The purpose of this article is to again look at what sort of companies may be appealing for purchase during September 2020. While we’ve seen some recovery, the situation remains only somewhat changed from last month. There are still appealing companies available if the investor knows where to look.
As always, it’s about the responsible allocation of investment capital, as best as I can see it in the market’s current position today. As with other articles in a similar spirit, we’ll focus on 1-3 companies per relevant sector. Some sectors may have more than one appealing company, and I try to offer alternatives wherever possible. However, some sectors either don’t have alternatives or don’t have higher-yielding equities. Here, investors have to make do with one suggestion from my side.
This article is of particular interest to those among you who feel they need to increase their exposure to any of the sectors of (Basic) Materials, Utilities, Communications, Consumer Staples & Consumer Discretionaries.
As before, the list will be made using my own QO-system of rating stock. It divides stocks into four classes based upon universal metrics that attempt to measure the company’s appeal for a dividend investor and ends in a score of 0.0-4.3, with both current valuation (opportunity) and fundamentals (quality) playing major roles. It arrives at these scores using 14 trackable data points, including things such as dividend safety, EPS yield, payout, earnings multiples, credit rating, dividend yield, dividend tradition, moat, and management. I’m constantly updating and developing the tool to be of more use and more precise, and I feel I’ve reached a point where I can comfortably base my investment decisions upon scores reached using the calculations. It of course comes with disclaimers I note when I make scoring and stances – everyone needs to make their own choices, after all.
Let’s see what we end up with.
1. Basic Materials
Of the dozens of Basic Materials companies I follow and try to update on, no class 1 company is what I would consider undervalued in September. Eastman Chemical Company (EMN), my previous choice, is now overvalued at about 0.5-1% above my target price and offers only a modest return on investments with a now-existing realistic potential downside or flat growth as well.
We delve deeper into Class 2 and find Celanese (CE) still undervalued around 5%, and with potential upside to my target value. In terms of potential returns, Celanese could yield up to 22.78% annually if returning to fair value, or closer to 9-10% if we use historical discounted valuations (see below) which should be considered more realistic. The yield is unfortunately rather modest, and the upside here isn’t as convincing as some we see in other sectors – but if you’re looking for a basic materials company, I do believe Celanese offers a risk-adjusted upside at good conservative prospects. Still, I usually couple a low yield with a demand for a very high dividend growth – CE currently doesn’t really offer this, so any prospective investment should be considered with care.
(Source: F.A.S.T. Graphs)
A word on quality. Despite what it says on F.A.S.T. graphs, Celanese is BBB-rated and the dividend is considered “Safe” at a sub-30% LTM payout ratio and a 31% five-year average dividend growth. Out of all class 2 stocks in the sector, the company’s three-year forward PEG ratio is the best at 1.27 given current forecasts. This is not even considering the company has a “Narrow” moat, and a management competency declared to be “Exemplary” by Morningstar.
All of these factors, and the fact that Celanese scores a ridiculously high chowder number due to its DGR, combined with a 14-year dividend streak means that Celanese scores a 3.2/4.3 and is my Basic Materials choice for September 2020 – much like the company was during August of 2020. The same trend we saw during August can be seen now, however – with upsides and potential returns growing smaller and smaller by the week, complicating matters.
An alternative for those wanting higher yield, I give you my secondary choice for this month as well – LyondellBasell (LYB). LYB lacks some of the conservative appeal found in Celanese, but it’s a qualitative class 3 stock (somewhat lower quality in terms of dividend safety, credit, and historical metrics) at 16% (20% last month) undervaluation yielding nearly 5.9% at the current price. It’s BBB+ rated and still offers an appealing potential upside in the industry of polyolefins, oxyfuels, and other things in the same segment.
(Source: F.A.S.T. Graphs)
Even if we allow the market’s view of fair value of 10X earnings, this multiple results in a nearly 14% potential annual upside – down 4% from last month due to recovery – if the somewhat volatile earnings trends come to pass. Mind you, this is what I view as a materially higher risk stock than Celanese, but LYB is still an excellent company trading very low. With a P/O ratio of under 45% LTM, we hardly need to expect a dividend cut in the nearest future. You can delve deeper into the company reading some of my articles specific on LYB.
Other fundamentals are equally interesting, with a Chowder number of around 15.4 and even a conservative “Narrow” moat, considered by Morningstar to make the company even more appealing as an investment. I own a bit of LYB and I wouldn’t mind buying more, even at this valuation.
Lyondell-Basell is my higher-yield choice, and I believe it to be a good one – even quite conservative, compared to some of the riskier prospects found “lower” in the totem pole.
2. Communications
Communications still remain somewhat unchanged in matters of company appeal. Unlike last month, Omnicom Group’s (OMC) undervaluation is now less than 50% – 48% at this time, but it nonetheless represents an appealing stock.
