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

May 04, 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
Another Week of Dividend Growth -- The Week in Dividends, 2016-04-29

Amid another onslaught of quarterly earnings reports--10 of our 26 portfolio holdings released results this week alone--our Dividend Select Portfolio benefited from another three dividend increases.

Our oldest holding, Johnson & Johnson JNJ, met my expectations on the nose. Starting with the payment due June 7, we will receive $0.80 a share each quarter, up 6.7% from the previous rate. Though this represents a 54th straight year of dividend growth, it's a far cry from the routine double-digit annual hikes of yore. No matter how well managed, the law of large numbers was bound to catch up with this giant enterprise, and in 2009 it finally did. Yet the mid- to high-single-digit dividend hikes we've received since then have been amply rewarding in the context of a diverse, financially secure, and still-expanding business with a current yield of 3%, give or take. The stock trades a little rich relative to our fair value estimate of $104 a share, but I plan to continue holding our stake for the long haul.

The small dividend increase Wells Fargo WFC issued Tuesday came as a surprise. Since 2011, changes to Wells' dividend--and those of the nation's other big banks--have been tied to the Federal Reserve's Comprehensive Capital Analysis and Review process (or "stress test") that was wrapped up each year in March. This year, CCAR results and regulators' answer to capital return requests were pushed back to June. As it turns out, Wells obtained permission for a second-quarter 2016 hike as part of last year's review, so the bank nudged up its quarterly dividend rate 1.3% to $0.38 a share.

Wells faces stagnant earnings per share in the near term, thanks mainly to dismally low short-term interest rates and weak economic growth. Even so, I don't think this will be the bank's only dividend hike this year. Wells has amply demonstrated superior profitability and risk control compared with its rivals, which has already allowed the bank to move beyond the 30% ceiling regulators had placed on bank payout ratios. My best guess is that Wells will meet my year-end 2016 estimate of a $0.40 quarterly dividend rate, commencing in the third quarter rather than the second. Even if it comes up a little short (say $0.39), the stock can still play a useful role in our portfolio for the long haul, and I remain interested in adding to our stake at some point.

Finally, AmeriGas Partners APU raised its quarterly distribution rate for a 12th straight year. As I expected, the rate of growth slowed from management's long-standing 5% target, though I was a bit surprised that the increase came in at just 2.2% rather than my estimate of 4.3%. But perhaps this ought not to be surprising: Not only was the most recent winter heating season extremely unfavorable for propane distributors, but nine years of distribution growth averaging 5.2% a year has slightly outpaced growth in distributable cash flow, eroding coverage from a historical average around 1.3 times to my weather-normalized estimate of 1.15 times this year.

AmeriGas has served us very well over the years, and I'm inclined to take a glass-half-full view of the slowdown in growth. First, I don't believe this betrays any change in my long-term thesis. Weather will be highly variable from year to year, but AmeriGas is still in healthy shape--both financially and operationally--to cope with the swings. Indeed, I applaud management for tapping gently on the brakes rather than barreling full steam ahead in difficult circumstances (as many other master limited partnerships have unwisely done). Second, any income growth can fairly be regarded as gravy from a security yielding nearly 9%; 2.2% is also enough to keep our income ahead of inflation. Third, while I will probably trim my five-year distribution growth outlook for AmeriGas, I think it's likely that growth can pick up a bit from this year's level, keeping the units' long-term total return prospect highly attractive.

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

Altria Group MO
Analyst Note 04/28/2016 | Adam Fleck, CFA

We don’t anticipate major changes to our $59 fair value estimate for wide-moat Altria following first-quarter results. Similar to rival Reynolds American, Altria enjoyed solid performance in its highest-end brand, as Marlboro held on to its market-leading share in a flat to down cigarette industry environment. Volumes in the brand grew 1% year over year (including the benefit from an extra selling day and inventory restocking at retailers), and along with continued solid performance in the smaller discount segment (with volumes up 6.4%), Altria’s total cigarette volumes climbed 1.2%, with market share  holding sequentially at 51.4%. We caution that we expect a return to health-driven 3% to 4% annual declines in industry volume following recent positive performance (which stemmed mainly from lower gas prices, reduced unemployment, and higher wages for tobacco consumers), but expect Altria to roughly maintain its market share for the foreseeable future as the firm enjoys moderate gains in Marlboro while deemphasizing discount brands.

