About the Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.

Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio. Josh joined Morningstar in 2000 as an automotive and industrial stock analyst. After leaving in 2003 to join UBS Investment Bank as an equity research associate, he returned to Morningstar in 2004 to develop DividendInvestor.

Peters holds a BA in economics and history from the University of Minnesota Duluth and is a CFA charterholder. He is also the author of a book, The Ultimate Dividend Playbook, which was released by John Wiley & Sons in January 2008.

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 Portfolio is to earn annual returns of 9% - 11% 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
5% - 7% annual income growth

Feb 12, 2016
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Josh Peters, CFA
Equities Strategist and Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio.
Featured Posts
SEP Lights the Way -- The Week in Dividends, 2016-02-05

Despite a return to red ink for the market in general, I again have the privilege of leading off our summary of the week's events with an increase to our income. On Wednesday, Spectra Energy Partners SEP raised its quarterly cash distribution to $0.63875 a unit; this represents an 8.5% increase from the year-ago period. For this continued growth in distributions, I credit SEP's high-quality assets (it owns legitimate "toll road" assets that many other partnerships only claim to have), conservative use of debt, healthy cash coverage of distributions, and a business model that actually has opportunities for profitable growth in an extended environment of low commodity prices. Though SEP's unit price has been volatile, like all MLPs in recent months, the 8.1% rally this week validates my long-term preference for midstream operators that are closely aligned with consumers of energy as opposed to increasingly cash-strapped energy producers.

SEP and its parent Spectra Energy Corp. SE also held their annual analyst meeting this week. In recent years the two entities have spelled out their plans over a three-year timeframe, and this year management extended the current trend of growth for SEP distributions (1.25 cent raises each quarter) and SE dividends (an extra 14 cents each year on an annualized basis) by one additional year to 2018. Both entities see higher cash-flow coverage than previously expected as well, with SEP looking to maintain coverage of 1.2 times or better in its new three-year plan. As a result, I'm now expecting average annual distribution growth of 6% a year from SEP, up from a previous 5.5%, and our fair value estimates for SEP and SE were reaffirmed at $50 and $31, respectively. Between the two, I continue to prefer SEP as a pure-play on the organization's most appealing assets, but SE--trading at roughly the same current yield as SEP--remains a worthwhile alternative for tax-deferred accounts.

Magellan Midstream
MMP, which raised its quarterly cash distribution last week, followed up this week with year-end results and updated forecasts for distribution growth. Management reaffirmed a goal of 10% distribution growth for 2016 and introduced a growth target of 8% or better for 2017. Guidance for $900 million of distributable cash flow this year (a drop from $943 million in 2015) was somewhat less encouraging, and even Magellan faces some mild headwinds in this environment. However, Magellan has been widely recognized for its conservatism, not least in the area of guidance. In the last six years (2010 through 2015), Magellan's actual distributable cash flow came in between 12.3% and 20.6% ahead of management's initial guidance.

Though Magellan's 8% or better target for 2017 distribution growth is a bit below my five-year estimate of 10% average annual growth, I see no reason to change my forecast. In addition to a solid backlog of internal expansion projects, I expect Magellan to leverage its financial strength through value-creating acquisitions at attractive valuations. Our fair value estimate remains $76 a unit, and though a 5.1% current yield pales in comparison to those offered by financially weaker MLPs, Magellan remains my top pick in the midstream energy sector.

I also think applause is in order for AmeriGas Partners APU, which reported results for the December quarter after the bell on Monday. While temperatures in the quarter were 16.8% warmer than in the year-ago period and retail propane volumes fell 13.3%, adjusted EBITDA (a useful proxy for the partnership's cash flow) dropped only 5.7%. Faced with unfavorable weather, the partnership cut its operating and administrative costs 6.4%, and--thanks to a narrow economic moat attributable partly to high customer switching costs--hiked its per-gallon markup by 7.5%. While AmeriGas is our best performer year-to-date with a 15.0% gain, it still offers an 18% discount to our reaffirmed fair value estimate of $48 a unit and a 9.3% yield, keeping it as one of my favorite buy recommendations.

