This is from the AMM Dividend Letter released January 8, 2015. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.
It’s that time of the year again. When we sit down and make our New Year’s Resolutions. A fancy way of saying we’re going to set some goals for the coming year. One of the more common resolutions/goals people make is “to save more money”.
From Most Americans Want to Save More in 2015 – But Can They? by Mandi Woodruff
Saving more is a great goal but how will we accomplish it?
It’s about systems versus goals. A goal is the end. The system is how you get there. The beauty of a system is even if you fall a little short of your goal you have still accomplished a great deal.
A sports team wants to win the championship. A goal. The daily practices, conditioning, video sessions, etc. designed by the coaches are the system to reach this goal. Even if the team falls short of their goal of winning a championship they still have improved immensely as a team because of the system.
The system needs to be easy and simple to follow at first to ensure compliance and then easily built upon.
The system also needs to be a combination of improvement by subtraction and improvement by addition. Improvement by subtraction is eliminating the bad habits. If your goal is weight loss then improvement by subtraction is removing the junk food from the pantry and not buying any more of it. Improvement by addition is getting better by doing things better and doing more of it. If your goal is to get in shape then you would add few workouts a week and then slowly add more to each workout and more workout days per week.
It is the same with saving money. If people really want to save more money then they need to create a system to do so.
1) Make the system easy to follow
Automatically have money taken out of your paycheck to go to a 401K or other retirement program so you don’t have to think about doing it. After a paycheck is deposited into your bank account use the bill pay feature to set-up a recurring payment to have money sent out to other savings accounts. The goal is remove your willpower out of the equation and to make savings as automatic and unconscious as possible.
2) Improvement by Subtraction
Use Mint, Quicken, or any other budget system to track what you’re spending. Where can you cut excess spending? Don’t just focus on the small things like cutting out one Starbucks latte per week. What about the big stuff like transportation, housing, or cable?
3) Improvement by Addition
Every year try to increase the percentage of your salary saved. Can you earn more money? Is it time for that raise at work? Can you turn a hobby into a side business? If you’re reading this letter you have already implemented a strong improvement by addition element to your savings system.
Dividend growth investing.
It is a system focused on earning more money every year. You are letting the management teams of the companies you own do the arduous day-to-day tasks of running a business while you get to collect a quarterly dividend from the business. You also have hired us to select the underlying investments. Our goal is to buy high quality companies with a market leading position that can grow their dividend year-in and year-out.
For 2014 the average dividend growth across the entire portfolio was 10.37%.** If you are able to achieve this kind of income growth consistently you will double your dividend income in 7 years, triple it in 11, and quadruple your income in 14 years. While there is no guarantee that we can achieve this level of dividend growth going forward, we will continue to do our best every day to build a strong dividend growth stream on your behalf.
When you sit down to make resolutions for 2015, financial or otherwise, make sure you spend more time on developing the systems rather than the goals themselves. Your chances at success will greatly improve.
Happy New Year!
Your Portfolio Management Team
*For more on creating systems and other tips to help achieve your goals head over to James Clear.
**This figure encompasses the annual dividend growth of all positions held in the Dividend Strategy portfolio as of 12/31/13. Not all investors in the Dividend Strategy as of 12/31/13 held all positions as of this date (specifically, newer investors who were not yet fully invested in the strategy and/or investors who have restricted us from investing in particular industries, did not own all positions as of this date) and therefore it is likely they achieved a lower dividend growth rate in 2014.
Year-End Review
We’ve been writing the AMM Dividend letter for over a year. Below we have provided a review on some of the investments that we have highlighted along with updates on our current view.
In chronological order:
SLM Corp (SLM) from Volume 1 October 31, 2013
Dividend Per Share Growth Since Write Up: 0%
We focus on 3 core types of dividend payers when building your portfolio: Dividend Stalwarts, New Dividend payers, and Restructuring/Special Situations. Our SLM Corp investment was a restructuring. The company was going to split into Navient (NAVI) and SLM Corp. (SLM). Navient would manage the cash flow from an existing book of student loans that would amortize over 20 years. The new SLM Corp. would become a small bank specializing in selling private student loans. Our original analysis valued the pre-split SLM Corp at $32 per share and we made our first purchases back in June of 2013. The split then occurred in April of 2014. We sold Both Navient and SLM to fund our recent purchase of BlackRock (BLK).
We sent out a special portfolio update back in October discussing our reason for selling Navient and SLM Corp to buy BlackRock and you can read it again by following the link below.
