Archives for May 24, 2018

Long-term business tailwinds and market-trouncing dividends have made Verizon Communications (NYSE: VZ) a staple in income investors’ portfolios. But Verizon isn’t the only top stock that’s rewarding investors with an envy-inspiring yield. BP PLC (NYSE: BP), Ford Motor Company (NYSE: F), and AT&T Inc. (NYSE: T) offer higher yields than Verizon does, and according to three Motley Fool contributors, each has catalysts that could make now the perfect time to add it to your income portfolio.

Time to warm up to energy

Todd Campbell (BP PLC): Energy exploration and production stocks took a drubbing after crude oil prices peaked in 2014, but commodity prices have been marching higher for over a year now, and that’s translating into increased profits at companies like BP.

One of the biggest energy producers on the planet, BP has its hands in upstream (finding and extracting oil and gas), midstream (transport, including pipelines), and downstream (selling to consumers) businesses.

Last quarter, BP reported its best quarterly profit in three years. I expect that we’ll see more of those “bests” as some very important new projects come online.

In 2017, the company started up seven new projects — on time and under budget — and as a result, its upstream production grew 14% year over year last quarter. In 2018, six new projects are coming online, including Atoll in Egypt and the massive Shah Deniz in the Caspian. Between 2016 and 2021, BP’s goal is to add 1 million new barrels of oil production per day.

Higher prices for that higher production could be a big driver of future profit growth, but BP’s also benefiting from operating leverage because of its cost-cutting during the downturn. According to management, margins on major projects through 2021 will be, on average, over a third higher than margins were on production in 2015.

BP’s also growing downstream by entering new markets, like Mexico, where it has 200 locations currently, and it’s expected to have 1,500 locations by 2021. BP’s also getting in on the renewable energy boom via its Lightsource partnership, and it hopes to grow its midstream business via a spin-off it did last year, BP Midstream Partners.

Overall, it’s hard to predict where oil and gas prices are heading, but it appears that the worst is behind BP. If so, then buying it now may pay off in more than the chance to collect its 5.35% dividend yield.

Hello, China

Daniel Miller (Ford Motor Company): If you’re scanning the market for dividends paying more than Verizon’s, take a look at Detroit’s second-largest automaker and its 5.3% yield — and that figure doesn’t include its annual supplemental dividend. Yes, new vehicle sales in North America have peaked, but Ford is determined to slash its budget, focus on SUVs, and expand in China. All those factors should help power Ford’s bottom line in the near term.

Last month, Ford announced its largest new vehicle launch in China. Those launches include the new Focus, Escort, and Ranger Wildtrak, as well as the Lincoln Aviator, MKC, and Nautilus. It’s the first wave of the 50 new products Ford plans to launch in China by 2025, in an attempt to capitalize on the world’s largest automotive market.

Meanwhile, back in the heartland, Ford is doubling down on cost-cutting. Originally Ford’s cost-cutting goal was $14 billion, a figure that was plenty big. Now, CEO Jim Hackett has bumped the cost-cutting target to a staggering $25.5 billion and expects to reach 8% global profit margin by 2020 (Ford’s global profit margin was 5.2% during the first quarter). It’s even possible that Ford could exit certain geographic regions and markets if reasonable returns aren’t viable in the medium term, similar to General Motors’ move to sell its European operations.

Ford is an intriguing automaker as it expands in China, cuts costs to boost the bottom line, and dishes out a juicy 5.3% yield. But to be more than a dividend stock for income investors, the company must find a way to generate revenue from the coming driverless-car trend.

A fallen Dividend Aristocrat

Leo Sun (AT&T;): Verizon’s rival AT&T; pays a forward dividend yield of 6% — its highest yield since 2011. That yield was inflated by the stock’s 17% year-to-date decline, which was caused by concerns about the sluggish growth of its postpaid smartphone, wireline, and pay-TV businesses. AT&T’s planned takeover of Time Warner, which could transform it into one of the biggest media companies in the world, also remains in limbo.

