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Peters: Many Dividend Increases Are 'Remedial Actions'

Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With earnings season wrapping up, I'm here with Josh Peters, he's editor of Morningstar DividendInvestor, to see what earnings brought for dividend investors and what increases we saw.

Josh, thanks for joining me today.

Josh Peters: Good to be here.

Glaser: So, Josh you manage two model portfolios for the DividendInvestor newsletter, and I saw that there were quite a few increases within those holdings. Let's talk about a few of them, the first being UPS. There has been lot of questions about how the logistics firms are going to handle the recovery. What did you see from UPS this quarter?

Peters: Well, we actually got a bigger dividend increase than I expected from UPS. I mean the company has done a pretty good job of raising its dividend over the years. As you might know, the company hasn't been public all that long for a company of its size. It only went public about 10 years ago, but actually it had paid dividends to its private shareholders for many years prior to that.

It has maintained a record of at least not cutting its dividend and raising its dividend in most years. In this case, we got an increase of 10.6% that will kick in here for this year. That's faster than dividend increase we had last year and the year before that, very tough circumstances all around. I was just glad, the company didn't cut its dividend and that they just held it flat.

So, as I see this starting to pick up, I'm actually feeling better and better about UPS' prospects going forward in part because they're now raising the dividend at a rate that I think is better reflective of how fast earnings are going to grow, even though they've just gotten back to that peak level in terms of earnings. Management's looking for a new record level in per share earnings this year, but not by a huge margin relative to where they were at in the last peak.

So, since the dividend is continuing to grow, I'm actually seeing that maybe they are even just a little bit more devoted to returning cash to shareholders through dividends this time around then they were at the last cycle, so, it's a very good sign.

Glaser: What about Genuine Parts?

Peters: Genuine Parts is one of my favorite all-time company's. I mean it is boring as the day is long. Their biggest business is distributing to the Napa chain of auto-parts stores, aftermarket auto-parts, repair auto-parts. They also distribute office supplies, electronic equipment, and factory maintenance parts. I mean these are just about some of the most humdrum businesses imaginable, but they grow a little bit over the course of the cycle. Management maintains a very good level of profitability. They throw off a huge amount of cash.

Even though they got hit much harder in the last recession than in prior recessions and saw earnings come down a little bit, they continue to raise their dividend. This year the dividend went up just under 10%. That was more than double the increases that we had in previous two years, in fact those increases were down in the 2.5% range. So, you got a thing that is capable I think of firing on all cylinders, good for an auto-parts related story. The firm now has 55 straight years of dividend increases.

When I see that kind of track record it tells me that the dividend isn't just an afterthought it is embedded in the way they are actually running the businesses. They know they need to pay and continue to raise the dividend to their shareholders over time. The stock's not especially cheap right now, I wouldn't be looking to buy it up here. But it's the kind of name that I think every dividend investor ought to have on their radar screen if there is a sell-off. If the stock traded down in the mid-$40s, and had a 4% current yield, then I would think that is pretty attractive.

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Glaser: One of the holdings that you do think is undervalued, we've talked about before is Abbott Labs. Can you talk a bit about their dividend increase?

Peters: Yes, they came in just like clockwork. They have been raising the dividend in the last two years by $0.04 a share on a quarterly basis, and they did it again this go-around for a new quarterly dividend rate of $0.48 a share. That actually pushed the stock's yield up into right about the 4% range. And this is really incredible when you step back and consider that this is a high-single-digit type of growth story for earnings and for the dividend, if not better coming, from businesses that don't really have a whole lot of economic sensitivity. There is not a lot of debt; there is not a bad balance sheet to worry about.

It's really just a terrific company that Wall Street has decided to literally punish it for its own success. The fact that one drug Humira has become a very large piece of overall sales and profitability, even though that drug's probably not going to face the competitive threats than let's say Pfizer's Lipitor will over the next couple of years. So, I was delighted to see that increase, but it was actually just a tiny amount less than I expected. I was looking for about 10%, maybe 11% or 12%; it came in at 9% on a percentage basis.

But still here you have a stock that I think is capable of providing a very good total return. There may not be any immediate catalysts, but if you look out a couple of years, I think a shareholder can probably look at a low to maybe even mid-double-digit type of annualized total return from the stock.

Glaser: Looking outside of your portfolios, were there any increases at the beginning of this year that surprised you or that you thought were the start of an interesting trend?

Peters: I'm seeing a little bit of what I'd call remedial actions. These would be some companies that either have paid very, very low dividends or perhaps no dividends at all for many years, and are now coming back to the table and saying "well maybe we need to put a dividend back in place." For example, some health insurance companies have done this, such as United Healthcare last year and Aetna more recently; I also understand WellPoint has put a more meaningful dividend in place.

But what kind of yields are you getting? How much of the stockholders' total return is now going to come through the form of dividends? In these cases it's still pretty low, such as 1% and change which is not better than the 1.7% or 1.8% for the market as a whole. So I'm not seeing any kind of a landslide shift. Church & Dwight is another case. I think its a pretty interesting consumer-products company that doubles their dividend, but the yield again winds up being 1% and change after doubling the dividend because it was sub-1% before. Earnings had grown a lot, and the dividend hadn't kept up, so now, we're playing a little bit of catchup. But you're still not really changing the total-return story in favor of income as opposed to the hope for growth and capital gains.

So what that does in my strategy is it really just keeps me focusing on the Genuine Parts of the world, where I've got 55 years of dividend growth. I've got a well-balanced dividend policy with a good payout ratio, capable of providing yield right now on the 3's percentage range, or 4%, if you can get in the mid 40s and if the stock was worth buying. There you're getting much, much better income, more than double what the market is on average. That means I'm not having to invest with so much growth in capital gains and, for the lack of a better word, hope in mind.

Glaser: Josh, thanks so much for joining me today.

Peters: Good to be here, Jeremy. Thanks.

Glaser: For Morningstar, I am Jeremy Glaser.