The company’s pricing also reflects its strong brand intangible assets. Revenue per product in the smokeables segment (which includes cigarettes and cigars) climbed about 4% year over year in the quarter, a bit behind our full-year 5.5% forecast given the higher rise of discount brands, but nonetheless helped drive up total revenue 5.3% year over year in the business. While this growth rate outpaces our full-year 2% to 3% expectation, we expect the aforementioned renewal of industry declines, combined with a reversal of the positive impact of selling days and inventory in the quarter, to lead to more-muted top-line growth rates as the year progresses.

That said, Altria’s smokeable profitability is in line with our projections. Adjusted operating margins climbed 170 basis points to 48.1%, tracking our full-year 48% forecast, as higher pricing and volumes, along with solid productivity gains and positive mix shift to premium cigars in the segment, helped boost margins. This segment remains the key driver in the firm’s portfolio, at 87% of adjusted operating income in the quarter, but we also note that improved profitability in the smokeless business (the majority of remaining consolidated operating income) also tracks our full-year projection. In all, our $3.03 earnings per share forecast splits management’s maintained outlook for EPS in the range of $3.00 to $3.05.

American Electric Power AEP
Analyst Note 04/28/2016 | Andrew Bischof, CFA

We are reaffirming our $61 per share fair value estimate, narrow economic moat, and stable moat trend ratings after American Electric Power reported first-quarter operating earnings of $1.02 per share compared with $1.28 in the same year-ago period. Management reaffirmed 2016 guidance of $3.60-$3.80, in line with our $3.72 estimate. We are reaffirming our 5.6% annual earnings growth through 2020, in line with management's 4%-6% target.

Management recently won state commission approval of its eight-year contract to sell power from 2.7 gigawatts of AEP's Ohio coal plants. However, the win was short-lived. On April 27, the Federal Energy Regulatory Commission rescinded AEP's affiliate sales waiver, and we don't think the power purchase agreements will pass the commission's affiliate abuse test.

Management has indicated they do not want to go through a protracted FERC review process and will either try to divest the PPA-related assets or seek state legislation for re-regulation of the assets. We think a sale is more likely and state re-regulation is unlikely. Management also said that they expect to divest the remaining Ohio power generation fleet by year-end, with final bids due in the third quarter, in line with our expectations. We value AEP Ohio's total merchant fleet at $6 per share, or $2.9 billion, assuming FERC or the courts reject the PPAs.

We think the issues with AEP's merchant generation are causing the market to ignore the value of AEP's high-quality regulated businesses. AEP has a long runway of regulated investment opportunities in constructive regulatory jurisdictions, supporting our 7% rate base growth forecast. Regulated returns should continue to improve. Management is forecasting 2016 regulated returns of 10.1%, up from 9.6% returns in 2015 and consistent with our outlook. Recent constructive rate case outcomes give us confidence that management can continue to improve regulated returns.

Compass Minerals CMP
Analyst Note 04/26/2016 | Jeffrey Stafford, CFA

Compass Minerals performed reasonably well in the first quarter despite underlying weakness in both of its primary end markets, highway deicing salt and specialty fertilizer. Operating earnings dropped 12% year over year, as a 7% earnings improvement in the salt business was not nearly enough to offset lower fertilizer prices and volume. We're leaving our fair value estimate of $89 per share and wide moat rating intact.

Salt sales volume dropped about 3.5% year over year as mild winter weather in the first quarter held back deicing purchases. The 11 cities representing Compass' primary markets reported 84 snow events during the first quarter compared with a 10-year average of 114 and a 2015 result of 126. We expect the mild winter has led to a buildup in customer inventories that will weigh on salt volume and prices during the upcoming bid season. In the long run, however, assuming a return to more normal winter weather, we think salt volume and pricing will regain some strength. We forecast total salt volume of 11.4 million tons in 2016 but expect Compass to sell more than 13 million tons per year in the long run.