Yet AT&T is still the second-largest wireless carrier in the US, and the nation’s top wireline and pay-TV service provider. Those businesses give it a wide moat against its potential challengers, and the telco has rebounded from plenty of market downturns in the past.

AT&T generated $18.3 billion in free cash flow over the past 12 months, and spent just 66% of that total on dividend payments. That gives it plenty of room to hike its payout, as it did annually for 33 straight years. That streak makes AT&T an elite “Dividend Aristocrat” — a member of the S&P 500 which has raised its dividend for over 25 straight years.

Wall Street expects AT&T’s revenue to slip 3% this year, but its earnings — boosted by buybacks, potential divestments, and better cost controls — to rise 12%. AT&T’s big drop reduced its forward price-to-earnings ratio to just 9, which is lower than Verizon’s multiple of 10. Therefore, I think AT&T’s downside is fairly limited at these prices.

For the past several years, American Airlines (NASDAQ: AAL) CEO Doug Parker has been one of the most prominent proponents of the idea that the airline industry has been permanently transformed and will produce big profits going forward. In the past year, he has doubled down on this argument, saying that in the new environment, airline managers don’t have to worry much about short-term profitability and can focus on making long-term investments.

If Parker is right, you wouldn’t know it from his company’s financial results. American Airlines’ profitability has been plunging ever since oil prices began to recover from a 2014-2016 slump. Furthermore, American Airlines cut its 2018 earnings per share (EPS) guidance last month due to rising fuel prices.

The rally in oil prices has continued in the month following American’s Q1 earnings report. This could cause the company’s earnings to fall even further behind management’s original forecast.

Profit comes under pressure

American Airlines’ adjusted pre-tax margin peaked at 15.3% in 2015. While a 41% drop in the carrier’s average fuel cost played a big role in that strong result, airline industry earnings had already started to rise in 2013 and 2014, before the oil price collapse. Thus, investors had some reason to hope that American could sustain a double-digit adjusted pre-tax margin regardless of where fuel prices went in the future.

American Airlines’ adjusted pre-tax margin reached 15.3% in 2015. Image source: American Airlines.

However, American Airlines’ adjusted pre-tax margin slipped to 12.6% in 2016 despite a further decline in fuel prices and plunged to 9.1% last year, when fuel costs started to rise again.

In conjunction with its first-quarter earnings report, American Airlines reduced its 2018 adjusted EPS guidance range from $5.50-$6.50 to $5.00-$6.00. This change in its earnings forecast was entirely driven by a higher fuel price assumption. Based on this updated guidance range, American expects to post an adjusted pre-tax margin of roughly 7% to 8% this year.

The oil price rally hasn’t ended

Unfortunately, oil prices have continued to rise since American Airlines revised its forecast. On April 20 — the day that the carrier updated its fuel price assumption — the price of Gulf Coast jet fuel was $2.07 per gallon. Gulf Coast jet fuel reached $2.21/gallon as of Monday.

American Airlines uses about 4.4 million gallons of jet fuel each year. Thus, on an annualized basis, a $0.14-per-gallon increase in the price of jet fuel would add more than $600 million to its fuel bill. The cost headwind for the remainder of 2018 could be close to $400 million if jet fuel prices stabilize near current levels.

Unless American Airlines can push through bigger fare increases — which would be tough in the current ultra-competitive environment — this cost headwind will drive almost 1 percentage point of incremental margin pressure in 2018.

Cash flow is becoming a concern

Even with the recent spike in fuel costs, American Airlines is likely to earn an adjusted pre-tax profit of roughly $3 billion this year. This might make it seem like shareholders have nothing to worry about. However, the company needs a higher level of earnings to support its substantial capex commitments and its weak balance sheet.

Operating cash flow has fallen steadily since the beginning of 2017. Over the past 12 months, American Airlines has generated just $4.3 billion in cash from operations. That figure could move even lower during the next few quarters as higher fuel costs pinch profits.

