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In this article, we chose two great high dividend stocks for 2018. Both are well known, have proven record in the recent years and, in our opinion, have a very promising future.
Let’s look at it in detail:
Royal Dutch Shell plc. (NYSE:RDS-B)
Yield investors sometimes shy away from stocks showing a dividend yield of above 6%, the theory being at a certain level it could prove too good to be true. This thinking may have provided a contrarian opportunity in RDS, with the energy sector being one of the few areas in global markets where sentiment is still relatively depressed and may be primed for a rebound.
The future dividend is clearly sensitive to movements in the oil price going forward, but if energy prices can remain near current levels the high dividend could well be sustainable.
The market has been skeptical of this in recent times, as the balance sheet has been impacted by the poorly timed purchase of British Gas in 2014. Energy prices collapsed at the same time, but the company has since transformed itself.
Operating costs have been reduced by more than 20% and they have delivered on more than half of a major asset divesting program, with substantial progress made on the remaining asset sales. This year they have demonstrated they are generating enough free cash flow to continue with the high dividend, whilst also reducing debt.
Despite the acquisition being ill-timed, it has placed the company in a position where the future earnings profile is likely to have more promise and with less volatility.
The increased relative exposure to natural gas from acquiring BG allows them to take advantage of the gradual secular shift towards cleaner energy. It may also benefit from the stability of longer term contracts in the sector and provide more diverse overall earnings.
Large transformational acquisitions like this are sometimes viewed by the market as management “empire building”, yet getting involved after some value destruction can sometimes reduce the risk for shareholders going forward.
I would think the pressure the company was put under as oil prices plunged in 2014/15 is too fresh in the memory for management to consider straying from the current stated objectives.
Pleasing operating results over the last few quarters has given some comfort amongst the credit rating agencies, although it remains crucial to see them continuing to deliver on asset sales.
Oil Price Dependency
As for where the oil price is heading, well recent history has probably proved the consensus is not always a great indicator. The relative lack of interest in the sector may be a good contrarian signal to buy.
There is a theory that you buy commodity-related stocks when at a high P/E ratio because the “E” in the equation is likely to be depressed and ready for a cyclical upswing. At recent prices of around $63 for the B class shares, RDS has a trailing P/E in the 30s but this can be expected to at least halve in the future as earnings pick up.
If oil prices were to begin a sustained trend up above the $60 level, then at current valuations it offers plenty of scope for a positive re-rating as suddenly there would be far more flexibility within the balance sheet.
In such a scenario a buyback could eventually be on the agenda and we have seen in many other examples how this can improve the share price. This may be the preferred approach in the future given the stresses the company faced after the BG acquisition in 2014.
The Procter & Gamble Company (NYSE: PG)
The second dividend stock I will examine is quite a different situation, with Procter & Gamble having a dividend yield of only a bit more than half of Royal Dutch Shell, but with far more certainty surrounding it.
It has been regularly reported that many of PG’s well-established brands have been losing market share and management has taken their time to respond. The path they have chosen is to dramatically reduce the under performing brands in their stable, and achieve greater focus on the brands they deem to have the most potential.
This approach has not been without controversy, with renowned activist investor Nelson Peltz having differing views on the best path forward.
Despite the public battle last month, the future direction that Peltz laid out for the company may not be as different to the current plan in place from management as you may expect. Contrary to the typical stereotype of activists being in it for the short term, he wants the company to be more dynamic and respond to consumer’s changes in preferences, with more innovative development in new brands for the long term.
Consumer’s Preferences Are Changing
PG have not done a great job in capturing the shift of many consumers to prefer smaller local brands, which have shown a tendency to display stronger growth in recent times. Such brands have enjoyed the changes to the advertising landscape where they can build their reputation by social media and digital advertising, rather than through more traditional mechanisms that were previously difficult to penetrate.
The close defeat that Peltz suffered in the voting for his board position surely has led to management seriously contemplating the dissenting views made public in the battle. They must realize that suggestions the company has become complacent and lagged with innovation are not unfounded.
Fewer Brands, More Quality
The renewed focus on a narrower set of brands can improve their ability to capture some of the demand shift to smaller local brands. They need to respond quicker to consumer’s preferences that are changing at a faster rate. With expectations, not that great, even subtle progress on this front may be looked upon favorably by the market.
Safe EPS Growth
After the restructure and cost-cutting in recent years, the company still produces modest, but albeit relatively safe EPS growth of around 6% at a time when they are widely considered to have little innovation and their established brands are under threat.
As an investor, it often pays not to lose sight of some of the factors that have been pushed aside to the background, amongst all the noise about a disruption of brands in the media. We should remember that whilst their growth may be more mature in developed markets, they have plenty of earnings coming from both outside the US that includes many emerging markets.
PG still has the benefit of a huge scale. Currently, Peltz would argue this is not being exploited enough and their profit margins should be better, so this along with other areas of the business have scope for improvement.
The last few years of culling brands may have distracted attention from various other positive changes they can make going forward. If over the next few years we read more about the improvements PG is making, rather than the ever so well documented threats to the business, that may be enough to provide solid gains in the share price. Currently, at about $87 a share, a relatively safe dividend yield of above 3% and a P/E in the low 20s has its appeal in a low-interest rate environment.
Full-time investor based in Australia, with a focus on global asset allocation, event-driven and activist investing strategies. You can follow some of his ideas at his investment blog here at valueinvestingforaliving.com