Portfolio Update ~ Selling Navient (NAVI) and SLM Corp. (SLM)
Wynn Resorts (WYNN) from Volume 2 from November 30, 2013
Dividend Per Share Growth Since Write Up: 25%
Wynn was one of our better performing stocks in 2013 and the early part of 2014. Gambling in Macau continued to rise for both VIPs and the mass market and earnings estimates and target prices rose with it. Then in May of 2014 a Macau Junket operator went missing with about $1.3 billion of its clients’ money. Unlike Las Vegas, the VIP market in Macau operates through junkets, companies that bring the VIPS to the casinos. The junket operators issue the VIPs credit and collect on the player’s debts. In exchange the junket operator gets a commission on the amount gambled at the casino. Wynn did not have direct exposure to this operator but it does deal with other junket operators. The disappearance spooked VIP gamblers and the amount of VIP money being gambled at Macau casinos dropped.
In response President Xi Jinping announced a crackdown on corruption which also targets the junket operators. Cheung Chi Tai one of the largest junket operators had his assets frozen and the FBI is monitoring him for potential connections to the Triad, China’s mafia. VIP gambling dropped even further and Macau is experiencing its first negative year-over-year growth in VIP gaming.
The bright spot according to Goldman Sachs is while 56% of Macau’s gaming revenue comes from the VIP market only 22% of EBITDA (earnings before interest taxes depreciation and amortization) comes from VIPs. The rest comes from mass market gaming. Wynn has positioned itself as the Macau luxury brand which attracts the VIPS but also the higher end of the mass market that wants a taste of luxury. Luxury anything gets to charge higher rates and attracts more money. Wynn consistently has the highest revenue and EBITDA per gaming table.
In 2016 the Wynn Palace will be completed doubling Wynn’s gaming tables and adding another 2,000 rooms to their operations in Macau. We also expect the capital expenditure requirements for Wynn to lower after the completion of the Wynn Palace. More gaming and room revenue coupled with less capex should allow Wynn to continue to increase both its quarterly and year-end special dividend.
Additionally, Wynn’s Las Vegas operations continue to improve as the U.S. economy climbs out of the doldrums. The company recently won the right to build a gambling resort outside of Boston. The Boston casino is estimated to cost $1.6 billion and it will pick-up some of the reduced capex spending in Macau.
There is little doubt that the anti-corruption crackdown in Macau will carry over into 2015 but even with these headwinds Wynn increased its quarterly dividend by 25% and made a special year-end dividend of $1.00 per share.
We may look to add more to Wynn on additional price weakness; however we are watching closely for a turn in the fallout from the anti-corruption crackdown.
Qualcomm (QCOM) from Volume 3 from January 1, 2014
Dividend Per Share Growth Since Write Up: 20%
Qualcomm has taken a hit recently on the news that it is facing an anti-trust probe in China, Europe, and even by the U.S. Federal Trade Commission. The target is Qualcomm’s extremely profitable royalty business. Qualcomm charges cell phone makers royalties on any phones that use Qualcomm’s patents to connect to wireless networks. This is pretty much every cell phone made. The probe in China came from the communist party’s regulatory mouthpiece indicating that party connected Chinese cell phone makers do not want to pay Qualcomm for using their patented technology. In fact Qualcomm recently has been having a hard time collecting royalty revenue from said cell phone makers as they use their political connections to reduce their royalty burdens.
It’s the same issue with the U.S. and European probes. Qualcomm put the time, money, and research into building a quality product and without it your cell phone and all the data it consumes wouldn’t be possible. Given how so many of us rely on our cell phones Qualcomm should actually charge more in royalties given the demand for its product.
While we fully expect the Chinese investigation and uncollected royalty payments to be resolved, it remains unclear whether or not Qualcomm will be fined by Chinese regulators and, if so, by how much. The uncertainty of the resolution also revolves around any new royalty fee structures for Chinese cell phone makers. If the Chinese cell phone makers get to pay less in royalties will non-Chinese cell phone makers agitate for lower royalty payments too? Short-term market participants don’t like uncertainty and Qualcomm’s share price has taken a hit.
If a new lower royalty rate happens we will reevaluate our fair value of Qualcomm. Even so, the secular global growth of cell phones, smart phones, 3G, and 4G networks puts Qualcomm in an enviable spot. The royalties should still provide tremendous free cash for Qualcomm to return capital to its shareholders via dividend growth and share buybacks.
