About the Editor

David Harrell 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.

David served in several senior research and product development roles and was part of the editorial team that created and launched Morningstar.com. He was the co-inventor of Morningstar's first investment advice software. David joined Morningstar in 1994. He holds a bachelor's degree in biology from Skidmore College and a master's degree in biology from the University of Illinois at Springfield.

Our Portfolio Manager

George Metrou is an equity portfolio manager for Mornigstar Investment Management. Metrou joined the team as a portfolio manager in August 2018. Before joining Morningstar Investment Management, he was an equity portfolio manager with Perritt Capital, and as a portoflio manager with Perritt Capital Management. Prior to that he served as Director of Research and as an equity analyst at Perritt Capital, and as a portfolio manager with Windgate Wealth Management. He holds a Bachelor's degree in finance form DePaul University, and 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 Editor's Photo
David Harrell
Editor, Morningstar DividendInvestor
David Harrell 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
George Metrou's Take on FirstEnergy -- The Week in Dividends 2020-07-24
From the DividendInvestor news file this week:

An update on FirstEnergy FE from Dividend Select portfolio manager George Metrou:

On Tuesday, the U.S. Attorney's office for the Southern District of Ohio disclosed a public corruption investigation. The investigation alleges racketeering, and a pay-to-play corruption scheme involving the House Speaker of Ohio, his aide, a number of lobbyists, and an unnamed company, known as Company A. It is understood that Company A is FirstEnergy, a holding in the Dividend Select Deferred portfolio. I'll provide a brief overview of the allegations and my thoughts on the selloff.

It is alleged that FirstEnergy funneled $61m of funds into a 501(c)(4) named Generation Now. That organization, controlled by the House Speaker, then funneled money into groups which made political contributions to numerous Ohio state politicians, was used to influence Ohio legislative outcomes, and made outright bribes. The purpose of the scheme was to secure votes for Ohio House Bill 6 (HB6). HB6 was in effect a bailout of two nuclear plants in Ohio. These plants are now owned by a former subsidiary of FirstEnergy, FirstEnergy Solutions (FES). The bailout bill provided $150m in annual subsidy to the two plants, totaling nearly a $1.5 billion bailout.

Over the next two days, FirstEnergy stock sold off by 34%. This equated to a loss of value of $7.5 billion in market capitalization. I think that this is an overreaction for a couple reasons. To start, FirstEnergy spun-off FES in 2018 and had a separation of management and governance even prior to that. These events occurred prior to the introduction or passage of HB6. FirstEnergy itself would not have benefitted from nuclear subsidies in HB6, but rather FES stakeholders.

Second, if there is an unknown liability that is recourse to FirstEnergy, i.e. some representation or guarantees provided by FirstEnergy in the spin-off related to the upholding of HB6, the loss of $7.5b in value seems to be a large overreaction relative to the potential liability. This possibility seems extremely remote. During this morning's earnings call, FirstEnergy management pushed back on the notion of any remaining financial obligations to FES. They also declared that the FES bankruptcy settlement contained no contingencies with respect to the passage of HB6. At the time of the spinoff, the settlement allowed FirstEnergy to avoid roughly $2b in financial obligations. If there was a way for this liability to come back (a scenario I do not foresee), and there was a repeal of HB6 (likely a given at this point), it still doesn't explain the outsized move in the stock.

Including legal expense and potential fines also doesn't square the math. A similar pay-to-play corruption scheme has been alleged here in Illinois between House Speaker Michael Madigan and the utility ComEd. In that case, ComEd parent company Exelon EXC was slapped with a $200mm fine. Doubling or tripling the fine wouldn't account for the FE stock move.

Hence, I see this as a large overreaction to what is an appalling headline. I believe the most likely outcome is a large fine, and a soured regulatory relationship with Ohio utility regulators. With the overhang of impropriety, regulators will be unlikely to cut the utility any slack in future rate decisions. This can affect profitability down the road. It's important to note, though, that Ohio only represents roughly 20% of FirstEnergy's earnings. The company is large. Operations span six different states as well as federally regulated assets. Reduced profitability in Ohio is unlikely to explain the massive loss in company value.

I believe the market is pricing in a scenario that includes the worst-case scenario and then some. I don't see that coming to pass. However, this is an evolving investigation. More details are bound to come out that are unflattering to FirstEnergy and its management team. I wouldn't expect an immediate rebound in the price, despite the fact the shares are trading well below a reasonable estimate of fair value.

A new analyst note for FirstEnergy from Morningstar Research Services is below, along with notes for Coca-Cola KO, Pfizer PFE, Philip Morris PM, and Texas Instruments TXN.

Amgen AMGN, Enbridge ENB, FirstEnergy, Magellan Midstream Partners MMP, and McDonald's MCD all declared dividends this week that were unchanged from their previous respective payouts. While Enbridge's dividend was unchanged in its base currency (the quarterly dividend remains 0.81 CAD), U.S. investors will see a small deviation from the previous payout due to currency fluctuations.