Despite unfavorable weather, Compass was able to increase salt earnings year over year, a testament to its cost focus and share gains from the prior bid season. We estimate costs per ton dropped more than 10%, and we expect further cost benefits as the company completes projects at its massive and low-cost Goderich mine in Ontario. Impressively, Compass' first-quarter EBITDA was $93 million this year with only 84 snow events; compare that with 2014's first-quarter EBITDA of $75 million when the company benefited from 151 snow events.

Specialty fertilizer remains a challenging business for Compass, a trend we expect will continue. Operating earnings for the segment dropped a whopping 75% year over year. As we expected, the spread between muriate of potash and sulfate of potash continues to contract. Our long-run pricing for this segment is intact.

Enterprise Products Partners
Analyst Note 04/28/2016 | Peggy Connerty

Enterprise Products Partners reported first-quarter adjusted EBITDA of $1.327 billion, ahead of consensus estimates of $1.313 billion and essentially flat with first-quarter 2015. Distributable cash flow was $1.054 billion, up 2.3% from $1.03 billion last year.  The company increased its cash distribution by 5.3% to $0.395 per unit versus $0.375 in the first quarter of 2015. Importantly, the coverage on the distribution was a very healthy 1.3 times, with retained cash flow of $229 million. Growth during the quarter was driven by strong natural gas liquids pipeline and liquefied petroleum gas export volumes and the EFS Midstream acquisition. Offsetting this were lower margins from commodity- and spread-sensitive businesses, asset divestitures (offshore pipeline segment), and lower volumes in crude oil and natural gas pipelines.

Enterprise’s business model has proved robust 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. The company'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. We expect management to continue to be prudent as it navigates current market challenges. We are maintaining our fair value estimate of $32.

Capital spending was $1.1 billion during the quarter, including $59 million in maintenance. For the year, management is targeting capital expenditures of $2.8 billion for growth (which is at the high end of the range that was announced at the start of the year), $1.0 billion for the final installment payment for the purchase of EFS Midstream, and $275 million for maintenance. Enterprise plans to use its retained distributable cash flow, equity financing, including additional EPCO equity purchases, debt, and noncore asset divestitures to fund its growth and distribution plans. Currently, Enterprise has liquidity of $5.1 billion in cash and available capacity on its revolving credit facility.

Procter & Gamble PG
Analyst Note 04/26/2016 | Erin Lash, CFA

We don’t expect to change our $90 fair value estimate for wide-moat Procter & Gamble after the firm’s third-quarter results. Excluding foreign exchange, organic sales edged up 1%, entirely due to higher prices. But despite the tepid sales performance, we perceive the profit improvement as impressive, with a 270-basis-point increase in adjusted gross margins to 50.9% and a 300-basis-point improvement in adjusted operating margins to 22.2%. Also, the firm targets extracting another $10 billion of costs from its operations over the next five years, but is unlikely to meaningfully boost margins as the bulk is slated to fuel product innovation (which includes improved packaging) and advertising (as well as increased sampling to prompt trial) to reignite its top-line prospects. Further, we’re encouraged by management’s commitment to "cleaning up the core business" and forgoing unprofitable sales across its business (such as its commoditized bathroom tissue lineup in Mexico). Despite hindering sales to the tune of around 1%, we believe these efforts illustrate P&G is focused on profitable growth longer term rather than just boosting its market share in declining or unprofitable categories.

Management maintained its top-line guidance for the full year (June year-end)--calling for a low-single-digit increase in organic sales--but narrowed its EPS range to down 3%-6% from down 3%-8% (and anticipates a negative 9% hit from unfavorable foreign exchange). We continue to believe that with its leading brand mix and vast resources, P&G is a critical partner for retailers, which are reluctant to risk costly out-of-stocks with unproven suppliers, supporting the firm's wide moat. In that vein, P&G strikes us as an attractive investment, as the market's confidence in its competitive edge and ability to drive accelerating sales growth (to a mid-single-digit level over the next several years) has yet to materialize, and we’d recommend investors consider building a position in the name.

