Yesterday we started selling Hilton Worldwide Holdings (HLT) in all client portfolios that held shares.
We first bought Hilton in February 2017 after it completed its three-way spin-off transaction. Hilton separated its timeshare business, real estate holdings, and hotel management and licensing business into three new companies.
We bought the hotel management and licensing business because we believed its asset light business model would lead to higher returns on invested capital (ROIC). Plus, Hilton was/is increasing its worldwide hotel market share through new construction. Both would lead to increased capital returns to shareholders through share buybacks and dividends.
Please read AMM Dividend Letter # 33 for our full investment thesis.
We’re happy to say our investment thesis played out. ROIC has grown from around 3% at the time of the spin-off to over 16% and we think it will continue to improve. Shares Outstanding have declined over 8% since buying Hilton. Construction on Hilton hotels continue and travel, both business and pleasure, remains robust.
So if everything is going well at Hilton why are we selling its shares?
In short, zero dividend growth.
Following the spin-off Hilton initiated a quarterly dividend at $0.15 per share and they have not increased it since. With the excess cash that Hilton has been producing they could have increased their dividend but Management stated they are focused on using excess capital to buy back shares.
“I mean, we – as you probably gathered from our commentary, we’re a lot more focused on returning capital in the form of buybacks. We obviously want to have a dividend, we want yield investors to be able to invest in the stock. But in terms of driving great, sort of market leading total returns to shareholders over a long period of time, we think being relatively modest on the dividend side and much more robust as robust as we can on the buyback side is going to lead to the best long-term returns.” – From Q1 2017 Earnings Call
While share buy-backs tend to create value for shareholders – when done at the right price – a core tenant of our dividend strategy is to invest in companies with solid dividend growth prospects.
To be fair, it has only been a year and in the same earnings call the CEO did say that as free cash flow goes up investors could see “modest increases in the dividend”.
Our dividend growth portfolio invests in both above average yielding dividend stocks and below average yielding dividend stocks. What we expect from our below average yielding dividend stocks is above average dividend growth. Visa and MasterCard both yield under 1% but both are growing their dividends at above-average rates. Visa grew its dividend 27.3% year-over-year and MasterCard grew its dividend 13.6% year-over-year.
Hilton is a below average yielding dividend stock that we thought would produce above-average dividend growth. It has not, and for this reason we have decided to begin selling out of our position. We’ve held Hilton over a year and we’re exiting with a total return of 39.2%*.
We still think Hilton is a great company with a strong business model, but if we’re going to invest in lower yielding companies we need above average dividend growth. We think we’ve found that in our new investment, Charles Schwab (SCHW). We’ll discuss this new investment in detail in an upcoming dividend letter.
For most accounts we sold the entire Hilton position but some accounts still hold Hilton. We did not sell the entire Hilton position in accounts that still have short-term taxable gains. Most remaining short-term gains expire within the next 41 days. We also did not sell Hilton in accounts that already have high cash positions. We still think Hilton trades at a fair price and its modest dividend coupled with appreciation potential is likely a better investment than cash. We did not want to raise more cash to earn less than we would with Hilton’s dividend and appreciation potential. As cash balances come down in these accounts, Hilton will be sold accordingly.
*Total Return figure is based on original purchase date for Hilton in February 2017. We may have purchased shares for some clients at a later date. The total return for those clients will vary from the figure outlined in this letter. Additionally, clients who invested in the Dividend Strategy at a later date may not own any shares of Hilton since we stopped acquiring shares once the price had risen above our fair value estimate.