On the other side of the ledger, American Airlines plans to spend $3.7 billion on capital expenditures (capex) in 2018, including $1.9 billion for new aircraft. This means that free cash flow will be close to zero.

Last month, management projected that aircraft capex would rise to $2.5 billion in 2019 before receding to $1.7 billion in 2020. Since then, American has ordered 30 additional regional jets, 29 of which will be delivered next year. This could increase 2019 capex (including non-aircraft spending) to nearly $5 billion, potentially pushing free cash flow into negative territory.

The balance sheet is a mess

During the past four years, American Airlines has dealt with weak free cash flow by borrowing heavily to finance new aircraft. This allowed it to return about $12 billion to shareholders, mainly through an aggressive share repurchase program.

American Airlines can continue to finance most of its new aircraft purchases to reduce its cash outflows. However, the bill for its previous financing activity is starting to come due. American has about $2 billion of debt maturing in the last three quarters of 2018. It also has nearly $10 billion maturing between 2019 and 2021.

With cash flow falling and interest rates rising, American Airlines will face some unpleasant choices as its debts come due over the next few years. As a result, while American Airlines stock has fallen more than 20% since March, investors should still stay away from this looming train wreck.

Smartwatches are taking over the wearables market. That product category continues to cannibalize other types of wearable devices like basic fitness trackers, a trend that is expected to continue for the foreseeable future. Apple (NASDAQ: AAPL) is now the top dog in wearables thanks to the strength of Apple Watch. In fact, the company beat out all competing smartwatch vendors combined in 2017, after excluding other wearables categories.

As Apple obfuscates Watch results, investors still have to rely on third-party estimates to gauge how the device is faring.

Still on top

Canalys estimates that Apple again grabbed the top spot in the wearables market in the first quarter, shipping 3.8 million units. That was good enough to grab 18% of the market, which saw overall unit volumes jump 35% to 20.5 million. China’s Xiaomi, which is preparing to go public, came in a close second with 3.7 million units. However, Xiaomi’s unit volumes predominantly consist of Mi Bands, the company’s low-cost basic fitness trackers. Thanks to the relatively higher prices of smartwatches, they now comprise 80% of global wearables revenue, despite only representing 43% of unit volumes.

Much like other analysts have found, the recent inclusion of cellular connectivity is helping drive demand. “Key to Apple’s success with its latest Apple Watch Series 3 is the number of LTE-enabled watches it has been able to push into the hands of consumers,” Canalys analyst Jason Low said in the release. “Operators welcome the additional revenue from device sales and the added subscription revenue for data on the Apple Watch, and the list of operators that sell the LTE Apple Watch worldwide is increasing each month.”

For the cellular-equipped subset of the smartwatch market, the Mac maker now enjoys market share of 59%. However, that could be more related to the fact that there simply aren’t many other smartwatches out there that feature cellular connectivity. Alphabet subsidiary Google is reportedly working on a Pixel-branded smartwatch that could include cellular connectivity, which has the potential to jump-start competition, as third-party Android Wear manufacturers are shifting their focus away from the platform.

Fitbit (NYSE: FIT) came in No. 3, with 11% market share (2.2 million devices sold) as that company continues to try navigating the transition to smartwatches, most recently with the Versa, which Fitbit hopes will appeal to mainstream consumers. Fitbit’s first smartwatch, the Ionic, fell flat, which Fitbit attributed to it being “more of a performance product.” Note that Canalys includes Fitbit’s Blaze as a smartwatch, even as Fitbit itself does not consider the Blaze to be a full-fledged smartwatch.

In many ways, Apple Watch is following in the footsteps of the iPod. The iPod wasn’t the first MP3 player, but quickly became the most popular product and defined the category. Apple Watch is now doing likewise.

Tuesday marked one year since Ford Motor Company’s (NYSE: F) board of directors ousted Mark Fields as CEO, replacing him with Jim Hackett — a futurist and former Steelcase CEO who had joined Ford to run its future-mobility subsidiary.