We recently did another purchasing round of Qualcomm to add it to new accounts and any account that was underweight the position. If prices remain around here or drop further we will likely do another round of buying.
Apple (AAPL) from Volume 4 from February 1, 2014
Dividend Per Share Growth Since Write Up: 7.8%
When we originally discussed our position in Apple the stock was trading around $500 per share. Since then the company split the stock 7-for-1 and increased its capital return program to a total of $130 billion. Part of this increase will be another $30 billion increase to share repurchases along with the 7.8% increase to its dividend. Even more critical to us as dividend growth investors is Apple’s stated intention to increase their dividend every year.
Additionally, the Board has approved an increase to the Company’s quarterly dividend of approximately 8 percent and has declared a dividend of $3.29 per common share, payable on May 15, 2014 to shareholders of record as of the close of business on May 12, 2014. The Company also plans to increase its dividend on an annual basis. With annual payments of $11 billion, Apple is among the largest dividend payers in the world.
-From Apple’s April 23, 2014 press release
Since our write-up Apple released its iPhone 6 and its new larger screen version, the iPhone 6 Plus, to tremendous demand. In its first weekend of sales, Apple sold a record breaking 10 million units and demand is still outpacing supply. Even better is the higher average selling price (ASP) for the new iPhones which should push Apple’s margins back up and generate more free cash flow for the company.
We mentioned Apple leveraging their reach and iTunes accounts to move into mobile payments. Along with the launch of its new phones Apple also announced Apple Pay, its foray into mobile wallets and payments. Mobile wallets are nothing new but Apple has the reach and cache to push greater adoption of the technology. Look at all the new bank commercials highlighting their compatibility with Apple Pay. Adoption rates so far have exceeded expectations and this is a very good thing for Apple. For every transaction through Apple Pay, Apple receives a small cut of the interchange fees charged by banks. The costs for Apple to run Apple Pay are so small that most revenue generated by Apple Pay turns into cash flow. As adoption rates for Apple Pay continue to grow so will Apple’s cash.
All this good news pushed Apple’s share price and investor sentiment to all-time highs.
We are not making any new purchases right now. If we see a large correction in Apple’ stock then we will consider adding to our position.
AbbVie (ABBV) from Volume 5 from March 1, 2014
Dividend per Share Growth Since Write Up: 5%
Humira continues to be the cash cow for AbbVie but the main concern is the drug goes off patent starting in 2017. Any patent loss is a concern but as we discussed in our initial write-up, Humira is a biologic not a chemically synthesized drug. A biologic is a very large drug that is made through the help of microorganisms by splicing DNA into them. It is a much harder process to replicate and it is a very expensive process. This will dissuade some generic drug makers from trying to make Biosimilars (generic copies) of Humira. Those generic drug makers that do succeed still won’t be able to charge too much of a discount to Humira because of the development costs.
AbbVie still needs to diversify its approved drugs and its pipeline for future growth. To achieve this and reduce its overall tax structure, AbbVie tried to buy Ireland based Shire plc (SHPG) in a tax inversion deal. Congress then decided to make it harder for US companies to move their headquarters overseas after buying a foreign company. The proposed rule changes by congress made the deal for Shire plc unworkable and AbbVie dropped their buyout offer after having to pay a large break-up fee of $1.6 billion.
AbbVie’s Hepatitis C drug was approved by the FDA last week and will be sold at price point below Gilead’s leading Hepatitis C treatment. Express Scripts, the largest U.S. pharmacy benefit management company, then dropped Gilead’s Hepatitis C drug Sovaldi in favor for AbbVie’s Viekira Pak. This should help AbbVie take market share and meet sales estimates but the underlying concern is a price war between Hepatitis C drugs.
We are not making any new purchases right now as the stock is trading slightly above our estimate of fair value. If we get a large correction in the stock then we will look to buy some more shares.
Lorillard (LO) from Volume 6 from March 29, 2014
Dividend Per Share Growth Since Write Up: 0%
One of the catalysts for capital appreciation that we discussed was a potential merger between Lorillard and Reynolds American (RAI). At the time when we wrote about Lorillard the merger rumor was just that, a rumor. Sources then confirmed the two companies were working on a deal. All that was left was making it official. Expectations had Reynolds American offering over $70 per share for Lorillard. The official offer came in at $66 per share in a mix of cash and stock. The market was underwhelmed to say the least. Lorillard sold off back to about $60 per share and languished there for the last many months. Recently Lorillard has been creeping back up in price and it has still been paying a dividend. However, management has held off on increasing the dividend while they work through the merger with Reynolds American.
