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Dividend Investors Look for Light in a Dim Year

Finding undervalued stocks among challenged dividend-payers.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Disclosure: Michael Hodel owns shares of Wells Fargo.

Michael Hodel: While the broader stock market has largely recovered from the pandemic-fueled sell-off in March--the Morningstar U.S. Market Index is now down less than 3% year to date--2020 has been a difficult year for dividend investors.

Dozens of firms have suspended, eliminated, or sharply cut dividend payouts, especially in the hardest-hit sectors, like retail, travel, energy, and real estate. Even utilities haven’t been spared. Dominion Energy (D), which has long been a favorite of Morningstar's, cut its dividend by a third earlier this week as it abandoned a pipeline project and decided to sell off assets to Berkshire Hathaway (BRK.A).

The 12 stocks we’ve highlighted in this video series haven’t been immune either. British ad agency holding company WPP (WPP) suspended share repurchases and its final dividend payout for 2020 to provide financial flexibility as clients pare back their marketing budgets. While the dividend suspension is disappointing, we expect WPP will be able to reinstate the payout as business returns to normal. In fact, we suspect the client firms will turn to ad agencies increasingly over the next several quarters to maintain brand awareness and reshape brand positioning as consumer spending patterns change.

We believe WPP is the most undervalued of the agency holding companies that we cover, but we also believe U.S.-based firms Omnicom (OMC) and Interpublic (IPG) are attractive as well, each trading in 4-star territory. Both firms have thus far maintained their quarterly dividend payouts, and we believe both are solid alternatives to WPP for those who need current income. Assuming the economy doesn’t take another major hit, we expect both will be able to maintain their payouts. Of the two, we think Omnicom has a bit stronger balance sheet and would be able to withstand more pain before cutting its payout. The stock currently yields nearly 5%.

Also in the U.K., telecom firm BT Group (BT.A) announced in May that it will suspend its dividend payout until 2022, and then pay its dividend at half the rate it has historically. In this case, the firm plans to direct all of its available resources to upgrading its networks, bringing fiber optics closer to more of its customer locations. We believe BT is making the right strategic decision for its long-term competitive position and financial health, and that the stock remains deeply undervalued. For income-seeking investors, though, the decision is clearly disappointing.

As with WPP, we wouldn’t advise selling BT shares at current prices, but for those who need current income, we’d look to another telecom firm we’ve highlighted several times over the past couple of years: AT&T (T). AT&T shares have languished around $30 per share  for some time, providing a yield of nearly 7%. While the firm isn’t immune to the pandemic, we believe it will be able to weather the current environment well, generating enough cash to fund its dividend and continue reducing leverage. We also expect management under new CEO John Stankey will be more focused on driving returns on existing assets rather than continued empire-building.

Lastly among challenged dividend-payers, we’ve highlighted Wells Fargo (WFC) as a top pick among banks for income-seekers. Regulators closely monitor bank shareholder returns, and the Federal Reserve recently released the results of its annual stress tests, indicating that most banks, including Wells, remain in reasonably solid financial shape. However, the Fed has banned share repurchases across all banks and placed limits on dividends to ensure the banking system remains healthy through the pandemic. We estimate Wells may need to cut its dividend by 25% in the third quarter and up to 40% in the fourth quarter to meet the Fed’s restrictions.

Even with a 40% reduction, Wells' shares would still yield more than 5% at current prices. The regulatory situation remains fluid--the banks have to resubmit capital plans to the Fed later this year--but we expect earnings at Wells will allow for a return to the current dividend rate in 2021. Wells' shares still look deeply undervalued to us, but several banks also look attractive. For example, wide-moat-rated JP Morgan (JPM) trades in 4-star territory and currently offers a dividend yield of nearly 4%.