Beyond the friendly confines of our Dividend Select portfolio, investors in the energy patch were smacked by the 66% dividend cut announced by ConocoPhillips COP. While ConocoPhillips is not usually included among "supermajors" like ExxonMobil XOM, Royal Dutch Shell RDS.B, or our portfolio's own Chevron CVX, it nonetheless raises the specter of similarly unfavorable dividend actions in this elite group.

I have to admit that my case for holding Chevron seems to grow weaker by the day--not because I think Chevron will be the next big energy company to slice shareholders' pay (I'm still quite sure it would be one of the last supermajors to take such a step, and only then under duress), but because the prospect of adequate dividend growth is slipping further and further away. I have no immediate plans to sell our Chevron position, but as of today, I no longer consider it a core holding--Chevron now falls in the supporting category. Furthermore, if volatile markets serve up an opportunity to replace Chevron's current yield with a dividend that is more secure and likely to grow faster, I am prepared to make such a swap. The last thing I want to do is dump Chevron at what could turn out to be a bottom in oil prices or energy sector valuations, but if another stock is capable of delivering superior dividend performance from here, why not let it?

All of the week's seven earnings reports for our portfolio holdings, plus those for Enterprise Products EPD and Chevron last week, are covered in the analyst notes below. The only fair value estimate changes for our holdings were routine time-value-of-money adjustments for Ventas VTR (fair value up $2 to $83 a share) and Welltower HCN (up $1 to $81). Earnings season will tail off from here; my calendar shows four reports next week: Compass Minerals CMP on Monday, Coca-Cola KO on Tuesday; Realty Income O on Wednesday; and Ventas on Friday. In addition, I expect Compass Minerals and United Parcel Service UPS to raise their dividends; my current estimates call for hikes of 6.1% and 8.2%, respectively, but we'll just have to see what we get in this newly turbulent economic and market environment.

Best regards,

Josh Peters, CFA
Director of Equity-Income Strategy
Editor, Morningstar DividendInvestor

Disclosure: I own all of the holdings of the Dividend Select portfolio in my personal accounts.

News and Research for Dividend Select Portfolio Holdings

Banks Look Under-Reserved for Energy Losses
Industry Note 02/03/2016 | Erin Davis

We've taken a close look at banks' energy exposures and potential losses, and see both good news and bad news for investors. First, the good news--for most banks, we think the losses will be manageable. And now the bad news--nearly all banks are under-reserved and several could be facing capital shortfalls in a worst-case scenario.

We use the bond markets to proxy what total losses could be. The S&P 500 Energy Corporate Bond Index (essentially all investment-grade) is down about 15% peak to trough, and the Bloomberg USD High Yield Corporate Bond Energy Index (junk) is down about 30%. We use these to model mark-to-market (15%) and stress case losses (30%). We then compare these to the reserves banks already have in place, and to the banks' common equity. This helps us to gauge whether energy losses are likely to be merely painful, or whether they could pose a serious risk to capital. As a rule of thumb, we think that anything under 10% of common equity (remembering that losses are likely to roll in over two to three years) is likely absorbable by a well-capitalized bank. After that, we think the risk becomes more serious, depending on the bank's existing capital and the quality of its book. On average, we think cumulative losses will be approximately 2.7% of common equity for the banks we cover, and could average 4.6% of common equity in a worst-case scenario. We think Commerzbank, Credit Agricole, and Standard Chartered are most at risk.

Most U.S. banks have reported their 2015 results, and the banks with material energy exposures have reserves averaging 2.8% of energy loans, far below the 15% cumulative losses the markets are forecasting. This means that additional losses are likely, in our opinion. Of the U.S. big four, we think Citigroup and Bank of America are the most exposed. Given their current reserves of about 3.8% and 2.4% of energy loans, respectively, we think they could face additional impairments worth about 1.1% of the common equity. We think this would dent earnings, but would not pose a threat to their financial health.

The Canadian banks have also reported and provide an interesting contrast. Canadian firms use IFRS accounting standards, while U.S. firms use GAAP. U.S. GAAP allows banks to reserve for losses earlier, so the Canadian reserves are notably lower than those of U.S. banks. Canadian banks have reserved an average of 0.4% of energy loans, compared with 2.8% in the U.S., which means they have further to go to absorb likely cumulative losses. We think the pain will be the greatest at Bank of Nova Scotia, where losses could consume 3.4% of common equity, and the least painful at TD Bank, where losses could be just 0.6% of common equity.