Finally, please note that I'll be out of the office next week, so we won't be publishing an update on July 31. Any analyst updates published that week will be included in the August 7 update.

Best wishes,

David Harrell
Editor, Morningstar DividendInvestor


News and Research for Dividend Select Portfolio Holdings

Long-Term Opportunity in Coca-Cola Shares Despite Remainder of 2020 Being Rife with Uncertainty
by Nicholas Johnson | Morningstar Research Services LLC | 07-21-20

Investors were already anticipating an ugly quarter heading into wide-moat Coca-Cola's second-quarter earnings report. Consequently, we think they were primarily looking for: details about margin dynamics, given the top-line pressure and information about the speed of recovery in major markets. The results (bottom-line beat and in-line sales relative to CapIQ consensus), as well as management commentary, were mixed, but we remain sanguine on the firm's ability to manage its business, and the health of the Coca-Cola system, throughout the crisis. As we tweak our short-term estimates, we do not plan to change our $54 fair value estimate, and while the firm's near-term trajectory remains murky, we still see a meaningful long-term value proposition in the shares at current levels.

Revenue came in at $7.15 billion, a decline of over 28% from a year ago, 26% of which was organic. Most of this drop (22%) came from volume, with roughly half the business being walloped by on-premises closures and confinement mandates, and more modest declines in price/mix, as adverse channels/packages were partially offset by the underperformance of finished goods businesses, like Costa. The extent of societal lockdown and on-premises exposure remain the biggest short-term drivers, but the firm may have a hard time catching a break even as these factors return to normal. For example, in a region like Latin America, with on-premises exposure below the corporate average (we estimate 15%-20%), reasonable organic performance is being countervailed by currency weakness.

Segment dynamics were salient at the margin lines. Despite tremendous top-line weakness, adjusted operating margins proved quite resilient, contracting just 20 basis points to 30.1% as structurally higher-margin concentrate businesses increased within the mix. While brand investments will accelerate through the rest of the year, we still expect favorable segment mix to continue supporting profitability.

In addition to business updates, management articulated a refined portfolio strategy. They remain committed to the leader (brands with dominant category shares and scale), challenger (growing brands with core consumer audiences), and explorer (brands in their incipient stages of growth) framework, but are looking to be more discerning in resource allocation going forward. Of the company's 400 master trademarks, half of them are single-country brands constituting only 2% of consolidated revenue and boasting anemic growth rates. Leadership plans to be more aggressive with pruning these “zombies” from the portfolio. We believe this approach is prudent, as while these trademarks likely get very little advertising or promotional resources, they still require meaningful operational investments in things like personnel, administrative systems, and supply chain capacity. Coke's unparalleled portfolio breadth in beverages, and the go-to-market optionality it affords, is integral to our wide moat rating. Still, pruning some niche brands will not materially affect the firm's portfolio advantage versus competitors, and it should support a robust growth trajectory and improved system economics longer term.

FirstEnergy Shares Sink After Ohio House Speaker Arrested on Racketeering Charges; Reaffirming FVE
by Charles Fishman, CFA | Morningstar Research Services LLC | 07-21-20

We are reaffirming our $44 per share fair value estimate and narrow moat rating after FirstEnergy's shares were down 17% following the arrest of the Ohio House Speaker Larry Householder (R) on racketeering charges. Federal investigators arrested Mr. Householder, his aide, and the Ohio Republican Party Chairman. Two lobbyists were also arrested, one that was working for Energy Harbor Corp. (formerly FirstEnergy Solutions, or FES).

FirstEnergy issued a news release indicating they had received subpoenas in connection with the investigation surrounding Ohio House Bill 6, legislation passed in 2019 to provide subsidies to two nuclear plants in Ohio. The plants were assets of FES when it was a wholly owned unit of FirstEnergy. FES separated from FirstEnergy in 2018 and filed for bankruptcy. In February 2020, FES emerged from bankruptcy proceedings and changed its name to Energy Harbor.

Although the news will likely impact FirstEnergy's regulatory relationships in Ohio, we believe the market overreacted to the news. FirstEnergy's three Ohio distribution utilities; Ohio Edison, Cleveland Electric Illuminating and Toledo Edison, only represent about 25% of distribution rate base. The distribution segment is approximately 70% of FirstEnergy's consolidated earnings, FERC-regulated interstate transmission the remainder. Thus, using rate base as a proxy for earnings, we estimate Ohio distribution utilities contribute less than 20% of FirstEnergy's earnings.

We also find it hard to believe that FirstEnergy's management was directly involved in any bribery scheme with respect to HB 6. Although FirstEnergy CEO Chuck Jones had been very vocal in his support for the legislation, his support was based on his belief that the nuclear plants were important to Ohio, the communities in which they were located, and the plant employees. When passed, HB 6 had minimal benefit for FirstEnergy or Jones, as FES was bankrupt and separate from FirstEnergy.

