2 High Yielding Stocks to Overcome Market Uncertainty

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Co-produced by Austin Rogers for High Yield Investor

Uncertainty abounds

The late Donald Rumsfeld stipulated three basic types of risk:

  1. known known
  2. Known unknowns
  3. unknown unknowns

Unfortunately, the list of risks in these last two categories seems to be getting longer, which is why the S&P 500 (SPY) has found more sellers than buyers this year.

S&P 500 2022 drop

S&P 500 2022 drop (YCHARTS)

Among the list of “known unknowns” is the degree to which interest rates will rise. Just a month ago, the market consensus was that the Federal Reserve would raise its key Fed Funds rate by half a percent to restart its rate hike cycle amid the worst inflationary spike since the Great Inflation. of the 1970s-1980s. .

Market expectations of the Fed as well as inflationary pressures sent corporate borrowing rates soaring. Yields on investment grade bonds (VCLT) with a BBB rating soared to almost 4%, while high yield (i.e. “junk”) bonds (JNK) saw their rates fall interest jump to almost 5%.

Rising interest rates

Rising interest rates (YCHARTS)

The days of virtually free money for corporate America are over. The party is over. The music has stopped, and now everyone seems to be scrambling for a chair.

What exactly is the “chair” in this metaphor? Well, on the one hand, it’s interest rate protection. Normally, businesses have a bit more time to cover their borrowing costs as rates slowly rise. This time, not so much. Companies that proactively hedged the cost of their debt in late 2021 and early 2022 will be rewarded.

However, businesses that were caught off guard now face two huge headwinds: rapidly rising borrowing costs and rapidly rising input costs.

Consider wheat prices, which nearly doubled from just before COVID-19 through the end of 2021.

Wheat prices soar

Wheat prices soar (YCHARTS)

This table ends before the outbreak of war in Russia and Ukraine, which together account for about 25% of world wheat production. (A lot of epidemics in recent years: coronavirus, inflation, war… what next?)

And then there is the volatility of oil. West Texas Intermediate crude oil prices rose from ~$92 on Feb 25 to ~$124 on March 8 and fell back to ~$100 on March 14. In fact, the price of oil peaked at just over $130 intraday but did not stay there for long. This indicates how volatile the price of oil was around the Russian-Ukrainian war.

Despite this, oil producers around the world have been significantly constrained in their slow and steady increase in oil production since the COVID-19 outbreak. In November 2021, global oil production remained about 5% below its pre-pandemic level, and oil production in the United States remained nearly 10% below its pre-COVID level at the start of 2022.

Oil production remains stable

Oil production remains stable (YCHARTS)

This major disruption to pre-pandemic stability lasted much longer than most of us realized, and current events look set to make it last even longer. But until peace and stability are restored, we investors must look for strong and resilient companies that exhibit certain crucial characteristics:

  1. Pricing power
  2. Absence of heavy reliance on debt markets
  3. Ability to come out of the current disturbance stronger

Let’s take a look at two high-yielding stocks to see if they fit this description.

1. Amcor PLC (CDMA)

AMCR manufactures flexible and rigid packaging for a wide variety of consumer goods that you will find in grocery stores, general merchandise stores, and some restaurants (mainly fast food restaurants).

consumer packaging for food

consumer packaging for food (Amcor PLC)

Although consumer packaged goods tends to be a slow-growing industry, AMCR has several organic growth opportunities that make its outlook more attractive than the typical CPG stock, including growing exposure to healthcare products (~15% of sales) as well as emerging markets (~25% of sales).

Amcor PLC Growth Engines

Amcor PLC Growth Engines (Amcor PLC)

Due to soaring cost of goods sold (largely due to higher paper and petrochemical/plastic prices), AMCR’s gross profit was down just under 1% year-over-year in second half of 2021. But due to savings elsewhere, operating income increased 6%, net income attributable to AMCR increased 2.4% and diluted EPS increased 5.3%.