European banks are just beginning to report, and given that they use IFRS, we think Canadian bank provisioning is a better proxy for what we'll see in 2015 results-–therefore, we expect losses to be low and manageable in the short term. In the longer term, we think cumulative losses could be a bigger issue. We think energy losses could consume about 10% of common equity at Commerzbank and Credit Agricole and 7.8% at Standard Chartered. The rest of the European banks we see as less exposed. We anticipate cumulative losses of 3.1% of common equity at Barclays, about 2.0% at Lloyds, UBS, and Nordea, and under 1% at Danske. We'll keep a close eye on this issue, as reporting on energy exposure has been thin among European banks, but we expect greater disclosure as results roll in over the next several weeks.

AmeriGas Partners
Analyst Note 02/02/2016 | Mark Barnett

We will be maintaining our $48 fair value estimate and stable narrow moat rating for AmeriGas Partners' common units after the partnership reported fiscal first-quarter results on Feb. 2. During the quarter, AmeriGas' well-oiled ROIC machine managed to limit the financial impact of a very weak quarter retail sales-wise with significant cost efficiencies and stronger per-unit margins, delivering just a 6% decline in EBITDA adjusted for the impact of non-cash items to $177.7 million from $188.5 million in the prior-year period.

The fall in adjusted EBITDA was driven by a 13% decline in total retail sales, well ahead of the 3% overall decline we had previously projected in our forecasts for full fiscal year 2016. We expect to lower our forecast EBITDA of $682 million for fiscal year 2016 to incorporate the lower volumes, though if AmeriGas manages to sustain some of the higher unitary margin--already stronger than our current expectations--the hit to full-year results may be less meaningful. Wholesale volumes--a much smaller but growing piece of the AmeriGas pie--rose 5% on new account wins. Regardless, weather rarely drives changes in our long-term view for the propane distributors, given its unpredictable nature.

Importantly, wholesale propane costs have continued to fall, which is crucial for maintaining underlying demand given how sensitive many users' usage is to commodity price levels. Persistent high prices can--unlike weather--erode long-term demand for propane, driving customers to seek alternatives or invest more in efficiency. Today's low price environment is a boon for the propane industry.

Chevron CVX
Analyst Note 02/01/2016 | Allen Good, CFA

Chevron turned in fourth-quarter results that looked remarkably similar to the prior three quarters of the year, with the U.S. upstream reporting a loss (punctuated with a $1.1 billion impairment charge), the international upstream turning in a modest profit that was substantially lower than that of prior years, and a rather strong contribution from the downstream segment. The combined result, however, was a loss for the quarter of $588 million, something Chevron had managed to avoid earlier in the year, even in the second quarter, when the company took a $2.7 billion impairment charge. With oil prices falling further in January from the $43/barrel average price in the fourth quarter, and with futures indicating continued low prices through the year, we expect results, excluding impairments, to worsen further. We make no change to our $102 fair value estimate or our narrow moat rating.

With a dour outlook, management took the opportunity to reiterate its commitment to the dividend and update its capital spending plans. After cutting its capital spending guidance last quarter, and announcing a 2016 budget of $26.6 billion in December, management indicated that it would now likely spend less, with capital expenditure coming in at the bottom end of the previously guided range of $25 billion-$28 billion. Furthermore, it indicated greater flexibility and the potential to spend less than the $20 billion-$24 billion guided for 2017-18. However, capital expenditure of $25 billion in 2016 still leaves cash flow short of covering the dividend, meaning another year of funding the dividend with the balance sheet. With $11 billion in cash and a net debt/capital ratio of only 14%, we do not see this as worrisome, assuming that oil prices recover in 2017, which we think they will. Additionally, the willingness to spend as little as $20 billion in 2017 means that Chevron’s cash flow break-even could fall to $50/bbl from a previously anticipated $60/bbl.

While this is still well above current futures prices of $40/bbl, it leaves the company in a better position to defend the dividend if prices do not recover as expected. Further reductions in costs (the company achieved 10% upstream operating cost reduction in 2015) and asset sales (it is targeting $5 billion-$10 billion) should also help improve cash flow and plug funding gaps.

We plan to update our model with the latest guidance, but do not expect any material changes to our fair value estimate, with the reduced spending being offset by the decline in oil prices since our last update. Chevron’s annual analyst day will be held in early March, where we expect management to divulge greater detail on spending and cost-saving plans for the next several years.

Emerson Electric
Analyst Note 02/02/2016 | Barbara Noverini

Despite facing significant headwinds in its oil and gas businesses in the first fiscal quarter, Emerson displayed the resilience we’ve come to expect from wide-moat firms during periods of cyclical weakness, and we reiterate our fair value estimate of $62 per share. In our view, successful execution of Emerson’s 2016 plans for long-lasting portfolio improvement through restructuring, asset divestitures, and the impending separation of the Network Power segment supports an estimated upside of about 35%, and we maintain that Emerson has ample opportunity for self-help amidst an otherwise challenging macroeconomic backdrop.

Consolidated revenue fell almost 16% year over year to $4.7 billion, as the negative impacts of currency translation and divestitures intensified a 9% decline in Emerson’s underlying sales. The Process Management and Industrial Automation segments suffered ongoing ill effects of reduced spending in upstream oil and gas; however, Process Management continued to shift resources toward serving relatively stronger end markets, such as life sciences and small to midsize projects in downstream power and chemical sectors, while preparations to divest parts of the Industrial Automation segment remain under way. Furthermore, strong activity in U.S. construction markets benefited Emerson’s Climate and Commercial and Residential Solutions segments, which we believe can support stronger underlying sales growth as the year progresses.

Although segment operating margins (excluding corporate expenses) contracted 170 basis points year over year to 13.3%, the benefits of restructuring actions in 2015 helped to mitigate the negative effects of volume deleveraging. Management is prepared to flex up restructuring programs should conditions weaken in Emerson's oil and gas-related businesses; however, we expect that improving sales in Emerson's residential, commercial, and consumer-focused businesses will also provide some counterbalance throughout fiscal 2016.

Enterprise Products Partners EPD
Analyst Note 02/01/2016 | Peggy Connerty

Enterprise Products Partners reported a solid fourth quarter that was slightly ahead of our estimates. Adjusted EBITDA was $1.33 billion, up 39% versus last year and ahead of our $1.22 billion estimate. Distributable cash flow was $1.09 billion for the quarter versus last year’s $1.06 billion. Excluding proceeds from asset sales and insurance recoveries, distributable cash flow was $1.02 billion versus $1.04 billion last year, or down 2%. Management raised the distribution by 5.4% in the quarter to $0.385 per share and had healthy coverage of 1.3 times on the distribution (excluding one-time items). Retained distributable cash flow during the quarter (including proceeds from asset sales) was $302 million, and over $2.6 billion for the full year. Enterprise's conservatism continues to serve it well in this challenging environment where many of its competitors are facing stretched balance sheets and thin (or no) coverage on the cash distribution.

Management announced 2016 growth capital expenditures of $2.5 billion-$2.8 billion with an incremental $1.0 billion for the second installment on the EFS Midstream acquisition and $275 million in maintenance capital expenditures. Management estimates the cash distribution will reach $1.61 per unit in 2016, a respectable 5.2% increase versus 2015. Total liquidity was $4.4 billion at year-end, including cash and capacity on its revolving credit facilities. EPD plans to utilize its retained cash flow, equity financing, including additional EPCO equity purchases, debt, and non-core asset divestitures to fund its growth and distribution plans. We expect management to continue allocating capital prudently, using retained distributable cash flow to offset some of its need to tap the capital markets. This is a key advantage over many of its peers that have been more aggressive with their growth plans and are now having to scale them back. We are maintaining the company's wide moat rating and our fair value estimate of $32.

Enterprise’s business model has proved robust thus far during the oil market's downturn, and we expect this to continue. Enterprise's simple structure, which lacks incentive distribution rights, gives it a lower cost of capital versus many peers. Its focus on fee-based businesses and its extensive network of tightly integrated assets spanning the midstream value chain help minimize direct commodity exposure and collect economic rents across the entire system. Importantly, Enterprise has a great management team that's been through the boom and bust periods and has grown its business along the way. We expect management to continue to be prudent as it navigates through current market challenges and view the downturn as an opportune time for patient investors to bulk up on EPD units.

