Our Best Dividend-Stock Ideas

Hi, I’m Susan Dziubinski with Morningstar.com. This week we're providing investors with strategies for finding income in a still low-yield world. Dividend-paying stocks can fill important roles in an income-seeker's toolkit. The key is identifying those stocks with durable dividends and purchasing them at good prices. We've pulled together a compilation of recent dividend-stock ideas from Morningstar's equity research team. The first idea is Enbridge, a high-quality midstream firm that's trading at a more than 30% discount to Morningstar's estimate of its fair value.

Joe Gemino: Enbridge has one of the most attractive dividends in the Canadian midstream energy sector. The stock is currently yielding almost 5.5%, while the remaining names in the Canadian midstream sector average 5%.

In the midstream sector, dividends are crucial to investors as growth project opportunities can be limited. Over the past 20 years, Enbridge has shown a commitment to return capital to its investors, while growing into North America’s largest energy infrastructure company. For 20 straight years, Enbridge has increased its dividend, with a compound annual growth rate of almost 12% over that time. We think the growth will continue, fueled by the company's extensive CAD 22 billion growth portfolio. Accordingly, with incremental cash flows from its growth projects, we expect Enbridge to grow its dividend at an average of 10% annually over our explicit forecast period. Based on distributable cash flow, Enbridge's payout ratio stands near 65%. After placing its current growth projects into service, we expect it to fall modestly to 60%. As such, we see Enbridge in a strong position to maintain its announced 10% dividend growth.

Looking beyond the dividend, the stock also represents an attractive buying opportunity for investors. Since late November, the stock has rallied over 8%, with shares currently trading near $39 (CAD 50). Despite the recent rally, we still almost 30% upside in the stock, while on average, the Canadian midstream sector looks fairly valued. We think the market doesn't realize the full potential of Enbridge's growth portfolio, which is highlighted by the Line 3 replacement project. Investors appear skeptical that the project will obtain its final approval amid continued protests and opposition. However, we believe that the project will obtain the remaining approval from the state of Minnesota, which we think will serve as a catalyst for the stock. The stock's immense upside combined with the attractive dividend yield, represents an appealing opportunity for investors.

Dzuibinski: Our second idea is a familiar name: Procter & Gamble, the world's largest consumer products manufacturer. The stock has been trading at a near-20% discount to Morningstar's fair value estimate.

Erin Lash: Wide-moat Procter & Gamble pays one of more attractive dividends across the household and personal care landscape with a dividend that yields north of 3% annually, far in excess of the low single digits it's peers boast. From our vantage point, P&G's commitment to returning excess cash to shareholders is evident in the fact that its paid a growing or stable dividend for nearly 130 years. We anticipate that it will continue to prioritize returning excess cash to shareholders. As we forecast, its dividend will grow at a mid- to high-single-digit clip annually over the course of the next 10 years.

Looking back, P&G has focused more recently on further bolstering its competitive position by shedding more than half of its brands as a means by which to focus on its highest return opportunities, while also also extracting excess costs, the combination of which we think stands to bolster profitability and further free up funds for the firm to allocate to bolster shareholder returns. As such, we forecast that P&G will direct around 70% of its annual earnings toward the payment of dividends for the benefit of shareholders going forward.

Despite its leading competitive edge, we believe that Procter & Gamble is not immune to the intense competitive headwinds that are plaguing its peers. More specifically, Procter & Gamble has chalked up stagnant top-line growth over the recent past. As other global branded players, lower price private label fare, as well as small niche operators work to chip away at Procter & Gamble's leading share position. However, we view the firm's efforts to reinvest behind its brands, both in the form of marketing as well as product innovation, as a means by which to offset these headwinds.

From a valuation perspective, we think Procter and Gamble's stock is attractively valued, trading at around a 10% discount to our valuation. When combined with its attractive dividend yield, we think long-term investors would be wise to stock up on this wide-moat name.

Dzuibinski: Duke Energy, one of the largest utilities in the United States, is our third idea. It's trading at a 10%-plus discount to our fair value estimate.

