2020 has quickly gone from a pretty mundane start to a year that will be heavily featured in world history classes for decades to come. The novel coronavirus that causes the deadly COVID-19 illness has become one of the quickest-spreading and farthest-reaching infectious diseases in modern times. Our ability to move people and goods so quickly has spread it to every country in a matter of months. As a result, nearly every major nation is taking drastic steps to arrest the spread just to buy time, and the global economy is being dragged to a screeching halt.
Consumer discretionary retailers like Macy's (M +0.42%) are temporarily closing stores, while automakers like Ford (F 3.03%) have shut down North American factories. Both companies have suspended their dividends. Dozens more companies could join them in the weeks and months ahead, and a lot of those companies will struggle mightily. More than a few won't survive.
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But there is also a group with incredibly compelling risk-reward profiles. Three in particular are Bank of N.T. Butterfield & Son (NTB 0.37%), CareTrust REIT (CTRE 0.15%), and Phillips 66 (PSX 0.66%). Keep reading to learn why they're more likely than not to be able to maintain their dividend payouts, and why even the risk that they have to cut their dividends shouldn't keep them from being profitable investments over the long term.
A bank that could be ideal for this environment
Butterfield Bank is a small offshore commercial bank, catering to a different clientele than more familiar banking names. It will feel the impact of the Federal Reserve having slashed interest rates, but Butterfield has another trick up its sleeve: fee-based income.
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In late 2019, Butterfield expanded to Europe's Channel Islands, and management has called out those new banking customers as an important source of increased income from banking fees. CFO Michael Schrum went so far as to call it a "positive differentiator" for Butterfield versus U.S. retail banks. The downturn could prove a positive for Butterfield as high-wealth individuals move into the perceived safety of cash. Growing its fee-based earnings could help Butterfield maintain a dividend that's now yielding over 11% at recent prices.
But even if Butterfield does end up cutting the payout, it's still worth owning. This is a high-quality bank in strong financial shape, with experienced management that should prove capable of navigating the downturn.
At recent prices, shares trade for 4.6 times trailing earnings and 84% of book value. Yes, last year's earnings are now irrelevant to what 2020 could look like, but it does give us a clue about Butterfield's earnings potential when things get back to normal. That's a price that could deliver multi-bagger gains in a few years.
Buy a critically important business on a huge dip
One of the first blows in the U.S. from COVID-19 was to a nursing home in Kirkland, Washington, which has killed at least 35 residents of the facility at last count. Families have been devastated, and investors have fled the industry en masse. Many top nursing home stocks had plunged more than 60% within weeks of the news. Even after a recent rebound, the group is still down substantially more than the broader stock market:
This is an excellent example of a panic sell-off. Yes, there's risk, and nobody wants to end up owning a nursing home owner that has a facility devastated by COVID-19, but skilled nursing facilities serve an important role in caring for many older people. That's not going to change as a result of COVID-19, though the top operators will take aggressive actions to keep their residents and staff safer.
And I think the over-emphasis of a near-term risk has created a wonderful opportunity for investors, particularly with CareTrust. CareTrust management has spent the past five years proving themselves, more than doubling the property count and raising the dividend every year since going public. CareTrust has one of the strongest balance sheets in the industry, with a lower debt profile than most peers, a wide margin of safety between cash flows and dividend and debt payments, and strong relationships with top care providers who are the tenants and operators of the properties it owns.
At recent prices -- which could change quickly in this volatile environment -- CareTrust yields well above 6%, and just increased the dividend in late February. It has plenty of cash flows to maintain the payout, and its care provider tenants are some of the best, safest operators in an industry that cares for tens of thousands of older Americans, a population that's set to double over the next decade.
This could be the biggest winner of the oil crash
Like almost every other oil and gas stock, Phillips 66 has lost far more of its value than the broader stock market over the past month. At this writing, shares of the logistics, refining, and petrochemicals company have lost 63% of their value, nearly double the market's losses so far:
And there could be more pain to come. The world's economy is expected to fall into recession (many economists think it's already happened), sending oil demand cratering as every type of travel slows.
Phillips 66 is sure to feel the impacts of reduced demand, but it could prove the biggest winner of the oil market crash. That's because while many U.S. oil producers are now paying more to pump oil than they can sell it for, Phillips 66 is buying that ultra-cheap crude, and in some cases, could actually boost its margins by acquiring more deeply discounted oils than the benchmarks that set fuel prices.
It also has a rock-solid balance sheet, with $1.6 billion in cash, additional liquidity via low-cost revolving credit facility, and a small amount of debt due in the next year that it should have little trouble refinancing. At recent prices, this is the cheapest Phillips 66 shares have been since September 2012, and the dividend yield is pushing 9%, more than double the 3% average yield it has paid over the past five years:
Like the other two companies featured, there's still the risk the payout will get cut. But unlike so many of its peers in the U.S. oil patch, Phillips 66's business isn't at much risk at all. Investors who buy Phillips 66 now and hold through both the recession and the oil price war could see enormous gains within a few years' time.
On balance, potential rewards outweigh the risks
Yes, I expect Caretrust, Phillips 66, and Butterfield should continue to generate meaningful revenues that support their dividends even as a global recession kicks in. And I expect their results should prove strong enough to allow them to continue paying their current dividends. But that's no guarantee that at least one of them won't cut their payouts, for one of various reasons that could make it necessary, or just the best option. And that's why I don't think these are necessarily great stocks for anyone who will be counting on the dividends for income today.
But even if they have to cut their payouts, I am confident that all three will prove very good investments for anyone who buys at recent prices, and then holds for at least three years. At some point things will return to normal, even if that normal is a little different than it was before. And when that happens, all three of these companies should prove to be worth far more than their current share prices value them at.