Magellan Midstream Partners
Analyst Note 02/04/2016 | Peggy Connerty

Magellan Midstream Partners reported fourth-quarter adjusted EBITDA of $315 million, up 4% from the $303 million last year and above both consensus and our estimate. Distributable cash flow increased 3.5% to $257 million versus last year’s $248 million. Distributable cash flow per unit was $1.13 for the quarter versus $1.09 in the year-ago quarter. The results were driven by reduced butane blending margin as a result of the lower commodity price environment but partially offset by contributions from Magellan's stable fee-based businesses. For the year, adjusted EBITDA increased 9% to $1172 million, while distributable cash flow increased 7% to $943 million. Coverage was a very impressive 1.4 times for the year.

Management announced its plan to increase the cash distribution by 10% 2016 and 8% for 2017. While management had originally intended "a minimum of 10% growth in 2016," the firm 10% target and the 8% target for 2017 reflect management and the investment community's strong preference for protecting the balance sheet given the difficult commodity backdrop. We believe the 10% growth rate in 2016 is very achievable, with many key projects due on line in 2016-17 to support this. Our forecast indicates the company can deliver this distribution growth while maintaining coverage levels in the healthy 1.2 times-1.4 times range. If commodity prices improve, we would expect the 2017 target to prove to be conservative. Guidance bakes in a crude oil price of $35 per barrel.

We are maintaining our fair value estimate of $76 and continue to view Magellan as a top pick in the midstream sector. It's not a matter of if but when U.S. crude oil production will begin growing again given the very strong economics of the major shale plays relative to the rest of the industry. We believe Magellan has the wherewithal to survive the current period of weak activity and thrive when market conditions begin to recover.

Management increased its budget for 2016 to $800 million from $700 million last quarter and from $550 million announced in second quarter. Management indicated it has "well in excess of $500 million" in growth projects and acquisitions under review that are not included in the budget at this point.

Philip Morris International
Analyst Note 02/04/2016 | Philip Gorham, CFA, FRM

Philip Morris International failed to run the board of positive earnings surprises in 2015, posting fourth-quarter results that missed our forecasts by a whisker. Of greater significance is that management provided guidance for 2016 below our forecast. The downside to guidance is likely, in our opinion, to reflect a stronger currency impact on reported results and an accelerated rollout of the firm's heat-not-burn e-cigarette iQOS throughout next year. Although we will reduce our 2016 margin assumptions, the fourth-quarter business performance indicates that industry fundamentals are still strong, so we do not expect to make a material change to our $92 fair value estimate. We are also reiterating our wide economic moat rating, as the firm's pricing power was once again clearly evident in the fourth quarter. Any weakness in the stock on this news should prompt long-term value investors, or those seeking a stable dividend, to kick the tires of this high-quality business.

Although the fourth quarter did not reach the heights of the previous three, 2015 was a solid year for Philip Morris International, excluding the strong negative impact of currency movements. Full-year organic revenue growth of 5.8% puts the firm in the top tier of large-cap consumer staples firms despite the secular headwind from falling volume, reflecting solid pricing power and market share gains from Marlboro 2.0. The European Union has been particularly strong, with full-year organic sales growth of 4.5%. Although momentum throughout Europe slowed somewhat in the fourth quarter, with revenue up 2.6%, volume fell just 0.5%, largely in line with the first nine months of the year. After a fairly weak third quarter, Asia rebounded with 8.3% organic growth, up from 4% in the rest of the year, driven by price hikes in Indonesia and the Philippines.

We think two factors are behind guidance being below our forecast. First, we have underestimated the impact of currency on reported earnings next year. Management has guided to a hit to earnings of $0.60 per share at current exchange rates, slightly worse than our initial estimate. We shall lower our 2016 estimates by around 5% accordingly, but we expect the negative effect of unfavourable foreign exchange to be offset by the positive impact of the time value of money in our model, so we remain comfortable with our valuation.

The second potential factor behind the guidance is incremental spending on iQOS. We expect Philip Morris to accelerate the roll out of iQOS in new geographies in 2016, which could provide a long-term boost to the top line. We think heat-not-burn is the category most likely to emerge as the long-term winner in the fragmented e-cig industry, so we think Philip Morris' investments are justified. At a time when e-cigs pose a risk to Big Tobacco's economic moats, heat-not-burn allows manufacturers to continue to benefit from procurement cost advantages and leverage the strong brand equity of their cigarette brands. For this reason, we believe Philip Morris may be one of the manufacturers most protected by the migration of smokers to e-cigs.