Andrew Bischof: One utility we really like for its healthy and growing dividend is Duke Energy. Duke has a 4.6% dividend yield, and we think it will grow 4% annually over the next five years. Utilities are down nearly 14% over the past three months and have underperformed the S&P by 19%. One of the key reasons for utility underperformance is that the 10-year Treasury, to which dividend yields are compared as an income proxy, have risen to near 3% during this time, the highest it's been since January 2014. Duke is one of our most attractive names, trading at a 14% discount to our fair value estimate, and its 4.6% yield 100 basis points greater than the industry average. So we think you get both a solid dividend yield and potential for capital appreciation.

The source of Duke's dividend are high-quality regulated utilities with a stable cash flow generating profile. The company's narrow-moat subsidiaries operate in constructive, regulatory environments where we have high confidence that regulators will provide for an appropriate return on investments. Duke operates in Florida, which is experiencing above average customer growth as more and more residents move to the sunshine state. Florida also allows a 10.5% return on equity, well above the national average. Duke also has a large presence in North and South Carolina, which has provided for supportive regulatory treatment and attractive growth opportunities.

We expect Duke's dividend to grow 4% annually, slightly below our 5.5% projected earnings growth rate, as Duke sits at the high end of its targeted 65%-70% range. Supporting that dividend growth is $37 billion of growth capital to be spent over the next five years. These high-quality organic growth opportunities include the typical nut and bolt utility investments. Duke will invest in new natural gas generation, gas pipelines, renewable generation, and grid modernization. The company has consistently earned returns on invested capital above its weighted cost of capital, the hallmark of a strong narrow-moat business.

Additionally, you have what I think is one of the best management teams in the industry running Duke. They have successfully integrated acquisitions, moved the business away from commodity-sensitive markets, and secured above average returns from regulators all while managing expenses well.

To sum it all up, Duke provides an investor an attractive 4.6% dividend yield, significantly above its peer group, and potential for dividend growth. Duke is, in our opinion, a premium regulated utility trading at an unjustified discount to its peer, with what I think is one of the best management teams at the helm.

Dzuibinski: Our last idea is Restaurant Brands International, owner of the Burger King, Tim Hortons, and Popeyes Louisiana Kitchen brands. The stock has been trading around 10% below our fair value estimate.

R.J. Hottovy: Restaurant Brands International, the parent company of Burger King, Tim Hortons, and Popeyes Louisiana Kitchen, has quietly become one of the more intriguing dividend stories in the restaurant space today. On its most recent quarterly update, the company effectively doubled its dividend payout ratio, now paying $1.80 annually, representing a 3% dividend yield. This puts the company in the upper echelon of dividend yields in the restaurants space today, even after Restaurant Brands and a number of its competitors have sold off company-owned locations of franchisees, taken on additional debt, and used those proceeds to return cash to shareholders. We expect the payout ratio to remain comfortably above 60% for the foreseeable future and grow at a high-single-digit clip.

Our confidence is backed by the company's unique master franchisee joint venture structure, where it assigns franchising rights in a given region to a well-established, well-capitalized player. With the company making some brand acquisitions the past couple of years, including Tim Hortons and Popeyes, we believe these master franchisee joint venture partners will have a lot of brands at their disposal to grow over the next several years, and in fact, expect the company to grow its top-line at a healthy mid-single-digit clip, thus giving us confidence in the company's ability to pay out a dividend.

Because of the annuity-like structure, restaurant franchisers have typically been a very reliable source of dividend payout and dividend growth over the past. However, we do see two potential risks to our projections on dividend growth for Restaurant Brands International. The first is a threat of a large acquisition. The company has been acquisitive the past couple of years, but there's rumors circulating that the company may be looking for a larger brand, like Domino's Pizza, Yum! Brands, or another large QSR chain. While the company has historically been able to balance acquisitions with dividend payouts, something this large may disrupt the company's potential to make a payout.

The second is the threat of a recession. While we're not anticipating anything like the Great Recession that we saw in 2008 and 2009, restaurants have generally had a pretty strong track record the past decade and could be due for a cyclical downturn. This could potentially impact sales at Restaurant Brands International's locations, which would impede the royalties they receive from franchisees and in turn could disrupt the company's ability to pay out a dividend. However, looking across this space, this is one of the most globally diversified and well-run companies in the restaurant industry. We think that they would have one of the best chances to maintain a dividend payout even under these circumstances.