We’re not making any new purchases but we are holding through the merger. The merger is not a done deal and there are risks that the deal falls apart. For one, there are still a lot of regulatory hurdles to get through. A combined Lorillard and Reynolds American creates a huge tobacco company and reduces competition. U.S. regulators don’t like this. The usual concern is less competition leads to increased prices hurting the consumer. However, lawmakers don’t want people to smoke and they have been raising taxes on tobacco to artificially raise prices on cigarettes to get people to stop smoking. Wouldn’t they want tobacco companies to raise cigarette prices?
Anheuser-Busch InBev (BUD) from Volume 7 from May 3, 2014
Dividend Per Share Growth Since Write Up: 7.4%
One of the issues facing Anheuser-Busch InBev is declining U.S. sales in its flagship brands, Budweiser and Bud Light, in part because of the explosive growth in craft beers. To counteract declining sales and to gain more exposure to craft brewing Anheuser-Busch InBev has been buying established craft brewers. These are usually older craft brewery brands that are looking for the capital to better compete with the newer craft brewers. Anheuser-Busch InBev has the capital and the distribution system to achieve both goals. Anheuser-Busch InBev had already acquired Goose Island (the maker of one of Glenn’s favorite beers, Matilda) and Blue point Brewery when we wrote volume 7 of the AMM Dividend Letter. Then last month Anheuser-Busch InBev bought another craft brewer, Oregon’s 10 Barrel Brewing.
The second step in combating declining U.S. sales of its flagship brands is to refocus its advertising, especially for Budweiser. Some 21-27 year olds, a prime beer drinking demographic, have never had a Budweiser. The company that has produced some of the more memorable advertising campaigns is shifting their focus back to this important drinking demographic. If Pabst Blue Ribbon, the original nemesis to Anheuser-Busch, can gain traction in the 21-27 year old crowd with minimal advertising Budweiser can regain some luster with a national campaign.
Anheuser-Busch InBev is so large that there are few markets where it doesn’t have a strong presence except in the faster growing African markets. SABMiller dominates these markets right now. This is one of the reasons why the Anheuser-Busch InBev buying SABMiller rumor has persisted for so long. The rumors became a little louder this summer when SABMiller’s offer to buy Heineken was rejected. It was seen as a move by SABMiller to make it too large for Anheuser-Busch InBev to buy. It was the same tactic used by August Busch IV when Interbrew wanted to buy the original Anheuser-Busch. We would like Anheuser-Busch InBev to buy SABMiller. A merger would be fertile ground for the Brazilian management team of Anheuser-Busch InBev to cut costs, improve efficiency, and produce strong rewards for its shareholders.
We are still buying Anheuser-Busch InBev on short-term price pullbacks around $100-$105 per share.
McDonald’s (MCD) from Volume 8 from May 31, 2014
Dividend per Share Growth Since Write Up: 4.9%
McDonald’s has been besieged with problems lately. There was the Chinese meat supplier found repackaging old meat. Then Russia shutting down restaurants and “inspecting” many more in retaliation to western sanctions over Ukraine. Then there is the ongoing declining Same-Store-Sales exacerbated by the above events.
Despite all that McDonald’s still has a 49.7% share of the U.S. fast food hamburger market. McDonald’s is still the most profitable quick serve restaurant company in the world. Then there is all that real estate McDonald’s owns.
The main issue with McDonald’s right now, the one we discussed in our original letter, is their menu problem. The menu has become so bloated it now requires so many more moving parts to complete an order that the famous quick and efficient McDonald’s kitchen is now inefficient. As we pointed out in the letter, McDonald’s added over 9 items to its menu in 2013. McDonald’s now has 14 breakfast sandwich options and 16 burger options. One of the worst additions was the McWrap. Not only has it not sold well but when a McWrap is ordered it slows the whole kitchen down earning it the nickname “showstopper”. 5 items still drive 40% of McDonald’s sales and none of the major sellers are new items.
Now the CEO Don Thompson wants to add a design-your-own burger option that patrons can order via a touch screen. The idea is to compete more with restaurants like Chipotle (which McDonald’s used to own). This sounds good if most of your ordering was foot traffic like Chipotle but 70% of McDonald’s sales come from the drive-thru. Ordering via touch screen becomes problematic in the drive-thru and wait times go up. When drive-thru wait times go up the loyal customers who are used to and expecting quick service are driven away.