Similar to its consumer product peers, its volume degradation was concentrated in emerging markets (down 5%) after actions to raise prices in response to the pronounced currency devaluation in select regions. This performance materially lagged the 3% volume growth the firm chalked up in developed markets, which we think reflects P&G's emphasis on winning with innovation and is a testament to recent rhetoric that it intends to be more laser-focused on driving profitable growth. In that light, management again articulated that core earnings within its emerging markets are growing 8 times faster than underlying regional sales. We continue to expect the firm to realize growth opportunities for its brands in many overseas markets, beyond the favorable demographic and disposable income trends we anticipate that will support emerging-market growth longer term. Further, we contend that the benefits from its more focused investments (following the completion of its product rationalization efforts over the next year), and subsequently the ability to more effectively tap into and respond to evolving consumer trends should bolster the brand intangible asset source of its wide moat. Overall, we forecast low-single-digit growth in the firm's developed-market regions and mid- to high-single-digit growth in its emerging markets.

Realty Income O
Analyst Note 04/27/2016 | Edward Mui

Realty Income reported first-quarter results, realizing flat funds from operations per share of $0.68 but 4.5% growth in adjusted funds from operations per share year over year, from $0.67 to $0.70. This allowed the 74th consecutive quarterly dividend increase for which the real estate investment trust is best known, increasing 4.8% for the quarter year over year to $0.588 per share. We are maintaining our $50 fair value estimate and narrow moat rating for now but will revisit our analysis in the coming months due to an analyst change.

We have been watchful regarding Realty Income's ability to maintain its compelling growth story, given its increasing size and meager contractual rent bumps in its leases. Therefore, we were pleased to hear management's updated acquisition guidance of $900 million for 2016, up from $750 million. However, the characteristics of the $352 million in first-quarter acquisitions and development activity leave a bit to be desired, with an overall 6.6% cash capitalization rate on income 23% generated from investment-grade tenants, both metrics representing historical lows. Even if the increasingly lower cap rates on acquisitions represent higher asset quality, the margin for creating shareholder value is lower, given our roughly 7% long-term weighted average cost of capital. We acknowledge Realty's currently low cost of debt, but we are concerned about management starting to stretch on marginal deals for the sake of growth and wonder if it also represents a decreasing level of compelling opportunities or a potentially permanent increase in competition with bid-up prices for these types of assets. We are especially watchful since occupancy showed softness, decreasing 60 basis points sequentially for the quarter.

The company has done a good job maintaining a strong financial position, giving it flexibility for an uncertain economic outlook. But we think investors should manage their expectations, especially at the current share price.

Southern Company SO
Analyst Note 04/27/2016 | Mark Barnett

We maintain our $48 per share fair value estimate and stable, narrow moat ratings for Southern Company after the firm announced its utilities and nonregulated power segment earned $0.58 per share in the first quarter, up 3.5% from first-quarter 2015 EPS of $0.56. The adjusted figures exclude the impact of another small writedown at the Kemper coal-to-gas facility in Mississippi of roughly $0.04 per share and another $0.01 per share of costs related to the acquisition of AGL Resources and PowerSecure, a behind-the-meter energy solutions business. Management reaffirmed its full-year EPS guidance of $2.76-$2.88, in line with our $2.83 projection.

The earnings performance was strong despite a 3% decline in retail power sales because of mild weather that affected residential demand (down 7%). Commercial and industrial demand slid by just under 1%. While lower sales means some lost margin--particularly in Georgia, where Southern has agreed to freeze rates for three years as part of the AGL merger approval--it won't affect our valuation, which already incorporates an overall decline in retail sales for 2016.

We're watching more closely Southern's long-term demand trends that drive investment needs and growth. Usage adjusted for weather was up 0.4%, led by 1.4% growth in residential and offset by a 1% drop in industrial usage, which is trending below Southern's expectations. This was attributed primarily to plant outages, but it bears watching as industrial activity is a major driver of demand in Southern's service territory.