Positive Updates from AstraZeneca and BioNTech/Pfizer's COVID-19 Vaccines Don't Change Our FVEs

by Karen Andersen, CFA | Morningstar Research Services LLC | 07-20-20

AstraZeneca published solid phase 1 data for its SARS-CoV-2 vaccine AZD1222 in the Lancet on July 20, and we're maintaining our Astra fair value estimate as we continue to see promise in the vaccine's efficacy and safety, but the firm's not-for-profit plan for the vaccine limits long-term underlying profit impact. Astra's rapid progress with development and manufacturing of a potential COVID-19 vaccine is a testament to the firm's wide moat, which is also supported by a strong portfolio of therapies in oncology and immunology. In addition, BioNTech and partner Pfizer released efficacy data from a Germany phase 1/2 study on July 20, adding further support to prior data, and we're not making any changes to our fair value estimates for either firm. We now have positive clinical data from four different vaccine programs; beyond Astra's adenovirus-based AZD1222, which is poised to enter a large phase 3 study in the U.S. in August, two RNA-based vaccines are rapidly moving forward. Moderna's mRNA-1273 and Pfizer/BioNTech's BNT162 have both generated strong phase 1 data and are on track to start phase 3 trials in late July. In addition, the Lancet published phase 2 data from CanSino's adenovirus-based vaccine on July 20, but we're concerned about pre-existing immunity to the vector limiting its ultimate efficacy, particularly in older adults. It is also difficult to compare CanSino's data with that of other vaccines without convalescent comparisons in the study, and the relatively low manufacturing capacity announced so far (100 million-200 million doses in 2021) is concerning. Although it isn't clear what level of neutralizing antibodies (that are expected to neutralize the virus) or T-cell response (that could help support long-term immunity) is necessary to protect against infection or against severe disease, comparisons to levels in recovered patients give us some comfort, and we continue to expect an effective and safe vaccine to be available by the end of 2020.

Philip Morris Managing COVID-19 Impact Well with Impressive Second-Quarter Cost Control
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 07-22-20

Philip Morris International reported a fairly strong second quarter, all things considered, with a good performance from IQOS. Management also reinstated full-year guidance at a level slightly better than our forecasts. Although we are raising our margin assumptions for the rest of the year because of these results, we are reiterating our $98 fair value estimate. We still believe that Philip Morris International is undervalued and the recent announcement that the Food and Drug Administration has approved IQOS to be marketed in the United States with modified exposure claims is not priced into the market value.

A net revenue decline of 13.6% was in line with our forecast, although the total tobacco volume decline of 14.6% was slightly better than our 15.5% forecast and price/mix slightly weaker. The upside to volume came from heated tobacco units in Europe, which grew an impressive 60%, albeit from a still small base. We expected customer recruitment to have been significantly impeded by the recent lockdown measures, which included the closure of some IQOS retail stores, but engagement appears to have continued to improve. One volume weak spot was combustibles in Indonesia, with the market decline accelerating to around 20%, as lockdown measures compounded the already delicate consumer situation reported in the first quarter. We expect downtrading in Indonesia to continue for the rest of the year, but a planned tax increase that will close the price gap between the company's premium brand Sampoerna and low-cost local brands would stabilize PMI's performance.

The upside to our second-quarter forecasts occurred at the EBIT margin, which was flat year over year when adjusting for currency despite the sharp drop in shipment volume. This is impressive.

Business Conditions Are Holding Up Well for Texas Instruments; Raising FVE to $120 From $115
by Brian Colello, CPA | Morningstar Research Services LLC | 07-21-20

Texas Instruments reported relatively healthy second quarter results, consistent with the better-than-expected revenue updates provided by some of the firm's peers in recent weeks. We're also encouraged by TI's outlook for the third quarter, as business conditions in most end markets (excluding automotive) have not significantly deteriorated due to the COVID-19 pandemic. Management continues to take a cautious tone toward future demand, as it is possible that the hearty sales levels stem from customers building up inventory in order to protect themselves in the event of future supply chain disruptions, rather than robust manufacturing activity. That said, TI did see a boost in end market demand from the medical end market, as well as tech sectors exposed to remote working trends. We are raising our fair value estimate for wide-moat TI to $120 from $115. However, shares still appear modestly overvalued to us.

Revenue in the June quarter was $3.24 billion, down 12% year over year but down only 2% sequentially and above the midpoint of the firm's prior guidance of $2.61 billion-$3.19 billion as discussed in April. The automotive end market was a clear drag, with sales down about 40% sequentially and over 40% year over year, due to COVID-19-related auto manufacturing shutdowns. Excluding auto, TI's chip sales would have been down only 3% year over year and up 8% sequentially. Communications infrastructure chip sales rebounded from a dismal first quarter, with sales up over 20% sequentially, albeit still down about 15% year over year. The firm's largest end market, industrial, saw modest growth both sequentially and year over year. Gross margin rose 160 basis points sequentially to 64.3%, in line with higher sales levels.

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