At the group level, Philip Morris is performing very well on an organic basis and above our forecasts of 6% medium-term, midcycle earnings per share growth. Although the strong dollar continues to erode value, we view the firm's e-cigarette strategy and competitive advantages in a positive light.

Southern Company
Analyst Note 02/03/2016 | Mark Barnett

We maintain our $46 per share fair value estimate and stable narrow moat rating for Southern Company after the company reported headline full-year earnings up to $2.60 per share from $2.19 per share. Adjusting for the benefit from lower Kemper project-related writeoffs and other costs, Southern's underlying EPS rose 2% to $2.85. This includes $31 million in costs related to the acquisition of AGL Resources, a deal we expect to close in 2016.

With a stable federal subsidy framework over the next few years, we expect Southern to continue aggressively expanding its renewables business, which helped boost earnings despite its reliance on the tax system to help accelerate growth from its slow-growing fully regulated utilities. We don't, however, expect it to grow large enough to meaningfully impact Southern's moat or moat trend rating. Higher rates at Georgia continue to support our view that Southern benefits from high-quality regulation.

Weak usage growth--which had tracked below management's and our forecast coming into the fourth quarter and which missed given a hot December--should ease with more normal January weather. Weather-adjusted usage remains a concern as residential rose just 0.3% and industrial fell 0.3% in 2015. Commercial usage, which had stagnated, was a bright spot at nearly 1% growth. We will be revisiting our projections to reflect a less encouraging economic picture, but we don't expect a material change to our fair value estimate because Southern should be able to compensate with higher rates.

Southern's risk profile has relaxed following a settlement around some costs for the Kemper plant, but a full prudency review remains a risk there. We also think the Vogtle settlement was a strong positive for investors, lowering future legal risk. So far, the Georgia PSC has been highly supportive.

As some of the headline risk has calmed, Southern's shares have risen above fair value, leaving shares overvalued by about 5%. We think some regulatory risk remains with the Vogtle nuclear project and Kemper, but we're much more concerned about Vogtle. Regulatory meetings and public discussions have become slightly more contentious, though we're still confident Southern will recover virtually all project costs. Further project delays or significant cost increases could lead us to cut our fair value estimate, making the stock even less attractive at current prices.

Spectra Energy Partners
Analyst Note 02/03/2016 | Peggy Connerty

Spectra Energy Partners reported fourth-quarter EBITDA of $457 million, up 9% versus $424 million a year ago and 3% above our $442 million estimate. Results were driven by new projects recently placed into service along with strong results from the underlying base business. Distributable cash flow was $260 million, up from $245 million last year. Importantly, the cash distribution coverage ratio was 1.2 times, which is impressive, given current energy markets, and handily above that of many peers.

We expect to get updated long-range plan guidance at the annual investor day Feb. 4. In the meantime, we are maintaining our wide moat rating and $50 fair value estimate. We continue to view SEP as one of the most defensive midstream names to hold in this tumultuous energy market. SEP is entirely a tollbooth-based business model, with margins generated by low-risk transportation and storage making up 100% of total margin. SEP does not incur direct commodity exposure and has minimal volumetric risk because 80% of EBITDA is generated by demand charges, which are paid regardless of actual usage.

For forecasting purposes, we continue to expect EBITDA to grow at a 9% compound annual rate, with projects in the U.S. transmission segment being the main driver of the firm's growth. In terms of the capital expenditure program, management indicated that it is on track with significant projects recently brought into service or under construction. In the U.S. liquids business, construction is underway for the Express Enhancement crude oil project, which will add to capacity and is expected to be in service in 2016. Given our growth outlook, we expect distribution increases of 7%-8% annually through 2017 with coverage above 1.0 times.

United Parcel Service
Analyst Note 02/02/2016 | Keith Schoonmaker, CFA

Seems the third time’s a charm. UPS stumbled during holidays the past two years by first underdelivering, then overstaffing, but this year matched capacity to demand to deliver best-ever fourth-quarter EBIT and EPS. While excellent, net results don’t differ much from our expectations and guidance supports our projections for next year, so we maintain our fair value estimate and wide moat rating.

