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Building a High Dividend Yield, Low Beta Income Portfolio (Part 3)

For income investors wanting to go it alone, they should consider creating a portfolio of high dividend stocks with low beta.  This type of portfolio will provide a risk to reward profile during times of uncertainty in the markets.  By adding the component of a bullish outlook to the low beta stocks indicates these stocks can be held in a long-term portfolio.  The high dividend yield can be compounded over time and will increase as these stocks raise their dividends each year.  This portfolio will be built in a series of articles.  You can read Part 1 here and Part 2 here.  Below is Part 3 with more stocks to look at for adding your portfolio.

Philip Morris International Inc. (PM) manufactures and sells cigarettes and other tobacco products.  Separated from operations in the U.S. and the
regulatory and litigation risk of that market, PM will, in our view, be better positioned to innovate, tailor offerings to higher-growth emerging markets,
achieve cost savings, and incentivize managers.  We think PM’s low penetration of markets with potentially high cigarette consumption, such as China, India and Vietnam, also provides attractive opportunities.  Also, the spinoff provided PM with currency for acquisitions.  We believe its high cash flow generation is
supportive of regular stock repurchases and its dividend, which recently yielded 3.5%.  PM increased its dividend 20% in the last year.  PM has a 3-year beta
of 0.61.  PM has an equity summary score of 9.7 out of 10 for a VERY Bullish outlook.

Pfizer Inc. (PFE), a biopharmaceutical company, engages in the discovery, development, manufacture, and sale of medicines for people and animals worldwide.  The world’s largest pharmaceutical company, Pfizer produces a wide range of drugs across a broad therapeutic spectrum.  In October 2009, PFE acquired rival drugmaker Wyeth for some $68 billion in cash and stock.  Although we expect the loss of U.S. patent protection on Lipitor and negative foreign
exchange to result in lower earnings this year, we think the decline should be cushioned by strength in several key pharmaceutical lines, growth in emerging
markets, cost restructurings and common share buybacks.  The company recently announced a $10 billion buyback, of which $5 billion is expected to be purchased in 2012.  We are also encouraged by PFE’s pipeline, which comprises potential breakthough treatments for arthritis, heart disease and other conditions, as well as by the planned spinoff to shareholders of non-core businesses.  PFE has a dividend yield of 4.03% and a 3-year beta of 0.75.  PFE increased its dividend 10% in Q1 2012.  PFE has an equity summary score of 7.4 out of 10 for a Bullish outlook.

Johnson & Johnson (JNJ) engages in the research, development, manufacture, and sale of various products in the health care field worldwide.  We believe
JNJ’s diversified sales base across drugs, medical devices and consumer products, along with its decentralized business model, has served it well in the past and should continue to do so in the years ahead.  In our view, JNJ’s pharma segment should benefit from a number of key new products, including Xarelto blood thinner, Incivek treatment for hepatitis C, Zytiga for prostate cancer, and Edurant for HIV.  In late April 2011, JNJ agreed to acquire Synthes for $21.3 billion in cash and stock.  We see significant operating synergies accruing from the proposed Synthes combination, which is expected to be completed in the
first half of 2012. JNJ has a dividend yield of 3.59% and a 3-year beta of 0.49.  JNJ has a 5-year average dividend growth rate of 8.23%.  JNJ has an equity summary score of 8.2 out of 10 for a Bullish outlook.

A Fresh IPO with an 8.6% Dividend Yield

Roundy’s Supermarkets (RNDY) is a strong regional food retailer with a local market merchandising strategy that provides high quality food products at competitive prices.  The company was founded in 1872 in Milwaukee and operates 159 retail grocery stores and 97 pharmacies under the Pick ‘n Save, Rainbow, Copps, Metro Market, and Mariano’s Fresh Market retail banners.  The company went public in February 2012 and has a market capitalization of $454 million.  Roundy’s generated $150 million of operating income on $3.8 billion of revenue in 2011.

RNDY began trading on February 8, 2012 at an initial stock price of $8.50.  Currently, RNDY is trading at $10.62, an increase of 25% from its IPO price.  What is unique to RNDY is that it will pay a dividend in 2012.  RNDY plans to pay a quarterly dividend of $0.23 per share.  This represents an annual yield of 8.6% at Roundy’s current price per share.  The dividend payout of ~$40 million represents 60-65% of net income and appears secure, given solid free cash flow generation.  The stock’s dividend yield is much  higher than any other names in the consumer staples universe, and we believe that this provides meaningful downside support to the stock.  In fact, the 8.6% dividend yield is higher than tobacco stocks like Altria Group (MO) at 5.5%, Reynolds American  (RAI) at 5,4%, Lorillard (LO) at 4.8% and Philip Morris (PM) at 3.6%.

Roundy’s is the dominant player in its key markets, with strong market share.  Strong local share is critical in supermarket retailing, given the inherently high fixed cost structure of the conventional model.  Most players in the industry believe that it is critical to be the number one or number two player to compete effectively in a market over the long term.  Roundy’s is the dominant player in its most important markets, holding the number one market share position in four out of its six primary markets. Roundy’s dominance is even more impressive in Milwaukee, its biggest market, where it has 55% share. The company’s average share in all markets is 35%, amongst the highest in U.S. food retail.

