Monthly Update: January’s a Record Month for the Markets and for Dividends

Marc Lichtenfeld, Chief Income Strategist, The Oxford Club Marc Lichtenfeld, Chief Income Strategist, The Oxford Club By Marc Lichtenfeld, Chief Income Strategist &
Kristin Orman, Research Analyst,

SafetyNet Pro Issues

Last month, SafetyNet Pro changed its ratings of 61 stocks. And although the number of changes suggests a quiet month, January was anything but.

For one thing, the Dow Jones Industrial Average hit an all-time high of 20,000 on January 25.

But the Dow wasn’t the only record maker. The Nasdaq Composite and S&P 500 indexes hit all-time highs last month as well.

Dividend declarations also reached a 10-year high last month.

A record 3,019 companies announced dividends. That’s 14.5% more declarations than we saw in January 2016.

January’s dividend action confirms what SafetyNet Pro subscribers already know… Investors want dividends. And companies are obliging.

They’re sitting on record levels of cash. Companies in the S&P 500 Industrials held $1.49 trillion in cash and cash equivalents at the end of the third quarter.

With stock prices so high, many companies are hesitant to use their cash to buy back shares. So they haven’t announced share repurchases… they’ve declared dividends instead.

But not all dividends are sustainable. It’s still important to make sure companies you own or are interested in owning have the cash flow to continue funding their dividends.

Issue Highlights

  • REITs saw the highest number of ratings changes, followed by industrial and financial stocks.
  • The market expects two Fed rate hikes this year, driving REIT interest rate expenses up and cash flows down.
  • Trump’s pro-business and pro-infrastructure agenda will mean growing revenues for industrial stocks and falling expenses for financial stocks. Both will help drive dividend growth. However, Trump’s trade proposals may hamper retailers’ foreign sales and free cash flow growth.
  • In January, 299 companies increased their dividends, 47 decreased their payouts and two stopped paying dividends.

Industrials and Financials Get a Boost Courtesy of Trump

The “Trump Rally” is still going strong. And many of Trump’s executive orders have been viewed as pro-business, giving the stock market a boost.

One of his first actions was to order construction of a border wall between the U.S. and Mexico. Industrial stocks soared on the news.

Construction management firm Tutor Perini Corp. (NYSE: TPC) rose 9.5% on the day of the announcement. And cement maker Martin Marietta Materials (NYSE: MLM) jumped 3.2%.

Financial stocks have been big winners, too. President Trump signed his first financial deregulation order less than two weeks after taking office.

The directive included steps to reexamine rules and regulations enacted after the 2008 financial crisis. Many hope that he will make good on his promise to change the Wall Street reform law Dodd-Frank.

Financial companies have spent an estimated $36 billion on its requirements. A reduction in regulations could add billions to banks’ bottom lines.

Industry Breakdown

SafetyNet Pro upgraded 36 companies and downgraded 25.

REITs saw the highest number of ratings changes in January, with nine downgrades and one upgrade. And the possibility of rising rates threatens their dividend safety as interest expense takes a bite out of REITs’ cash flows.

Industrials and Financials received the second-highest number of changes at nine each.

To view the full list of ratings changes, including company names, click here.

An Upgrade Courtesy of Rising Cash Flow

Vulcan Materials Company (NYSE: VMC) is the biggest U.S. supplier of crushed stone called “aggregate gravel” and a top producer of asphalt mix and ready-mixed concrete.

Investors believe that Vulcan’s core markets are about to take off. The potential for supplying materials to build the border wall as well as an increase in public construction are fueling growth.

And Vulcan’s cash flow is picking up, too.

The company’s 2017 free cash flow is now expected to increase by 71.8%, from an estimated $280.4 million in 2016 to $481.8 million this year.

Vulcan was upgraded from a “D” to a “C” in January.

A Beat and a Bump Push This Bank’s Rating Higher

Last month, bank PNC Financial Services Group (NYSE: PNC) reported its full-year 2016 financial results. Instead of posting a decline in net interest income (banks’ free cash flow metric), the bank eked out a small 1.4% gain.

Its 2016 net interest income was $8.39 billion, versus the $8.28 billion it reported in 2015.

The company says rising rates, tax reform and regulatory relief will lift its 2017 financial results.

And analysts also lifted their 2017 net interest income estimates from $8.71 billion to $8.88 billion.

PNC has been upgraded from a “C” to a “B.”

Rising Rates Ding This Resort Operator

FelCor Lodging Trust (NYSE: FCH) is a hotel REIT. It operates luxury urban and resort hotels.

The company finances many of its projects with debt, so the amount of interest FelCor pays on its borrowings is a major expense.

Analysts expect FelCor’s interest expense to go higher. So they lowered their 2017 estimates for funds from operations (a measure of REITs’ cash flow) from $0.89 per share to $0.88 per share.

That’s 1.12% less than the $0.89 FelCor is supposed to report for 2016. The lack of growth should be a concern for investors, and it’s the reason for the company’s dividend safety rating downgrade.

FelCor has been downgraded from a “C” to a “D.”

Focus on What Matters

February may have the fewest days of the year, but it won’t be short on action. The new administration is just getting started.

For now, “Trumposals” will drive the prices of stocks across nearly every industry. Executive orders (and tweets) will continue to be market-moving catalysts.

But remember, the new administration is still in its infancy. And as it develops over the coming months, investors will want to see Trump’s actions positively impact corporate bottom lines.

Companies and investors are waiting for infrastructure projects and deregulation to show them the money.

So make sure to keep up on what really matters to dividends – cash flow – and its effect on payout safety. When it comes to dividends, cash flow from operations and capital expenditures matter. These numbers are easy to find on a cash flow statement.

Cash flow from operations tells you how much money a company makes running its business. Capital expenditures are the amount a company spends on equipment, facilities, etc.

And free cash flow is what’s left when you subtract capital expenditures from operating cash flow.

More free cash flow means more money to pay dividends.

But remember to monitor payout ratio as well. SafetyNet Pro prefers the dividends paid to be no more than 75% of free cash flow. That way, if a company’s free cash flow dips in the future, it should still have enough free cash flow to pay the dividend.

Be sure to monitor SafetyNet Pro’s ratings of the stocks in your portfolio.

Remember, not all ratings will improve under President Trump’s economic agenda. Some safety ratings will fall. Don’t get surprised by a dividend cut.

Good investing,

Marc and Kristin

This Month’s Rating Changes: