5 Dividend-Payers with Lower Credit Risks than U.S. Treasuries

Published Mon, 08 Apr 2013 09:00 CET by DividendYields.org

When it comes to credit risk, U.S. Treasuries tend to represent the safest of investment instruments. This means that the cost of insuring U.S. Treasury debt against the possibility of default is lower than the cost of insuring credit obligations of other insurers, including corporate debt, with the cost represented in terms of spreads on credit default swaps (CDS). However, there are corporations with an impeccable record of financial stability, earnings growth through different business cycles, and consistent dividend payments that are considered less risky than U.S. Treasuries in terms of a probability of default or some other adverse credit event. This lower credit risk implies CDS spreads below those of the U.S. Treasuries and thus the lower cost of insuring the high-quality corporate debt.

Income investors who seek safety of their investments against the heightened credit risk are generally attracted by the companies with superb credit quality. These companies tend to have strong balance sheets with robust profitability and ample liquidity that point to these companies’ capacities to meet their financial obligations in a timely manner. As corporate credit safety is a highly sought-after feature in the post financial-crisis investment environment, it justifies the valuation premiums that often accompany the stocks of companies with minimal credit risk.

With this in mind, here is a closer look at five long-standing U.S. corporations that pay dividend yields above those of the 10-Year Treasury bonds and carry CDS spreads below those of the U.S. government debt. These stocks represent different industries and are not necessarily defensive plays. Moreover, their returns are not necessarily less volatile than those of the general market. However, even though they are not substitutes for bonds, they offer an alternative investment opportunity for income investors prudently allocating assets in a low-yield environment.

American Electric Power Dividend Table
American Electric Power (NYSE: AEP) is one of the largest electric utilities in the U.S., serving over 5.3 million customers in 11 states. The company has paid cash dividends every quarter since 1910. In 2012, the company earned $14.9 billion in revenues and $1.5 billion in operating profit. Its assets at the end of last year totaled $54.4 billion. AEP operates in a stable regulatory environment –with the Ohio fleet deregulation behind it– with some 85% of the company’s operations regulated. It is the stability of AEP’s regulated earnings and the company’s strong balance sheet that support stable dividend payouts over such long periods. The company expects its dividend to grow in the future “in line with earnings from regulated operations.” In fact, the company’s Board recently upped its dividend payout ratio target to the range of 60%-to-70% of consolidated earnings. The company sees its EPS growing at a CAGR of between 4% and 6% through 2015, while analysts forecast the company’s EPS CAGR of about 3.9% for the next five years. The utility has achieved a five-year ROE of 10.6%, which is higher than the average for its peers of 7.1%. Earlier this year, AEP made the list of Morgan Stanley’s 17 best high-yield dividend plays (check out the list here, courtesy of Business Insider).

Comcast (Nasdaq: CMCSA) is the U.S. entertainment, communications, and cable products and services company. In 2012, the company reported total revenues of $62.6 billion and operating earnings of $12.2 billion. Comcast’s revenues have grown at a CAGR of 12% since 2010, while its adjusted EPS has expanded at a rate of 22%. The company’s cable business has shown robust performance, with the number of combined video, high-speed Internet, and voice customer subscribers increasing by 1.5 million or 3% year-over-year. The company’s acquisition of the remaining 49% stake in NBC Universal from General Electric (GE) will also boost its top and bottom lines. Comcast hiked its dividend by 20% earlier this year, achieving a five-year average annualized dividend growth rate of 26%. A robust expansion in the company’s free cash flow –at a rate of 12% per year since 2010– has made this possible. Going forward, the company appears to be an attractively-valued growth play, boasting a forward P/E of 17.6x (below its peer average) and long-term EPS CAGR of 17.5%. Aside from dividends, the company is also boosting shareholder value through share repurchases (valued at $2 billion this year alone).

Johnson & Johnson (NYSE: JNJ) is the U.S. pharmaceutical and healthcare giant with total 2012 revenues of $67 billion and net earnings of $10.9 billion. J&J is the world’s largest medical devices and diagnostics company, sixth-largest consumer healthcare company, and eighth-largest pharmaceuticals company. The company has a robust portfolio of new products, solid balance sheet, and growth potential, especially in emerging markets. It has achieved 29 consecutive years of adjusted earnings increases and 50 consecutive years of dividend growth. Through 2016, the company expects to grow its sales at a CAGR of between 3% and 6%. Analysts expect J&J to expand its EPS at a CAGR of 6.6% for the next five years. J&J’s stock is characterized by low volatility of returns and beta of only 0.47, indicating that its returns are only as half volatile as the market’s. This makes it a desirable defensive play. However, all these strong attributes have driven J&J’s share price up more than 30% over the past year, boosting its valuation. Currently, the stock looks fairly priced at 15.4x forward earnings, on par with the pharmaceutical industry’s multiple.

Stanley Black & Decker (NYSE: SWK), a power and hand tools company, is another S&P Dividend Aristocrat, boasting 45 consecutive years of dividend growth. In fact, the company has paid dividends for 136 straight years. Last year, SWK earned $10.2 billion in revenues and xx billion in net income. Between 2003 and 2012, the company realized a 17% revenue CAGR, 18% EPS CAGR, and 92% cumulative growth in its dividend. Its long-term revenue growth target is in the range of 10%-to-12% annually, or 4%-to-6% organically, while its long-term EPS target CAGR is in the mid-teens. While the company has failed to meet these targets last year, it has a good potential to reach the targets in the future. SWK aims to achieve these targets through a combination of organic growth, international expansions via acquisitions, expansion into adjacent markets, intensified innovation and product development, as well as streamlined manufacturing. The rebound in U.S. residential and non-residential construction, strong trends in Do-It-Yourself (DIY) markets, and reacceleration of global economic growth, including growth in emerging markets from which the company derives 52% of its sales, bode well for its future financial performance. The stock is valued at 14.4x forward earnings and boasts a five-year EPS CAGR forecast of 11.1%.

Union Pacific (NYSE: UNP) is a leading U.S. rail transportation company and an operator of one of the largest railroads in North America. Last year, the company realized total revenues of $20.9 billion and net income of $3.9 billion. Driven by strong chemicals, intermodal traffic, and automotive sectors, and despite weak coal transportation volumes, the company achieved a 10% growth in EPS to an all-time quarterly record in the fourth quarter of 2012. Analysts forecast the company’s EPS CAGR at 14.2% for the next five years. The overall railroad sector appears especially appealing for the periods of high oil prices, as it provides a low-cost transportation alternative to oil-intensive transportation modes. Therefore, the sector boasts large potential as global economies accelerate growth, driving oil prices higher in the future. Legendary investor Warren Buffett long before recognized the potential of railroad transportation companies and acquired Burlington Northern Santa Fe LLC in 2009. He remains bullish on the sector for the long haul. As regards UNP specifically, the company has posted a strong financial performance driven by an economic recovery and the shale oil and gas boom. It caters to several industries, including agriculture, automotive, intermodal shipping, energy, chemicals, and industrials. This company has paid dividends for 114 consecutive years.

In summary, all these stocks offer decent income with low level of assumed risk. They boast decades or even more than a century of dividend payments. Therefore, investors seeking sleep-at-night stocks with dividend yields above the 10-Year U.S. Treasury bond should refer to these stocks as part of their research for the long-term safe income plays. Still, all these stocks should be evaluated based on their risk profile, valuation, and total return potential.