While the company’s core business provides no real opportunity for growth, we believe their expansion into the adjacent Chicago market presents an underappreciated opportunity.  Chicago is the third largest market in the United States, with struggling market leaders in Supervalu and Safeway.  Roundy’s is rolling out a differentiated format focused on high-quality fresh product at highly competitive prices.  Roundy’s management team has a history of success in the market, and the company has negotiated a labor advantage with the local union.  The company has only five stores in the market currently but plans to open four to five annually.  We do not expect Chicago to provide a material lift to earnings in the near term; however, it could be a catalyst within the next few years if successful.

RNDY estimates fiscal 2012 EPS of $1.42, fiscal 2013 EPS of $1.50, and fiscal 2014 EPS of $1.65.  At a PE of 10, RNDY should trade at $14.20, a 33% increase from its current value.  At a stock price of $10.62 with a 8.6% dividend yield, we believe the market has not properly valued its steady income stream and assigned value to the growth in Chicago.  Investors should at least clip a steady coupon on the dividend and could see solid appreciation once the company’s story becomes better understood.

List of Calendar Spread Trades for August 2011

Below is a list of potential calendar call spreads for further evaluation.  There is an option to purchase shown in the buy side column.  These options are the January 2012 call options.  The sell side column shows the option to sell in the August 2011 listing for each stock.  All other metrics are based on the previous closing price and current option pricing.  These will change depending on the market prices of each stock.  You should watch for earnings releases and actively manage these trades.

Click to enlarge

Exxon Mobil Corporation (XOM) is a manufacturer and marketer of commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics and a range of specialty products. It also has interests in electric power generation facilities. It has many divisions and hundreds of affiliates with names that include ExxonMobil, Exxon, Esso or Mobil. Divisions and affiliated companies of ExxonMobil operate or market products in the United States and other countries of the world. Their principal business is energy, involving exploration for, and production of, crude oil and natural gas, manufacture of petroleum products and transportation and sale of crude oil, natural gas and petroleum products. On June 25, 2010, it acquired XTO Energy Inc. by merging a wholly owned subsidiary of ExxonMobil with and into XTO. In October 2010, Global Partners LP acquired retail gasoline stations from Exxon Mobil. In June 2011, the Company acquired Phillips Resources.
Philip Morris International Inc. (PM) is a holding company. PMI, through its subsidiaries and affiliates and their licensees, is engaged in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States of America. As of December 31, 2010, its products were sold in approximately 180 countries. Its portfolio comprises both international and local brands, which include Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris and Red & White. PMI also owns a number of local brands, such as Sampoerna A, Dji Sam Soe and Sampoerna Hijau in Indonesia, Fortune, Champion and Hope in the Philippines, Diana in Italy, Optima and Apollo-Soyuz in Russia, Morven Gold in Pakistan, Boston in Colombia, Belmont, Canadian Classics and Number 7 in Canada, Best and Classic in Serbia, f6 in Germany, Delicados in Mexico, Assos in Greece and Petra in the Czech Republic and Slovakia.
General Motors Company (GM) is a global automotive company. It develops, produces and markets cars, trucks and parts worldwide. GM also provides automotive financing services through General Motors Financial Company, Inc. (GM Financial), formerly AmeriCredit Corp. (AmeriCredit). These financing operations consist principally of financing automobile purchases and leases for retail customers. The Company operates in five segments: GM North America (GMNA), GM Europe (GME), GM International Operations (GMIO), GM South America (GMSA) and GM Financial. GM Financial is an automotive finance company. GM Financial purchases automobile finance contracts for new and used vehicles purchased by consumers primarily from franchised and select independent dealerships. On October 1, 2010, GM completed the acquisition of GM Financial. In February 2010, GM completed the sale of Saab Automobile AB (Saab). In May 2010, the Company completed the sale of Saab Automobile GB (Saab GB).
Oracle Corporation (ORCL) is an enterprise software company. The Company develops, manufactures, markets, distributes and services database and middleware software, applications software and hardware systems, consisting primarily of computer server and storage products. It operates in three segments: software, hardware systems and services. Its software business is consisted of two operating segments: new software licenses and software license updates and product support. Its hardware systems business consists of two operating segments: hardware systems products and hardware systems support. Its services business is consisted of three operating segments: consulting, On Demand and education. In January 2010, the Company acquired Sun Microsystems, Inc. and Silver Creek Systems, Inc. In January 2011, the Company completed the acquisition of Art Technology Group (ATG), Inc.
General Mills, Inc. (GIS) is a global manufacturer and marketer of consumer foods sold through retail stores. The Company is also a supplier of food products to the foodservice and commercial baking industries. General Mills manufactures its products in 15 countries and markets them in more than 100 countries. The Company’s joint ventures manufacture and market products in more than 130 countries and republics worldwide. The Company’s businesses are organized into three operating segments: U.S. Retail, International, and Bakeries and Foodservice. The Company sells ready-to-eat cereals, through its Cereal Partners Worldwide (CPW) joint venture. The Company’s primary customers include grocery stores, mass merchandisers, membership stores, natural food chains, drug, dollar and discount chains, commercial and noncommercial foodservice distributors and operators, restaurants and convenience stores. In July 2011, it acquired 51% controlling interest in Yoplait S.A.S.
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