(Source: F.A.S.T. Graphs)
With a nearly 5% yield, BBB+ credit, a Very Safe dividend, chowder number of 15+, a 30-year dividend streak, moat, and an excellent forward three-year average PEG ratio of 1.84X, it’s little wonder the company scores the combined QO-score of 3.6/4.3, the highest in the entire sector out of all companies I follow. While some may be discouraged by advertising as a whole given the situation we’re in, I still believe Omnicom is capable to excel over time, and I highly encourage potential investors to look at the company at this time.
Comcast (CMCSA) is now nearly fully valued. If you didn’t buy the company before now, I’m afraid I have to say I view the upside somewhat more limited now – and it’s debatable if you should consider the company a choice at this time. Instead, I would point you to Class 2 stock, AT&T (T). 
(Source: F.A.S.T Graphs)
Unlike other stocks, AT&T hasn’t recovered from pandemic lows in any meaningful way. This is despite debt repayment and earnings beats, and maintaining one of the core important parts of the infrastructure to most people today. Even trading sideways, this BBB-rated company would return 12% per year until 2023 based on current forecasts. Fundamentals are in fact another strong point for AT&T now. Previous fears of dividend cuts and not being able to handle its debt should now have been put to rest.
AT&T yields nearly 7% at a sub-60% payout ratio – better than most Swedish telecommunications companies while being more than 10 times as large in terms of market cap. The company holds an appealing mix of infrastructure as well as content segments in its portfolio and seeks to continue to use these to its advantage. A 9X earnings multiple while corresponding companies across the world are trading at nearly 1.5X or 2X such a multiple is what I consider to be rather ridiculous. That’s why AT&T maintains a 2% weight in my portfolio at a cost basis close to $30.90/share. While the company’s “poor” management (according to Morningstar) could scare some investors off, we need to consider the value of what AT&T owns – and this value is undeniable both in the mid- and longer term.
At these valuations, if you don’t want OMC, you should look at AT&T.
Because we have companies like Omnicom and AT&T, I see no reason whatsoever to go for anything else in this sector. Omnicom is my first choice, and AT&T my second. Communications is a sector where what I consider “safe high yield” is still very much alive and well.
3. Consumer Discretionary
Discretionaries remains one of the most unappealing sectors amidst either cut dividends, cloudy forecasts, and dubious quality metrics, or extreme overvaluation for the company’s which trade in the face of such things.
One of the very few light points in terms of quality in the sector is Whirlpool (WHR), but I wouldn’t buy the company at this valuation. Whirlpool has had its run, and my own position is up more than 100% including dividends. At this point, we should be looking at other qualitative stocks, but there are very few with the appeal. Leggett & Platt (LEG) currently defies gravity and has risen to nearly 20X earnings despite a forecasted terrible FY20. Estimating return to fair-value levels here means returns of less than 5% per year – that’s a hard “No.” Both of these cyclical, which I own, currently offer less than 9% conservative potential annual upside over the next few years – and that’s where my target is. I want a realistic 9-12% or more when I put money to work.
If pressed, we must start looking at companies like Kering (OTCPK:PPRUF). Kering is a French company specializing in luxury goods. It owns, among other things, brands like Gucci and Yves Saint Laurent. I view this as a timeless potential investment in consumer discretionary goods, but one must do extensive due diligence to buy the company – not to mention NA investors are looking at French dividend withholdings and thinly traded ADRs. I can see the issue for many here, and to be honest, I’d invest in US/NA companies over Kering at this time – even in September of 2020. So while I mention Kering, I do it to point to the diversity of international stocks on sale in all segments – not because I personally am looking to buy at this time (though I do own stocks in the company).
Sometimes a sector simply needs to be declared “uninteresting” for a time, either in relation to other sectors, or because of macro trends resulting in poor visibility. I see Consumer Cyclicals to be in that space for the time being.
Therefore, my stance is to choose different investments over Consumer Discretionary stocks. I won’t guide for any suggestion to look at here, much like I avoid the Energy sector.
4. Consumer Staples
Unfortunately, things have changed in Consumer staples as well.
We find class 1 Archer-Daniels-Midland (ADM) no longer trading at the previous undervaluation of 6%, but barely an undervaluation of 0.2%. The company does offer some upside, but we need to consider this with far more care now. Take a look.
(Source: F.A.S.T. Graphs)
So here’s the thing. ADM still represents a decent buy, as I see it. Now, however, trading at above a weighted average earnings multiple of more than 15, that upside is almost entirely based upon earnings growth, and no longer a return to fair value, as we had weeks and months ago. An 11.4% annual rate of return is excellent, but this is now based solely upon these expectations. It’s likely that these will come to pass – more or less – but the fact is, we can remember clearly when potential returns for the company exceeded over 20% under the same premise – but with more undervaluation.
Company safeties are convincing with an A-grade credit rating, nearly 3.3% yield considered very safe, and expect a massive profit boost over the coming years, resulting in a three-year forward average PEG-ratio of 0.89X. Even trading flat or negatively over the next few years, your returns will exceed 8-10% unless the company truly collapses.
