Retirees have different investing needs than the rest of us: older Americans keep their money in the stock market to preserve their wealth and to generate income to support their lifestyles once their careers have finished. Given that, value stocks are often the wisest choice for retirees. These stocks, favored by Warren Buffett, tend to trade at cheap valuations compared to their peers and the broader market, and usually pay dividends, providing a cushion against a down market.
An incredible value
Matt DiLallo (Kinder Morgan): Natural gas pipeline giant Kinder Morgan is an ideal investment option for retirees. Thanks to long-term, fee-based contracts, the company earns remarkable steady cash flow. That was evident during the recent oil market downturn. While oil prices lost more than half their value, Kinder Morgan's distributable cash flow only declined 7% from its peak.
Despite the stability of its underlying business, Kinder Morgan's stock still got hammered during the downturn, falling nearly 60% from its peak. However, because of that sell-off, investors can scoop up this top-tier pipeline stock for an incredible value these days. The company currently expects to pull in $2.05 per share in distributable cash flow in 2018. Since shares were recently around $18, the company is selling for just 8.8 times cash flow, which is well below the 14.9 times average of its peer group.
What makes that valuation even more compelling is the fact that Kinder Morgan expects to grow its already above average 2.8% dividend by 60% next year and another 25% in both 2019 and 2020. Further, it can achieve that impressive dividend growth rate -- the best in its peer group -- while still maintaining best-in-class dividend coverage of more than two times. That blend of income and growth is hard to find these days, which is why retirees should seriously consider Kinder Morgan's stock.
Grossly undervalued ethanol assets
Maxx Chatsko (Green Plains): Shares of North America's second-largest ethanol producer lost roughly 40% of their value in 2017. The usual volatility of the ethanol market became turbocharged with the heightened policy uncertainty coming from the nation's capital and an unusually weak second quarter. Both turned out to be short-term concerns, but Mr. Market has been taking his time readjusting market valuations. I think that presents a great opportunity to pick up Green Plains on the cheap.
Consider that shares currently trade at 0.19x sales and 0.76x book value, among the cheapest in the industry. Green Plains also offers an attractive EV/EBITDA ratio of 8.5 (a value under 10 is considered cheap). That's better than peers Archer Daniels Midland (11.9) and Pacific Ethanol (10.3).
Management is aware of Mr. Market's lack of respect. In a November investor presentation, president and CEO Todd Becker explained that at the current share price, Wall Street is only valuing the company's ethanol production assets at $0.16 per gallon. That's a real drag considering Green Plains owns 1.5 billion gallons of annual capacity. If the company's ethanol production assets were instead valued at $1 per gallon -- roughly the market price for ethanol -- then the company would boast a market cap of nearly $2 billion. And even that might be cheap.
Why? Green Plains may be one of the largest ethanol manufacturers in the world, but it generates sizable income from a diverse range of high margin products that don't seem to be properly accounted for. The company is the world's largest producer of food grade vinegar (supplying brands from Windex to Heinz) and America's fourth-largest cattle feedlot owner (supported by a long-term supply agreement with Cargill). The diversification means only about 40% of total EBITDA this year will come from ethanol production. Long story short, this undervalued stock -- which also pays a 2.9% dividend -- could be a steal for any retirement portfolio.
A retailer regrouping for the future
Jeremy Bowman (Target): Retail stocks have gotten crushed this year as brick-and-mortar chains continue to struggle with the transition to e-commerce. As a result, valuations have plunged on many big-box chains, dropping into the single digits for some even though they remain amply profitable. While some sectors, like department stores, are deservedly getting hit harder than others, and some retailers (cough, Sears, cough) are surely headed to the dustbin, there are opportunities to capitalize on the sell-off. Target looks like one such potential winner.
Shares of the big-box chain are down 11% this year, but have moved higher since the company announced an ambitious turnaround plan in February and comparable sales returned to positive growth. Target has raised its base wage to $11/hour, and acquired logistics provider Grand Junction earlier this year and Instacart-rival Shipt last week, which will allow it to provide same-day delivery as early as next year. Those assets will help it make an assault on Amazon and e-commerce in general -- with hundreds of urban stores, Target is in a better position than competitors like Costco and Wal-Mart to cater to city-dwellers, who are the most profitable customers for online retailers.
In fact, in may ways Target's turnaround plan resembles Wal-Mart's from 2015, which was built on investing in stores, higher wages, and acquiring e-commerce assets like Jet.com. That plan has been a huge win for Wal-Mart investors, and that stock is up 42%. Target stock could do the same if management executes effectively, and the stock still presents a solid value at a P/E of 13. With a dividend yield of 4% and its status as a Dividend Aristocrat, the payout alone may be enough to entice value investors.
Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.