About the Editor

Michael Hodel is the editor of Morningstar DividendInvestor, a monthly newsletter that focuses on dividend income investment strategy. For illustration purposes, issues highlight activities pertaining to a Morningstar, Inc. portfolio invested in accordance with a current income and income growth from stocks strategy.

Michael is portfolio manager for Morningstar Investment Management LLC, a federally registered investment adviser and a wholly-owned subsidiary of Morningstar,Inc. At Morningstar, Mike was a technology strategist for Morningstar, responsible for telecommunications research. He also served as chair of Morningstar's Economic Moat Committee, a group of senior members of the equity research team responsible for reviewing all Economic Moat and Moat Trend ratings issued by Morningstar. He joined Morningstar in 1998.

Hodel holds a bachelor's degree in finance, with highest honors, from the University of Illinois at Urbana-Champaign and a master's degree in business administration from the University of Chicago Booth School of Business. He also holds the Chartered Financial Analyst® designation.

 
Investment Strategy

Dividends are for everyone regardless of age. The outcome of owning dividend-yielding stocks is the key variable-higher-yielding stocks with safe payouts being less risky while affording investors who don't need current income the ability to reinvest/reallocate the capital.

The goal of the Dividend Select Portfolios is to earn annual returns of 8% - 10% over any three-to-five year rolling time horizon. We further seek to minimize risk, as defined by the probability of a permanent loss of capital. For our portfolio as a whole, this goal is composed of:

3% - 5% current yield
4% - 6% annual income growth

 
About Josh Joshs Photo
Michael Hodel, CFA
Editor, Morningstar DividendInvestor
Portfolio Manager, Dividend Select Portfolios
Michael Hodel is the editor of Morningstar DividendInvestor, a monthly newsletter that focuses on dividend income investment strategy. For illustration purposes, issues highlight activities pertaining to a Morningstar, Inc. portfolio invested in accordance with a current income and income growth from stocks strategy.
Featured Posts
Raises for Southern and Magellan -- The Week In Dividends 2017-04-21

DividendInvestorâ„  focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Dividend Select strategy. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, who manages other client portfolios using these strategies.

From the DividendInvestor news file this week:

It was a busy week of earnings announcements for Dividend Select portfolio holdings, but first a bit of housekeeping: The May issue of DividendInvestor released yesterday contained several errors. One was an incorrect yield number for AbbVie ABBV and a subsequent discussion of that amount in the cover story. In addition, the portfolio section on Page 3 understated the dividend rates (and hence the yields and annual income amounts) for seven portfolio holdings. We sincerely apologize for these errors and are actively working to implement procedures to minimize future errors. You can download a corrected PDF using the following link. (If your issue shows a 4.0% yield for AbbVie, then you have the correct version. If not, please update.)

http://mdi.morningstar.com/Newsletter.aspx

This week saw three dividend announcements from holdings in Morningstar's Dividend Select portfolios: Southern SO raised its quarterly distribution to $0.58, giving the firm 16 consecutive years of annual dividend increases. Its forward yield is 4.64% as of today's close. Magellan Midstream Partners MMP also raised its payout to $0.8725, a 2% increase that brings its forward yield to 4.60%. Public Service Enterprise Group PEG also announced a quarterly distribution, unchanged from the previous quarter.

Finally, five Dividend Select portfolio holdings reported earnings this week. Please see new analyst notes below for General Electric GE, Genuine Parts GPC, Johnson & Johnson JNJ, Philip Morris International PM, and Verizon VZ. Several holdings were also tagged in a general note about two recent power industry conferences.

Best wishes,

David Harrell
Managing Editor, Morningstar DividendInvestor


News and Research for Dividend Select Portfolio Holdings

Despite Weak Industrial Cash Flow in the Quarter, We Believe GE's Longer-Term Story Is Intact
by Barbara Noverini | 04-21-17

Shares of wide-moat General Electric slumped April 21 as investors reacted to negative industrial cash flow in the first quarter, which largely overshadowed healthy 7% year-over-year growth in organic sales and a solid 130 basis points of operating margin expansion in the industrial segment. We do not intend to alter our $32 fair value estimate based on the quarter's operating results.