Southern faces a busy regulatory calendar in 2016, particularly in Georgia. With the AGL deal approved there, Vogtle will be front and center as regulators examine last year's lawsuit settlements, which will now include a review of all plant costs. Our fair value currently incorporates $500 million ($0.50 per share) in unrecoverable cost overruns at Vogtle.

United Parcel Service
Analyst Note 04/28/2016 | Keith Schoonmaker, CFA

UPS affirmed its expectation of 5%-9% EPS growth in 2016 following its delivery of 13% growth in the first quarter. Packages produced record results, and while supply chain expanded sales due to an acquisition, its EBIT contracted due to weak airfreight forwarding and less-than-truckload trucking markets. We maintain our wide economic moat rating and expect to maintain our fair value estimate. Three factors are most worthy of investor note.  

First, UPS realized solid parcel demand despite the mixed economy. The consumer seems healthy but industrial activity is tepid. UPS grew domestic package volume 2.8% but international contracted 2%, and revenue per piece contracted 1.6% company wide due chiefly to lower fuel surcharges.

Second, UPS is operating well and produced high margins in parcels. Domestic package (63% of sales) operating margin of 12.1% was 50 basis points higher than in the year-ago period, international package (20% of sales) improved 290 basis points to an impressive 19.7%, and supply chain and freight (17% of sales) declined 80 basis points to 6.1%.

Finally, UPS announced a potential liability. When in 2007 UPS withdrew from the Central States Pension Fund via a $6.1 billion payment and a $1.7 billion liability to restore lost benefits, no UPS benefits could be reduced without UPS consent, but in a backstop provision UPS covered future lawfully reduced benefits. A 2014 law permits Central States, crippled by low assets, to reduce benefits. It proposes to do so by an average of 53% for some UPS employees on benefits earned before 2008. UPS objects to this. It appears to trigger UPS’ backstop obligation and result in a $3.2 billion to $3.8 billion non-cash charge. Management expects Treasury to rule on this before May 8. Timing is unclear, but we think the likely outcome is an increase to annual service costs. We note a $1 billion cash payment today drops our fair value estimate by $1 or 1%, so we expect this to impact valuation by less than 2%.

Ventas VTR
Analyst Note 04/29/2016 | Edward Mui

Ventas released first-quarter earnings results, reporting normalized funds from operations growth of 7% for the quarter on a comparable basis, adjusting for the Care Capital Partners spin-off, to $1.04 per share from $0.97 a year ago. Reported same-store cash net operating income grew 1.7% in the quarter year over year, or 2.9% adjusted for certain nonrecurring items, mainly buoyed by solid 4.2% NOI growth in its same-store medical office portfolio. We are maintaining our $63 fair value estimate and narrow moat rating.

Despite relatively decent performance, the quarter seemed a bit quiet, for better or worse. Ventas' senior housing operating portfolio, historically a significant growth driver, turned in 2.4% NOI growth for the quarter on increased rate but lower occupancy before foreign exchange adjustments for its same-store stabilized properties, potentially signaling continued new supply pressure. Additionally, Ventas' triple-net leased post-acute care portfolio coverage has continued to deteriorate, albeit still remaining at a current 2 times cash flow, on declining occupancy both year over year and sequentially to 71.8% as of quarter end. Interestingly, Ventas amended its master lease with Kindred to reallocate $8 million in rent from seven of its long-term acute care hospitals and then put the assets to market, expecting to only receive $6.5 million. Perhaps this represents a one-off situation, or, altogether with the decrease in post-acute performance and strength in medical office properties, it could represent the continued shift in healthcare delivery.

Ventas' capital is currently more focused on internal redevelopment opportunities, while external development and acquisitions activity remained relatively subdued. While we acknowledge the positive risk-adjusted returns redevelopment has historically represented, we also wonder to what extent compelling external growth opportunities are becoming few and far between.

Along with the continued focus on deleveraging the company, we think investors shouldn't be surprised if it's more of the same in the coming quarters. Company management reaffirmed prior 2016 guidance of 3%-5% normalized FFO per share growth on a normalized basis on 1.5%-3% same-store cash NOI growth.


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