It has been a year of ups and downs. Hackett’s promotion was followed by a broad reshuffling of Ford’s senior executives and a lot of talk about improving Ford’s “fitness” as a company.

A year later, Ford’s share price looks to be stuck in neutral.

To understand why, I think we need to look back at why Ford’s board chose Hackett — and at what he has and hasn’t done in the year since then.

Jim Hackett marked his one-year anniversary as Ford’s CEO on May 22. Image source: Ford Motor Company.

Why Ford ousted Fields and promoted Hackett

Hackett’s selection as Ford’s CEO was about more than the company’s stock price. Executive chairman Bill Ford told me at the time that the decision to replace Fields with Hackett was driven by a need to accelerate the transformation of the company in the face of impending disruption from new high-tech entrants.

The fact is that we are in unprecedented times, both in terms of opportunities and potential landmines. I believe that we need a transformational leader who has done it, who has reimagined a company into a future and then brought that company along with him. We’re very fortunate to have that in Jim.

To be clear, I absolutely think that was sincere. At the time, analysts were questioning the state of Ford’s future-tech efforts, particularly given the very visible work being done at rival General Motors (NYSE: GM) around self-driving, electric vehicles, and shared mobility.

But I think Ford’s board of directors might have also had another, more blunt reason for replacing Fields. Ford’s share price had taken a big dive during his tenure as CEO.

F data by YCharts. Chart shows the price of Ford’s common stock from July 1, 2014, when Mark Fields took over as CEO, through May 19, 2017, the last trading day before his departure.

Those things are related, of course. In the last year or so of Fields’ tenure, it became clear that GM was making significant progress toward a future vision of mobility, and its stock price was reflecting that progress. Ford’s directors were right to wonder if Fields had let the company fall behind its old rival.

F data by YCharts. Chart shows the price change of General Motors and Ford stock from May 19, 2016 through May 19, 2017 — the last year of Mark Fields’ tenure as Ford’s CEO.

I think Ford’s board hoped that Hackett would be able to drive a more rapid transformation of Ford into a company that could thrive in a post-disruption automotive future. I think they also hoped that investors would reward his work with a higher stock price, just as they had been rewarding GM’s efforts.

But while Ford’s stock hasn’t tanked under Hackett, it still hasn’t kept pace with GM’s share-price growth.

F data by YCharts. Chart shows the price change of General Motors and Ford stock from May 22, 2017 through May 22, 2018 — the first year of Jim Hackett’s tenure as Ford’s CEO.

What’s the problem here?

Why Ford’s stock has yet to soar

I think the problem is that after a year in office, Hackett still has yet to articulate a clear, detailed plan for improving Ford’s profitability and ensuring that it remains competitive in the high-tech near future. He has said quite a bit about his intentions in general terms, but the details are still lacking.

Here’s an example of what I mean. During Ford’s first-quarter earnings presentation last month, Hackett showed this slide.

Image source: Ford Motor Company.

As you can see, the slide makes clear how Hackett and his team are thinking about the challenge of boosting Ford’s profitability. Some of Ford’s products and businesses are very profitable, and some are unprofitable. The clear hint is that Ford is looking at jettisoning some or all of the latter. But we don’t yet know what those “low-performing” products or businesses are, or when that jettisoning might happen.

We’ve seen some bits and pieces of the effort, of course. Ford’s much-talked-about move to eliminate most of its sedan models from its lineup in North America is a big one. But we still don’t know what else might be coming — or what any of these moves will do for Ford’s profitability and competitiveness.

That’s one thing that has changed in a big way under Hackett. Fields had his ups and downs as Ford’s CEO. But as with his highly lauded predecessor, Alan Mulally, investors always felt informed. We knew where Ford was going and why.

Though it’s still true to some extent under Hackett, we have had to squint through an awful lot of vagueness to see it. Simply put, I think Ford’s share price is unlikely to rise significantly until (or unless) that haze of vagueness clears.

Or put another way, until Hackett — or someone — explains Ford’s plan in clear terms that resonate with investors.