Industrial cash flow from operating activities was a $1.6 billion use of cash, mostly due to higher-than-anticipated working capital in the quarter and lower cash payments collected from GE's long-term service contracts. We're satisfied that these are all largely timing issues and believe the company's 2017 goal of $12 billion-$14 billion of industrial cash flow from operating activities is still reasonable.

Otherwise, GE reported solid year-over-year gains in industrial revenue after excluding the impact of M&A and foreign exchange. Six out of seven segments achieved positive organic revenue growth, led by the power, renewables, and aviation segments. This was GE's strongest quarter of organic revenue growth in nearly two years. Orders also showed positive momentum, up 7% organically, with equipment orders increasing 5% and services 9%. This included a 9% organic increase in oil and gas segment orders, which, while off a low base, is a step in the right direction. With broad-based strength in backlog growth, we're more confident that GE's near- to medium-term goal of 3%-5% annual organic revenue growth is achievable.

Industrial operating margins expanded 130 basis points to 12.6% in the quarter, with equipment margins increasing 30 basis points and service margins growing 140 basis points year over year. All told, we believe the company is on track, and we urge investors to focus less on quarterly cash flow ebbs and flows and more on the sustainable changes GE has made to its portfolio, which we believe will lead to stronger, higher-quality cash flow over time.

Genuine Parts Sees Solid Start to Fiscal 2017, Driven by Early Signs of Industrial Recovery
by Zain Akbari, CFA | 04-19-17

Our $85 per share valuation for narrow-moat Genuine Parts should rise 10%-15% after it posted solid first-quarter earnings. While the results and the time value of money account for about 5% of our planned uptick, much of the hike is due to incorporation of our 2018 tax reform expectations.

The firm saw a 5% sales uptick against a 7.3% operating margin, outpacing our 3% and 7.1% full-year marks. Management raised its full-year diluted EPS guidance to $4.75-$4.85 (from $4.70-$4.80), versus our $4.76 target. Though results were strong, we do not anticipate changing our long-term outlook (mid-single-digit top-line growth and 8% operating margins, on average, over the next decade).

Helped by energy sector recovery, the industrial segment (30% of 2016 sales) drove performance, with sales up 7% (3% on a comparable basis). The uptick comes after 0.3% and 2.6% full-year sales declines in 2016 and 2015, respectively. Segment margin rose by about 25 basis points due to cost leverage. We believe this unit benefits from cost and intangible asset-based advantages against small peers. Genuine Parts' scale allows it to economically provide rapid access to slow-turning but critical components and trained store staff to provide purchasing and installation guidance, leading to recurring service contracts that drive half of segment sales.

Automotive (about 53% of 2016 sales) results were softer, with flat comparable sales and 36 basis points of cost deleverage-based margin degradation. Warm winter weather contributed, with temperate conditions leading to fewer part failures. We believe these sales are merely delayed and expect a return to mid-single-digit segment sales growth long-term, driven by a professional segment that should outpace DIY as vehicles become more complex (about 75% of the firm's automotive sales come from commercial clients). We see Advance Auto Parts and AutoZone as the best opportunities to capitalize on overblown fears of Amazon’s expansion in the space.

Johnson & Johnson Posts in Line Quarter Reflecting Our Longer-Term Growth Concerns
by Damien Conover, CFA | 04-18-17

Johnson & Johnson reported first-quarter results largely in line with our expectations, and we don't expect any major changes to our $108 fair value estimate. We continue to view the stock as slightly overvalued as the growth prospects for the company's divisions don't appear strong enough to support the current market price. Further, we are concerned that the pending acquisition of Actelion is an overpayment, partly motivated by an effort to accelerate growth in the drug group. Despite valuation concerns, the company's wide moat continues to look strong with innovation and brand power continuing to drive stable cash flows.

