DividendInvestor℠ 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:

Editor, Morningstar DividendInvestor

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News and Research for Dividend Select Portfolio Holdings

P&G Has Begun Delivering on Its Strategic Agenda, Sending Shares Up, but Growth Not Yet Broad Based
by Erin Lash, CFA | Morningstar Research Services LLC | 12-05-18

Nearly a year since its proxy battle with activist investor Nelson Peltz came to an end (Peltz assumed a board seat in March), P&G's shares have jumped 6%, versus a mere 2% appreciation in the S&P 500 Index. While we never believed one individual stood to accelerate the change already underway (rationalizing its cost structure, removing more than 100 brands from its mix, and returning significant cash to shareholders in the form of dividends and share repurchases), we think these efforts are only now beginning to bear fruit. As evidence, the 4% sales growth chalked up in the first quarter (ending Sept. 30) was a marked improvement from the flat- to low-single-digit gains that had been characterizing its operations of late.

While it will take a few more quarters before we view this as sustainable, we think P&G is taking the appropriate steps to elevate its performance. For one, while beauty was long a laggard in its mix, it has reversed course, stringing together mid- to high-single-digit top-line gains over the past few years after parting ways with unprofitable products and launching fare centered on its core anti-aging messaging. We believe the lackluster grooming business is also poised for improvement (although not to the same magnitude), as it works to apply a similar formula after falling victim to intense competition from lower-price upstarts. In this vein, we view P&G’s intent to drive further efficiencies to fund added spend behind its brands favorably.

Overall, our forecast calls for 3%-4% average annual sales growth through fiscal 2028 and 300 basis points of operating margin gains to more than 24% (versus consensus forecast for low-single-digits sales growth and just 200 basis points of operating margin benefit over the next few years). And while shares trade at just a 4% discount to our valuation, we suggest investors keep this wide-moat name on their radar. For those interested in the space, we view wide-moat Colgate as more attractive currently.

Reanalyzing Bank Profitability: Funding Advantages, NIMs, and Peak Profitability Amid Rate Changes
by Eric Compton | Morningstar Research Services LLC | 12-04-18

One of the biggest historical differentiators between strong and weak banking franchises was the deposit base. With interest rates so low for so long, however, deposit cost advantages had largely disappeared. With interest rates trending higher, funding costs are coming back into the forefront, and it is imperative for investors to understand exactly how rising rates affect profitability, and to be able to pick winners and losers in the current rising rate environment. Overall, after an extensive review of our coverage list, we view Cullen/Frost, Comerica, Zions, Regions, and M&T as the most advantaged from a deposit base point of view. We also see Bank of America and Wells Fargo as having attractive deposit bases. With all the banks under our coverage still asset sensitive, we still see room for net interest margins to expand over the medium term, although at a slower rate than witnessed from 2015 to 2018. Further, we expect net interest income growth, with moderate growth in earning assets expected over the medium term as well.

While a decreasing 10-year yield and the possibility of a slower rate hike outlook are top of mind in recent days, we note that for our current outlook, we are only assuming two more rate hikes through 2021, leading to a normalized rate of 2.75% for the federal-funds rate. This was already on the more conservative side of the rate hike spectrum. Further, knowing which banks have the most sensitive loan portfolios is just as important on the way up for rates as it is on the way down. Finally, the majority of the rate sensitivity for the banks covered is still tied to the short end of the curve. While the movements of the 10-year may be an indicator of a potential economic downturn on the horizon, which is certainly an important factor to consider, the immediate impacts on profitability are small in comparison to that caused by movements on the short end of the curve.

We have developed a comprehensive framework for analyzing deposit costs, as we have ranked the deposit bases of each of the banks under our coverage. We then analyze asset yields and translate all of this into the ultimate impact on each bank’s profitability. This piece will be useful to any investor looking to better understand how rising rates affect banks, which banks will benefit the most from a rising rate environment, and where we are in the current cycle with regards to profitability.

Deposit cost differences do exist between banks, and not all deposit bases are created equal. We have found deposit advantages to be persistent over time. This persistence means that the cost differences are not random and can lead to sustainable competitive advantages, fitting well within our moat framework for banks. Further, deposit cost advantages do correlate with overall profitability and can lead to differences in a bank's return on equity of 100-200 basis points or more.

The industry level deposit beta was only 20% from the end of 2015 through the first quarter of 2018, but given the lag effect for betas, we have been expecting them to pick up greatly. This had already begun in the second quarter of 2018, where betas were 38% for the banks under our coverage, and in the third quarter betas picked up to 59%. We are projecting betas in the 80s, on average, for the rest of the cycle, leading to a full-cycle beta of 46% for the banks covered.

All banks under our coverage remain asset sensitive. Given the expectation for a rising rate regime over the next several years, we do not expect this to change, which leads us to remain positive on both NIM expansion and net interest income growth over the medium term. While we are positive on NIMs and net interest income growth, we note that we expect this expansion to occur at a slower rate over the second half of the cycle, as funding costs begin to catch up. As the tailwind of NIM expansion begins to slow, the headwind of a normalizing credit environment will pick up. We calculate that the normalization of the credit cycle will more than offset the remaining NIM expansion left for the banks covered. These banks will need to release excess capital to further balance out a normalizing credit environment, and we are likely reaching the peak of sustainable profitability levels. This reality is already present within our modeling for the banks in this piece, where on average we have returns on tangible equity staying roughly flat from 2018 forward.

On an individual basis, we project that Comerica, Regions Financial, M&T Bank, Cullen/Frost, and Zions have the highest likelihood of having an advantaged deposit base in the future. We project that Bank of America and Wells Fargo are also likely to be advantaged in the future. We believe PNC, JP Morgan, Fifth Third, BB&T, and SunTrust have deposit bases which are in the middle of the pack. KeyCorp and U.S. Bancorp are less likely to have an advantaged deposit base, while we believe Huntington, Citigroup, and Capital One have the least advantaged deposit bases under our coverage. Comerica is still the clear standout when it comes to interest rate sensitivity, with an advantaged deposit base, and the highest percentage of variable rate loans on its balance sheet.

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