Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar.com. As the year comes to a close, we thought it'd be a good time to pull together some of our best dividend-stock ideas from the past few months.
First we'll take a look at the yield-rich energy sector. Two of Morningstar's favorites in the sector, Enbridge and TransCanada, remain undervalued.
Joe Gemino: Some of our best energy dividend growth stocks are among some of our top calls in the sector.
Five-star rated wide-moat Enbridge offers 50% upside and also gives investors an attractive 6.3% yield. More impressively, we think that the company will meet its planned 10% annual dividend growth through 2020. Enbridge sports a near-term CAD 22 billion in commercially secured capital projects in its growth portfolio, which is highlighted by the Line 3 replacement project. We expect the growth portfolio to generate almost CAD 4 billion in incremental EBITDA, which will support the dividend growth with a healthy distributable cash flow ratio of 1.4 times the dividend, which is more than enough buffer.
If the stock price doesn't appreciate from current levels, we expect it to yield 7% at the end of 2019 and 7.7% at the end of 2020 when Enbridge increases its dividend each year.
Narrow-moat 4-star rated TransCanada offers 40% upside coupled with a 5.3% dividend yield. Like Enbridge, the company expects to grow its dividend, but in the 8% to 10% range throughout 2021. TransCanada boasts CAD 32 billion in commercially secured growth projects in its portfolio, highlighted by the Keystone XL.
If the stock price doesn't appreciate from current levels, we expect it to yield 5.9% at the end of 2019, 6.5% at the end of 2020, and 7.1% at the end of 2021 when TransCanada increases its dividend each year.
It's worth noting that the Keystone XL is not one of the projects that we expect to underpin near-term dividend growth. If the project is successfully placed into service, we could see further attractive dividend increases after 2021.
Dziubinski: Next up, the technology sector. This may not be the first place investors think of when it comes to finding dividend stocks. Yet there are some solid dividend payers among semiconductor stocks in particular. They include Intel, KLA Tencor, and Lam Research, which are undervalued today.
Brian Colello: There are three names with healthy dividends in technology that we'd like to highlight, all in the semiconductor space. They've been beaten down due to a near-term slowdown, but we think these are the times when it makes sense to buy moaty businesses that are poised to recover when the industry upturn begins. It may get worse before it gets better, but when the pickup in demand happens, it's often too late.
First is Intel. We have a $65 fair value estimate and see the stock as 25% undervalued. Intel has been beaten up due to a CEO transition and manufacturing delays, but we think it's a wide-moat firm that will ultimately recover from its missteps. The firm is still well-positioned, not only as the dominant PC processor supplier, but also the dominant server and data center chipmaker. With growing opportunities in automotive, artificial intelligence, and 5G, Intel is highly profitable and we think the dividend is safe.
Our other top two picks in tech are both in chip equipment, KLA Tencor and Lam Research. KLA has a wide moat with a 3.2% dividend yield. We have a $128 fair value estimate and see the stock as about 25% undervalued. Lam Research, narrow moat, positive moat trend with a 2.9% dividend yield. We have a $185 fair value estimate and see the stock as about 20% undervalued.
The story is similar for both firms: 2017 and early 2018 was a tremendous time for chip equipment spending as Samsung and other memory chipmakers expanded their capacity. There's now been a slowdown in spending on chip equipment. However, we think a recovery is in the works for 2019 and long term. There's ultimately few substitutes for the type of equipment that KLA and Lam provide to its customers.
KLA dominates in process diagnostic tools, helping customers improve their manufacturing yields. Lam Research is strong in etch and deposition, needed to carve out microscopic transistors inside of semiconductors. In both cases, we again think the dividend is safe and that management is committed to paying current payouts.
So for investors willing to weather the storm in the semiconductor space, we like Intel, we like KLA-Tencor, and we like Lam Research, not only for their nice dividends but also potential upside in the stock price.
Dziubinski: Finally, we'll consider a pair of stocks battling at the breakfast table: Kellogg and General Mills. Both dividend payers are inexpensive by our measures.
Erin Lash: While sales and consumption growth in the cereal aisle has languished over the past few years, we think investors would be well-served to indulge on the shares of the leading manufacturers in the space, namely wide-moat General Mills and Kellogg, both of which we view as undervalued.
For one, we think the market's confidence in General Mills' ability to restore top-line growth has faltered, considering continued softness in volume across the industry as well as skepticism around the acquisition of natural pet food company Blue Buffalo earlier this year. While the deal carries some inherent risk as General Mills enters a category in which it has limited experience, we remain confident in the firm's ability to efficiently integrate Blue Buffalo and extract cost synergies from combining these operations, as we expect it will lean on the experience gained when it added Annie's and others to its mix--leveraging its supply chain and distribution capabilities while largely leaving the acquired firm's operating model intact.
Further, we don't surmise its hunger for deals will compromise its ability to return cash to shareholders. We model a dividend payout ratio averaging 65% over our 10-year explicit forecast (which is in line with its five-year historical average), and implies mid-single-digit dividend growth. Given its discounted price, trading about 25% below our $58 fair value estimate, and with a 4%-plus dividend yield, we think the stock provides a sufficient margin of safety for long-term investors.
Further, we suggest investors with an appetite for income should give Kellogg a look, as it boasts a dividend yield of more than 3%. Kellogg's position as a leader in the U.S. cereal aisle (holding more than one third share of the domestic ready-to-eat cereal space), combined with its efforts to bolster its position in the on-trend snacking category (which now accounts for more than half of its total sales base, up from just one quarter at the start of the century) makes it a valued partner for retailers.
From our vantage point, Kellogg's decision to pivot away from direct-store distribution (which had accounted for about a quarter of its U.S. business) and transition completely to a warehouse model has been a prudent means to free up resources to invest further behind its brands in terms of innovation, marketing, and new packaging, and ultimately support its entrenched relationships with retailers, which we believe is a pillar of its intangible asset-based wide moat.
As such, with shares trading around a nearly a 15% discount to our valuation, combined with our expectations for mid-single-digit annual growth in its dividend over our explicit forecast horizon, we think investors would also be wise to keep this wide-moat name on their radar screens.