Many decades ago, dividends were a key part of any investment decision. Investors often prioritized the highest yields with the most consistency. However, after the dot-com bubble, there was a sustained shift towards technology/growth companies that didn’t pay a dividend. Even after the bubble burst, many investors turned against dividends, preferring companies to invest the cash in growth instead.
More recently though, as we shift into a bear market, investor psychology has once again turned towards dividends and consistent cash flows. This has been driven by macroeconomic concerns such as rising inflation. The recent CPI inflation rate of 8.2% for September is much greater than the Federal Reserve's average target of 2%. As Warren Buffett (Trades, Portfolio) said at his Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual meeting in 2022, “Inflation swindles almost everybody."
Thus, in this article, I’m going to outline my top two favorite defensive dividend stocks which are poised to pay a healthy and consistent dividend during this high inflation environment; let’s dive in.
1. Global Partners LP
Global Partners LP (GLP, Financial) is one largest owners and operators of gas stations across the U.S., with ~1,700 owned or leased. The company also owns 24 oil terminals across the northeast of the U.S. and has a storage capacity of 10 million barrels. During 2020, when oil prices went negative, oil storage was in short supply and a valuable commodity. Therefore, I consider storage capacity to be an excellent advantage for this company. This is a great stock to play in times of rising oil prices. The stock has a trailing 12-month dividend yield of 8.17%.
The company also operates 343 convenience stores across the U.S., which has been a fragmented industry historically. For example, 70% of the industry has chains of less than 50 stores, thus Global Partners sees this as an opportunity to become the dominant player. In mid-September 2022, the company acquired Tidewater Convenience, which includes 15 locations across southeast Virginia. Many more acquisitions such as this are expected to occur in the future as part of the company's growth plan.
Growing financials
The company generated revenue of $5.2 billion in the second quarter of 2022, which beat analyst estimates by $1.01 billion. In addition, the business generated net income of $162.8 million, which increased by a staggering 1,250% from the $12.1 million generated in the prior year. This was driven by higher product margins but also included a $76.8 million net gain on the sale of its assets related to the Revere terminal. Taking this one-time even out of the calculation, net income was $86 million, which still increased by a solid 610% year over year.
The company also generated Ebitda of $211.8 million, which was substantially higher than the $58.5 million generated in the prior year.
As Global Partners is setup as a “Master Limited Partnership,” analyzing distributable cash flow makes sense. In this case, distributable cash flow was $178.2 million in the second quarter of 2022, up substantially from $26.6 million in the second quarter of 2021.
Overall, the business generated earnings per share of $4.61 for the quarter, which beat analyst expectations by $3.40.
The company has $7.4 million in cash and short term investments on its balance sheet. This is fairly low but is expected as MLPs must distribute a large portion of profits to shareholders (hence the healthy dividend yield). The business does have $1 billion in long-term debt, but only $70 million in short term debt, so this is manageable.
Valuation
Global Partners trades at a price-earnings ratio of 4, which is 53% cheaper than the energy sector average. In addition, the business trades at a price-to-free-cash-flow ratio of 1.99, which is 56% cheaper than its five-year average.
The GF Value calculator indicates a fair value of $31 per share for the stock, which makes it “fairly valued” at the time of writing.
2. Apartment Income REIT Corp
Apartment Income REIT Corp. (AIRC, Financial) is a Real Estate Investment Trust which owns a variety of apartments across the U.S. The company owns 25,363 apartments across 77 multi-dwelling properties, with a portfolio value of ~$1.4 billion. Management focuses on creating a community of “Good Neighbors” which further increases tenant retention and enables rent to be charged at a higher level.
The stock has a trailing 12-month dividend yield of 4.71%.
Financials
Apartment Income REIT generated revenue of $182.6 million in the second quarter of 2022. This is up slightly from the $178.3 million generated in the first quarter of 2021. Its revenue growth of 1.7% may not seem incredible, but this is still higher than the -1.8% average for competitor REITs in the coastal apartment industry. The real estate market is currently going through a slight correction after an enormous boom during 2020 and 2021.
The business is operating fairly efficiently and has managed to cap its general and administrative expenses at 15 basis points relative to the gross asset value. This has resulted in industry-leading net operating margins and greater free cash flow when compared to industry peers.
Earnings per share was $1.26 in the second quarter of 2022, which beat analyst expectations by $1.04.
The company has grown through acquisitions, and in 2022, the REIT acquired two main properties. The first was “The Reserve” at Coconut Point in Florida, which was purchased for $72 million and consists of 180 apartments. The company also acquired the Watermarc at Biscayne Bay for a staggering $211 million. Both properties are expected to generated between 3.8.% and 4.1% in net operating income in year one. However, longer-term, an internal rate of return (IRR) of ~8% is forecasted.
Apartment income REIT has a flexible balance sheet as the business has issued $400 million of senior unsecured note debt. In addition, only 2% of the business' leverage is exposed to variable interest rates (which are rising), therefore the company is well protected from extra debt servicing costs.
Valuation
A key metric to use when valuing a REIT is the price-to-funds-from-operation ratio (P/FFO). In this case, P/FFO = 15.52, which is cheaper than historical averages. The price-to-adjusted-funds-from-operation ratio (P/AFFO) is 16.82, which is also cheaper than historic levels.
The GF Value calculator indicates a fair value of $42 per share, which means the stock is “modestly undervalued” at the time of writing.
Final thoughts
Both Global Partners LP and Apartment Income REIT are two great plays on the high inflation environment in my opinion. Both oil and real estate have performed well during this type of environment historically. Apartment Income REIT is slightly more exposed to the macroeconomic environment due to the discretionary nature of luxury apartments. However, its fixed debt and mix of price points in different regions generally offsets most of the risks for the long-term investor.