If you want consumer staples, I’d definitely tell you to at least take a look at ADM, but being aware that the same things which have happened to other stocks have happened to ADM as well. The upside is just not as big anymore, and things are looking dimmer.
ADM is far from the only appealing investment, it’s just the one I consider most qualitative.
Philip Morris International (PM) offers a 10% undervaluation and at a 5.9% yield may be more appealing to some. Potential returns are enticing here, 13% annual simply at fair value until 2023, and analyst accuracy has historically been excellent here.
(Source: F.A.S.T graphs)
Altria (MO) is only slightly lower-graded due to its borderline-considered dividend safety, but offers almost 8% at current valuation and technically scores even higher than PM because of this, with a higher emphasis on opportunity than quality.
Both are excellent choices, but my own MO position is at the desired size, and therefore I’d choose PM for me. Still, MO offers a 30%+ undervaluation to what I would consider fair value, though we may be years from such a share price. If I were to invest more in MO, I’d be happy with a 10-15% annual rate of return due to the high yield and maintaining a sort of “fair” average weighted P/E valuation. The company is also BBB rated, whereas PM sports an “A.” Tobacco shares have been troughing, but seem to be on the rebound, so this is a choice for the more yield-conscious investor.
Given a choice between tobacco and grain, however, I choose grain and will continue to put capital into ADM. It’s important to note, however, that at this time, no Consumer Staples stock I follow aside from ADM and tobacco, is appealingly valued. This goes to show what sort of overall overvaluation we’re looking at at this time.
5. Utilities
For the first time in this series, as of September 2020, I’m also including a utility stock in this list. I recently published an article on Pinnacle West Capital Corporation (PNW) – so for more of a deep dive into the company’s operations, I suggest you look into that article. For now, here are what I consider to be the state of things.
Pinnacle West is something very rare, because it’s an A-rated undervalued utility company with excellent fundamentals. It yields over 4%, has less than a 70% EPS payout ratio, and manages a large part of the electricity of the state of Arizona. While the dividend growth rate isn’t stellar at 5% 5-year DGR average, it’s better than many of its peers – but most importantly of all, it trades well below its historical premium. For a utility company of this caliber, this is worth noting – and, as I see it, investing in.
(Source: F.A.S.T Graphs)
You might think that 9.67% annually isn’t that good – but remember, that’s based on a 15X fair value, where the company usually trades at a premium, which brings this up to over 12-13% annually. Additionally, investing in utilities isn’t about quickly becoming a millionaire based on a $10,000 investment.
As I’ve said before, none of my investments are about that. It’s about responsible capital allocation to companies that have a high likelihood of growing that capital (or at the very least, not allowing it to shrink/drop) and paying you part of that growth through dividends.
A utility company is, as I see it, an excellent way of doing just that – and that’s why I view PNW as a good choice here at a mere 2-3% undervaluation. I also view the company’s 4%+ yield as quite high overall for the sector, given the conservative nature of what you’re getting.
Wrapping Up
This wraps the relevant sectors and what companies I view as interesting for September 2020. Remember, the point of these monthly updates is not to do a deep-dive or even an overview of how a company has been going – but rather their valuation with respect to the bigger picture, and what, on a valuation basis, provides appealing upside at a certain point in time.
This month, the following companies can be said to be appealingly valued.
Quickly summarizing qualitative stocks, we’re looking at:
- Basic Materials: Celanese
- Communications: Omnicom Group
- Consumer Discretionary: N/A
- Consumer Staples: Archer-Daniels-Midland
- Utilities: Pinnacle West Capital Corporation
Alternatively, you could consider
- Basic Materials: N/A
- Communications: AT&T
- Consumer Discretionary: N/A
- Consumer Staples: Philip Morris International, Altria
- Utilities: N/A
For the highest possible yield, while still being safe, I personally would look at:
- Basic Materials: LyondellBasell
- Communications: AT&T
- Consumer Discretionary: N/A
- Consumer Staples: Altria
- Utilities: Pinnacle West Capital Corporation
I try to pick, for myself and for you, the very best companies in each sector I follow to construct a risk-adjusted and profitable, long-term portfolio. The aim of my portfolio is not to turn $100,000 into $1,000,000 in the shortest time possible – this is very important to point out. View my ambitions as more of the construction of a respectable “savings” account with an ever-growing amount of appealing interest at a very safe/conservative level of risk, while also providing at the very least an inflation-level of capital appreciation for my investments over a long time.
Keep in mind while reading my articles that my targeted investment time period is a minimum of 10 years while preferring 25+. If I don’t want to own a stock for 10 years, I won’t own it for a week either. While I do try to rebalance overvalued stocks and reinvest profits in other companies, I don’t do this lightly. As of right now, I’ve only done this once during all of 2020.
If you feel that I’ve missed some consumer discretionary stock that you view as appealing enough to warrant a second look, let me know in the comments or in a private message and I’ll take a look at it.
Thank you for reading.
Disclosure: I am/we are long ADM, CE, CMCSA, EMN, LEG, LYB, MO, PM, PNW, PPRUF, T, WHR, OMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