Modest growth across the board led to the company's largely flat operational growth of 1% year over year, excluding acquisition and divestitures. In the pharmaceutical group, price discounts, competitive pressures, and an unfavorable prior period adjustment weighed on sales. We expect increasing generic competition to lead to 3% average annual growth for the segment over the next three years. While we remain optimistic about cancer drugs Imbruvica and Darzalex, the increasing competition for the company's leading drug Remicade from both branded and biosimilar drugs will create a tough headwind for growth. Additionally, while the Actelion drugs help boost top-line growth, we believe the deal came at too high of a price. Nevertheless, we expect the deal to close late in the second quarter, in line with management guidance. Outside of the drug group, the device and consumer divisions look poised to contribute similar long-term growth, resulting in overall company growth of close to 3% annually over the next three years. While the consumer group posted growth below this longer-term view in the quarter due partly to competitive pressures, we believe the brand power and entrenched products should return to a more normalized growth rate in the remainder of the year.

PMI's 1Q Miss Highlights Market's Frothy Expectations
by Philip Gorham, CFA, FRM | 04-20-17

After adjusting for a one-time tax benefit, Philip Morris International slightly undershot our expectations in the first quarter due to weakness in European volumes. Management raised full-year guidance to account for the tax event to EPS of $4.84-$4.99, up from $4.80-$4.95, and reiterated its near-term outlook on an underlying basis. We reiterate our $95 fair value estimate and our wide moat rating for the company.

We were aware that the first quarter would be somewhat weak on a volume basis because the low-price segment has been soft in several markets and due to timing issues relative to the prior year, but we slightly underestimated these issues. Shipment volume in both the EU segment and the Eastern Europe, Middle East, and Africa, or EEMA, segment modestly undershot our forecasts at negative 7.5% and negative 10.4%, respectively, with Bond Street and the small brands particularly weak.

However, there are several reasons not to panic. First, the shipment timing issues imply that the firm may make up this shortfall through the rest of the year. Second, the economy end of the market has limited impact on profitability, highlighted by the relatively minor miss on the EBIT line. Third, sales of HeatSticks are mitigating the slightly elevated decline in volumes. The company reported 4.4 billion in HeatStick sales in the first quarter, representing 2.5% of total volume, despite only being available in a small number of markets. The impressive uptake rates iQOS has generated since last year supports our thesis that heated tobacco has a strong chance of gaining critical scale.

Having said that, we regard this volume miss as a reminder of the frothy expectations that are being priced into the stock. With shares trading at 23.4 times our 2017 earnings estimate before the results release, we think the market is pricing in not only growth in HeatSticks, but also margin accretion, despite the lack of visibility into the product's health benefits and tax structure.

Verizon Surprisingly Loses Postpaid Wireless Customers; Shares Fairly Valued
by Alex Zhao, CFA | 04-20-17

Tough wireless competition caused Verizon to lose 307,000 net retail postpaid customers this quarter, while both postpaid and total retail customer churn, including prepaid, ticked up to 1.15% and 1.4%, respectively. We affirm our narrow moat rating for the firm despite the escalation in competitive intensity, as we find no evidence that the firm's scale advantage and spectrum intangible assets are structurally damaged. However, we are lowering our outlook for Verizon's wireless segment by projecting a postpaid phone customer loss in 2017 and faster decline in average revenue per customer. We will maintain our $50 fair value estimate for Verizon and the stock appears fairly priced, in our view.

