5 New Income Picks That Offer You More
If you’re an income investor, you may find life more challenging this year. Here’s why – along with strategies to help you out.
Global growth, led by the East and the developing world overall, is set to accelerate. This could mean higher commodity prices; possibly (at long last) rising wages in the U.S.; higher inflation; and rising interest rates. It adds up to a recipe for lower bond prices. Meanwhile, with inflation making things more expensive, it will take more income to cover living expenses.
That’s why this month we take an ultra-close look at our Income/Value Portfolio to make sure our picks offer both market-beating yields and the ability to outpace inflation, in terms of dividend growth and earnings alike.
The key – and this goes for all investors, not just income-oriented ones – is to focus on quality. Though 2018 opens with the global economy on solid footing, risks have been growing. For instance, populism could lead to trade barriers that stymie growth. Mideast tensions could cause oil prices to surge. And then there’s the ongoing Korean situation, which reflexively makes investors more willing to pay a higher premium for solid all-weather companies.
High growth itself carries a risk that the Fed could overreact, tightening too much and bringing on a sharp slowdown or even recession. Or it could tighten too little, goosing inflation.
Our Income/Value Portfolio already is solidly positioned to keep income-oriented investors well above water, but the following changes – five new picks replacing five sales, described here and in the following article – make it even better, strengthening protection against risk while offering greater upside potential.
First, we are selling one limited partnership – Plains All American Pipeline, L.P. (NYSE: PAA) – and replacing it with another, Cheniere Energy Partners (NYSE: CQP). While PAA remains a good turnaround bet, oil storage and transport is unlikely to become a growth industry.
CQP is one of three parts making up Cheniere Energy (NYSE: LNG), the country’s leading exporter of liquefied natural gas – perhaps the most significant industry to emerge from the boom in shale.
The parent company, LNG, sits atop a complex corporate structure that is helping turn the U.S. from a natural gas importer to the world’s second-largest exporter over the next five years. CQP owns three critical cogs in that process: Sabine Pass LNG, Sabine Pass Liquefaction, and Cheniere Creole Trial Pipeline.
Over its first nine years of trading, CQP has paid a quarterly distribution of $0.425, most of it a return on capital rather than excess funds from operations. The October distribution, however, rose by a bit more than 3%, a small number with a large meaning. It indicates CQP is poised for a protracted period of growth in its distributions. Both the volume and eventually the price of the liquefied natural gas coursing through the Sabine and the Creole Pipeline, which connects Sabine to gas suppliers, should rise over the foreseeable future. CQP has years of rising distributions ahead as it helps supply the world with natural gas.
George Carlin famously riffed on how Americans’ lives revolve around needing a place for their “stuff.” And indeed, Americans, who love to buy things – over the past 50 years spending has grown 20-fold – have more stuff than their own homes and apartments can hold. That has helped make the self-storage industry one of the most dynamic slices of the real estate market. The self-storage market also benefits from life’s disruptions, as people move because of new jobs, divorce, or some other change. The rising proportion of Americans who rent rather than buy further stokes demand for outside storage.
To best capitalize on this trend, we’re selling Public Storage (NYSE: PSA), the largest self-storage REIT. We replace it with a smaller, more nimble, and faster-growing REIT in the same niche: CubeSmart (NYSE: CUBE). By virtually any measure of either growth or value, CubeSmart is the better play, and in coming years its funds from operations should grow at a rate several points higher than its larger rival.
Relative to other storage REITs, including Public Storage, CubeSmart’s facilities have the largest populations within a three-mile radius. The percentage of its facilities located in supply-constrained markets is greater than for any other REIT. And average household income in the vicinity of its facilities is the highest.
By the end of 2018, CubeSmart’s storage space in its top 12 markets will have grown by 7%. That along with continued increases in both occupancy rates and rents per unit will produce solid gains in funds for distribution to unit shareholders.
Over the past eight years the company also has become increasingly active in third-party management. It now manages more than 350 stores for others, compared to eight at the start of that period. Its owned stores have risen to 476 from 367.
Managing for others is less immediately profitable than ownership but provides a direct way to assess market conditions. Since 2010 CubeSmart has purchased 63 properties from its managed program. Managing stores, in other words, lets it leverage long-term growth while minimizing financial risks. While Public Storage remains a solid play in the storage industry, CubeSmart is the better choice for both current income and income growth.
An ideal income stock has a decent yield and products and prospects that are largely unaffected by economic conditions. Coca-Cola (NYSE: KO), which we sell this issue, comes close. But our new pick, General Mills (NYSE: GIS), comes even closer while offering faster growth in both earnings and dividends.
One measure of safety is how well a stock performs during the worst market conditions. In the market crash starting in 2008, Coca-Cola did well, declining 44% compared to the S&P 500’s 58% drop. But General Mills did even better, with a 36% drop from its high to its low. And it needed just nine months from its low to get back to its 2008 high.
We won’t quarrel with you if you still want to hold Coca-Cola. But we would quarrel if you don’t also buy General Mills, a multifaceted producer of branded consumer foods such as Cheerios and Yoplait. Since 2005, dividends and earnings have grown without interruption. Recent profit growth has come solely from improving margins as revenues have lagged. With a new CEO, Jeff Harmening, at the helm, the company is focusing on research to produce better offerings and on e-commerce, efforts that are paying off.
The recently introduced “Oui” yogurt has won rave reviews and a bucketful of new customers. New flavors have boosted ice cream sales, and new cereals like Reese’s Puffs are selling well. We expect revenue growth to return to at least the mid-single digits, which should drive growth of nearly 10% in profits and dividends. While we wouldn’t yet call General Mills a growth stock, that day could come. Meanwhile, with its 3.4% yield, it’s a superb total return play.
We continue with our remaining sales and purchases in the article beginning on p.6.