Depot’s net debt position before taking the HD Supply deal into account was already quite large. However, the company’s cash flow profile remains impressive. During the first nine months of fiscal 2020, Home Depot generated $15.9 billion in free cash flow which fully covered $4.8 billion in dividend payments and $0.8 billion in share repurchases made during this period. We view Home Depot’s pro forma net debt load as manageable.
Our fair value estimate for Home Depot sits at $265 per share, indicating shares of HD are about fairly valued as of this writing. The top end of our fair value estimate range sits at $318 per share, though for Home Depot to justify the high end of our valuation range, the firm would need to showcase that its recent sales gains are long lasting and have legs. Improving its relationship with non-professional customers and expanding its MRO business will be key here. Shares of HD yield ~2.2% as of this writing, and we give Home Depot an “EXCELLENT” Dividend Safety rating due to its impressive cash flow profile (its Dividend Cushion ratio is 1.5).
Home Depot’s 16-page stock report >>
Home Depot’s Dividend report >>
Honeywell International – 2% weighting
With GE’s (GE) fall from grace years ago, Honeywell (HON) has taken the reigns as one of Valuentum’s top industrial ideas. Though Honeywell’s valuation is not attractive as we’d like it to be at the moment, we recently raised our fair value significantly to north of $200 per share. With respect to this idea, we’d like to add some more industrials exposure to the Dividend Growth Newsletter portfolio to take advantage of what could become a very strong global economic rebound in 2021.
At the moment and like many other industrials, Honeywell continues to feel pain as a result of the COVID-19 pandemic, but several pockets of its operations have shown resiliency during these tumultuous times. Demand in the areas of defense and space, warehouse automation, and personal protective equipment remains strong, the latter undoubtedly bolstered by the outbreak of the coronavirus around the globe. The firm’s recurring software sales have also been growing at a nice double-digit clip.
On a normalized basis, the company generates very nice segment margins. Its ‘Performance Materials and Technology’ segment boasts its highest profit margins in the low- to mid-20% range, followed by its ‘Aerospace’ segment in the low 20% range. The company is also working to optimize fixed costs in its manufacturing and logistics facilities, which should help to keep profit margins moving in the right direction in the long run.
In addition to its highly-respected brand name, Honeywell’s massive installed base and large services business offer considerable competitive advantages. Free cash flow generation remains resilient, too, and the company’s net balance sheet position isn’t as bad as many others in the space (think Boeing or GE). At the end of the third quarter, Honeywell held $18.2 billion in total short and long-term debt and $15 billion total cash and equivalents. The company’s Dividend Cushion ratio stands at 2.3 with a dividend yield of ~1.8%.
Honeywell’s 16-page stock report >>
Honeywell’s Dividend report >>
UnitedHealth Group – 2% weighting
UnitedHealth Group (UNH) provides health benefits and services. The company offers investors defensive characteristics, and it has revealed considerable resiliency in the face of the COVID-19 pandemic, as well as through changes in healthcare laws during prior administrations.
Strong earnings momentum (i.e. a recent guidance increase), solid and growing free cash flow generation, and a very healthy balance sheet are key components to its story. The company has put up sizable double-digit dividend increases in recent years, and we believe it has the capacity to continue to do so.
UnitedHealth’s cash flow from operations advanced to $16.1 billion during the first nine months of 2020 versus $12.3 billion in the same period a year ago. Its capital spending held in the range of $1.4-$1.5 over the comparable nine-month periods, with free cash flow generation thereby exploding on a year-over-year basis handily covering cash dividends paid. Free cash flow generation during the first nine months of 2020 covered dividends paid by a factor of 4.2x.
UnitedHealth’s balance sheet is also net-cash-rich, with the firm ending the third quarter with $20.8 billion in cash and short-term investments and $39.2 billion in long-term investments (about $60 billion in cash and short-term/long-term investments). Short and long-term debt came in at $43.8 billion at the end of the quarter. The company’s dividend yield is ~1.5%, and the company has an impressive Dividend Cushion ratio of 3.1.
United Heath’s 16-page stock report >>
United Health’s Dividend report >>
Dick’s Sporting Goods – 2% weighting
Retailer Dick’s Sporting Goods’ (DKS) is experiencing strong fundamental momentum in its omnichannel e-commerce and brick-and-mortar strategy that serves the athlete in how they want to shop (in-store, curbside or online). During its third quarter, sales through its e-commerce channel leapt 95%, while brick-and-mortar comparable store sales grew at an impressive double-digit clip. Consolidated same store sales advanced 23.2% during the quarter (significantly higher than the 6% mark it registered in the same period a year ago).
Dick’s Sporting Goods’ balance sheet and cash-flow generation are also very healthy. The company ended the third quarter of 2020 with $1.06 billion in cash and cash equivalents and $411 million in convertible notes (due 2025), though we note it does have $2.3 billion in long-term operating lease liabilities. Free cash flow generation of $761.1 million during the first nine months of 2020 covered dividends paid of $80.9 million over the same period many times over. Its strong balance sheet and impressive free cash flow coverage of the dividend drive its impressive 3.2 Dividend Cushion ratio at the time of this writing; its dividend yield is ~2.1%.
Dick’s Sporting Goods 16-page stock report >>
Dick’s Sporting Goods Dividend report >>
—–
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.