Total wireless service revenue declined 6% year over year, due to decreasing coverage revenue, lower postpaid customers, and continued promotional activity. Verizon now has 72% of postpaid customers on unsubsidized plans, compared with about 48% last year. However, the average service revenue and phone installment billings per account grew less than 1% this quarter, relative to 1.4% a year ago. In mid-February, management finally threw in the towel and decided to offer unlimited data plans with deep pricing discounts (yet still slightly above T-Mobile's comparable plans), which they were reluctant to do for a few years. This move helped add back about 109,000 postpaid customers in the second half of the quarter. Wireless EBITDA margin was down to 45% from 46% a year ago, due to declining service revenue and the increase in advertising spend associated with the Unlimited Plan launch. We maintain our view that market competition will continue to be intense through 2017 and much of 2018, but the market structure should stabilize at some point due to potential industry consolidation or more rational pricing from T-Mobile and Sprint.

Power Conference Takeaways: No End to Renewable Energy and Infrastructure Growth
by Travis Miller | 04-19-17

We are reaffirming our fair value estimates, moat ratings and moat trends for all U.S. utilities after Morningstar analysts attended and presented at two recent power industry conferences.

The key theme at both conferences was how utilities should navigate the transition to a cleaner, smarter electricity system. Our most conservative forecasts for the next eight years show U.S. renewable energy capacity doubling, gas continuing to steal power generation market share from coal, and carbon emissions falling near Obama administration-era targets. Consensus is building that President Donald Trump's policies will not disrupt--and could even promote--a move toward lower-carbon generation through state renewable portfolio standards, low-cost gas, and favorable tax policy.

We think valuations across the sector are stretched, but utilities that can navigate the regulatory processes to address grid modernization and infrastructure siting are best-positioned to protect or widen their economic moats. We forecast annual earnings and dividend growth hitting 8% for some utilities with constructive state regulatory relationships supporting investment in renewable energy, transmission, natural gas-fired generation and distribution. A few well-positioned U.S. utilities include Dominion Resources, Duke Energy, American Electric Power, Southern Co., NextEra Energy, Edison International, and Xcel Energy.

Grid modernization is critical to enabling more consumer energy choice, a trend we anticipate during the next decade. First-movers could benefit from investment and new business opportunities while laggards could face falling central-network load and earnings.

Easing siting constraints is one way we think the Trump administration can promote investment. We think more gas pipelines, grid expansion and system integration are essential to achieving state renewable energy goals and grid modernization.

©2017 Morningstar, Inc. All rights reserved. The Morningstar name and logo are registered marks of Morningstar, Inc. The information contained in this document is the proprietary material of Morningstar, Inc. Reproduction, transcription, or other use, by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited. All data presented is based on the most recent information available to Morningstar, Inc. as of the release date and may or may not be an accurate reflection of current data.  There is no assurance that the data will remain the same.

Disclosure:
The commentary, analysis, references to, and performance information contained within Morningstar® DividendInvestorâ„ , except where explicitly noted, reflects that of portfolios owned by Morningstar, Inc. that are invested in accordance with the Dividend Select strategy managed by Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc.  References to "Morningstar" refer to Morningstar, Inc. 

Opinions expressed are as of the current date and are subject to change without notice. Morningstar, Inc. and Morningstar Investment Management LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use.  This commentary is for informational purposes only and has not been tailored to suit any individual. 

The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.   

Investments in securities are subject to investment risk, including possible loss of principal.  Prices of securities may fluctuate from time to time and may even become valueless.  Securities in this report are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information.  Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

Common stocks are typically subject to greater fluctuations in market value than other asset classes as a result of factors such as a company's business performance, investor perceptions, stock market trends and general economic conditions.  

All Morningstar Stock Analyst Notes were published by Morningstar, Inc. The Week in Dividends contains all Analyst Notes that relate to holdings in Morningstar, Inc.'s Dividend Select Portfolio. Morningstar’s analysts are employed by  Morningstar, Inc. or its subsidiaries.  In the United States, that subsidiary is Morningstar Research Services LLC, which is registered with and governed by the U.S. Securities and Exchange Commission.

David Harrell may own stocks from the Dividend Select and Dividend Select Deferred portfolios in his personal accounts.

 
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