CEO Don Thompson is a great rags-to-riches story but it is clear he is not the right man to lead McDonald’s right now. The combination of an out of touch CEO, a highly profitable business, obvious shorter-term fixes, and hidden real estate value makes McDonald’s attractive for an activist investor. A company as large as McDonald’s used to be a deterrent for shareholder activism, the activist couldn’t build a meaningful stake to affect change, but now it’s not. In recent years several successful activist campaigns have been launched against very large companies like McDonald’s.
We said we would be buyers of McDonald’s if it fell below $100 per share and we did. Don’t be surprised if we make another round of purchases again soon.
Exelis (XLS) & Vectrus (VEC) from Volume 9 from June 28, 2014
Dividend Per Share Growth Since Write Up: 7.1%
Exelis spun off Vectrus, its mission systems business, as planned back in September. The new Exelis retained the higher margin and faster growing business divisions. The new Exelis also maintained its commitment to paying a dividend and even increased its quarterly payout post spin-off.
As for Vectrus, we usually like to hold onto the equity of spin-offs for at least a year to see if the new companies will become the dividend growers that we are looking. Spin-offs also tend to outperform the broad market for a few years after the spin-off event with most of the gains coming in the first year. So far with Vectrus this pattern has played out rising 40% in the first few months of its existence.
We are not making any new purchases in Exelis as we reevaluate its dividend growth potential post spin-off.
Gaming & Leisure Properties (GLPI) from Volume 10 from August 2, 2014
Dividend Per Share Growth Since Write Up: 0%
Two of the items we listed under the pre-mortem for Gaming and Leisure Properties were they are no longer the only gaming REIT (Real Estate Investment Trust) and a deal to buy Isle of Capri Casinos (ISLE) doesn’t materialize.
GLPI is still the only gaming focused REIT but it looks like it won’t be for long. Orange Capital successfully pushed through their plan to have Pinnacle Entertainment (PNK) spin-off their real estate assets into a REIT. Also, Caesar’s Entertainment (CZR) in an effort to restructure its heavy debt load and avoid a restructuring in bankruptcy announced that it wants to spin-off its real estate holdings as a REIT. More Gaming REITS equals more competition for deals. GLPI wants to pay around 9-13x EBITDA for any new assets. Deals at those multiples add value to GLPI. Deals at higher multiples destroy value. More REITS competing for deals can push the prices and multiples up to levels that are bad for GLPI and it would lead to GLPI paying too much or missing out on acquiring more properties.
The good news is before GLPI became a REIT its former parent Penn National Gaming (PENN) got IRS approval for the REIT and locked up a lease agreement between GLPI and PENN. Pinnacle Entertainment has not received IRS approval yet. The Caesar’s Entertainment REIT proposal is just that right now, a proposal. Caesar’s Debt holders have to agree to the restructuring and then Caesar’s Entertainment needs to get IRS approval too.
Isle of Capri deal chatter has slowed down from the summer. Deals usually don’t just happen because people start talking about them. They take time. Just look how long it took Reynold’s American to make a deal for Lorillard after rumors started floating; and those rumors were more substantiated.
Still we are monitoring GLPI for further erosion in our investment thesis. If we see more erosion we will likely sell our position in GLPI and look for better opportunities.
Visa (V) from Volume 11 from August 30, 2014
Dividend Per Share Growth Since Write Up: 20%
The catalysts we outlined a few months ago remain the same and nothing new has developed since then.
We will make further purchases on any short-term price weakness.
MasterCard (MA) from Volume 12 from October 4, 2014
Dividend Per Share Growth Since Write Up: 45%
The catalysts we outlined a few months ago remain the same and nothing new has developed except one item. MasterCard is initiating a new $3.75 Billion share repurchase program and they will increase the quarterly dividend by 45%.
We will make further purchases on any short-term price weakness.
Novartis (NVS) from Volume 13 from November 8, 2014
Dividend Per Share Growth Since Write Up: 0%
The catalysts we outlined a few months ago remain the same and nothing new has developed since then. The Wall Street Journal recently put out another article on using our own immune systems to help fight off cancer. Novartis’ Car T-Cell therapy was mentioned among others. You can read the article by following the link below.
Cancer’s Super-Survivors: How the Promise of Immunotherapy is Transforming Oncology
We will make further purchases on any short-term price weakness.
BlackRock (BLK) from Volume 14 from December 6, 2014
Dividend Per Share Growth Since Write Up: 0%
We will make further purchases on any short-term price weakness.
All previous AMM Dividend letters are archived here.