While some express products were quite robust (next day and deferred product volumes increased 10% and 15%, respectively), ground volume increased a mere 40 basis points. In fact, overall revenue only improved 1% from the prior-year period as declining fuel surcharges offset a 1.7% boost in total average daily parcels, but UPS improved margin in both domestic and international operations (the former by 270 basis points to 13.1% and the latter by 410 basis points to 19.7%). Supply chain and freight revenue grew 6% in part due to the Coyote acquisition, and EBIT margin improved slightly to 7.6%, but within these decent results, LTL declined 10% in shipments and 12% in gross weight, with rates up just 2.1% as the firm rationalized its mix. Distribution grew sales at a double-digit percentage rate.

The firm attributes improved margins this peak to customer collaboration in smoothing volumes over several days, investments made in the past year, price controls, and disciplined operations that accepted packages in appropriate volumes and steered toward services which avoid overstressing networks.

Management guides to 2016 EPS of $5.70-$5.90—straddling our existing $5.75 estimate, which we maintain. This represents 7%-11% growth excluding a nonrecurring tax benefit in 2015. Importantly, we note the contrast between declines in rail freight of many colors and UPS' expectation of 2%-4% volume growth in express and ground parcels next year. Further, management expects muted growth in U.S. GDP in the first half of 2016, improving in the second half and led by the consumer.

Ventas VTR
Valuation 01/29/2016 | Stephen Ellis

We are increasing our fair value estimate to $83 per share from $81 to reflect the time value of money adjustment. Our overall expectations for Ventas and its industry are unchanged; we think Ventas is left with a relatively more attractive portfolio following the spin-off, as we like the skilled nursing facilities that CCP owns less than Ventas' remaining portfolio.

Our $83 fair value estimate implies a mid-5% cap rate on our 2016 NOI forecast, a 20 times multiple on our 2016 normalized adjusted funds from operations estimate, and a 3.6% dividend yield, based on a $2.98 annualized payout, which we think Ventas can hit by year-end 2016.

The major assumptions in our valuation model drive annual same-store NOI growth averaging 2.6% across our 10-year forecast. We also expect Ventas to continue winning its share of acquisitions, with a projection of $1 billion annually at an average cap rate of 7%. We plan to incorporate potential large acquisitions, similar to the recent $1.75 billion Ardent deal, as they are announced. We expect Ventas to invest roughly $300 million annually in developments at an 8% average yield. We estimate maintenance capital expenditures of $110 million-$230 million per year, higher than historical levels because of the increased impact of senior housing operating assets.

Outside of our cash flow forecasts, we give Ventas credit for its loan book, joint ventures, current debt-funding costs that are well below our long-term expectation, and other minor assets, which add nearly $3 billion to our valuation, or $8 per share to our fair value estimate.

Welltower HCN
Valuation 02/01/2016 | Stephen Ellis

We are increasing our fair value estimate to $81 from $80 because of a time value of money adjustment. Our fair value estimate implies a 5.6% cap rate on our 2016 NOI forecast, a 21 times multiple on our 2016 normalized AFFO estimate, and a 4.1% dividend yield.

Major assumptions in our valuation drive annual average same-store NOI growth of 2.7% across our 10-year forecast. We forecast Welltower's EBITDA margin to settle in near 49% longer-term, lower than historical averages, owing to the addition of the lower-margin operating (RIDEA) assets in the recent past.

We expect Welltower to continue winning its share of acquisitions, with a projection of $1 billion annually beyond 2015 at an average cap rate of 7%. We plan to incorporate larger acquisitions, which are possible, if and when they are announced. We also forecast roughly $500 million annually in additional investments made, mainly related to its existing operating partners expanding their businesses to meet the increasing healthcare needs of a growing and aging population; these investments carry expected initial yields of up to roughly 8%. We estimate that maintenance capital expenditures will increase with the addition of the operating assets recently and range between $66 million and $140 million per year across our 10-year forecast.

Outside of our cash flow forecasts, we give Welltower credit for its loan book, joint ventures, current debt-funding costs that are well below our long-term expectation, and other minor assets, which add roughly $8 per share to our fair value estimate.


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