Inflationary pressures can be observed by looking at EBIT margins in each major product segment for the second half of 2021 compared to the same period of 2020:

EBIT margin

2H 2020

2H 2021

Soft

13.5%

12.9%

Rigid

9.9%

7.4%

Nevertheless, the inflationary environment was not sufficient to prevent AMCR from seeing strong results in terms of both turnover and profit. Net sales increased by 12% and adjusted EPS increased by 9% during the second half of 2021. For the full fiscal year 2022 (July 2021 to June 2022), management expects EPS growth between 7 and 11%.

This guidance is largely based on the active pricing actions currently being taken to improve AMCR’s margins in the second half of fiscal 2022 (first six months of 2022).

Based on fiscal 2022 sales of approximately $13.5 billion, AMCR expects to generate $1.1 billion to $1.2 billion in free cash flow.

With this FCF (and perhaps tapping into cash reserves and/or additional low-cost debt), management plans to allocate $600 million to share buybacks in fiscal year 2022. During the first half of this period, AMCR had already completed $295 million in share buybacks. (1.6% of outstanding shares). Since the beginning of 2020, AMCR has reduced its number of shares by approximately 5.5%.

Amcor share buybacks

Amcor PLC share buybacks (Amcor PLC)

In addition to share buybacks, management returns cash to shareholders through dividend increases. With the release of second-half 2021 results, AMCR also increased its dividend by just over 2% to $0.48 per year from the previous payment of $0.47. From fiscal year 2014 to fiscal year 2021, the dividend has increased at an average annual rate of 6%.

The dividend is expected to represent 60-65% of free cash flow in fiscal 2022.

Although total debt has increased slightly year over year, AMCR’s leverage is by no means a significant threat at this time. Net debt to EBITDA LTM ​​was 2.9x at the end of 2021.

The AMCR is currently trading around a P/E ratio of 14.3x, close to its lowest point at any time in the last three years. We find this attractive value for a global packaging leader.

Amcor Investment Case Summary

Amcor PLC Investment Case Summary (Amcor PLC)

Between EPS growth and the 4%+ dividend yield alone, AMCR expects to generate at least 10-15% total returns going forward, but rising valuation could easily push that figure into the range of 15 to 20%.

2. Conagra Brands (GAC)

CAG has a portfolio of leading consumer packaged goods brands. They are one of AMCR’s customers and, like AMCR, CAG has done a good job of moving into faster growing product lines and categories. CAG, for example, is heavily exposed to the snacks and frozen meals categories.

Conagra brand logos

Conagra brand logos (Conagra brands)

Plus, CAG is a good way to play up the plant-based food trend. The company owns the Gardein brand of plant-based meats as well as the Earth Balance brand of vegan butter, and the company has introduced plant-based options in several of its product lines.

Like all of its peers, the main issue for the company right now is inflation. For CAG’s fiscal year 2022 (ending May 2022), the company expects a staggering 14% increase in cost of goods sold. Therefore, we find that the biggest pressure facing the consumer goods business is the rising cost of goods sold:

Inflation impact of Conagra brands

Inflation impact of Conagra brands (YCHARTS)

CAG’s operating margin actually increased in fiscal 2021 (ending mid-2021), but this crucial metric has since collapsed as inflation raged. In the second quarter of the fiscal year (ending November 28, 2021), CAG’s adjusted operating margin fell 500 basis points, from 19.6% to 14.6%. This was almost entirely due to rising input costs.

Conagra Brands slashes operating margins

Conagra Brands slashes operating margins (YCHARTS)

Like almost all manufacturers of physical products, CAG expects its margins to improve in the second half of this year by raising the prices of its own products.

Fortunately, US companies like CAG typically receive very little wheat and other agricultural materials for their products from Russia or Ukraine, but rising global prices for these commodities aren’t helping to repair margins.

Another chance for CAG is the fact that its nationally recognized brands have strong pricing power amid a broader inflationary moment. In the three months ending November 2021, for example, CAG prices increased by an average of 5.4% while unit volume sales increased by 1.5%.

Conagra Brands Hiking Awards

Conagra Brands Hiking Awards (Conagra brands)

In other words, people keep buying as prices go up. As more workers transition to a work-from-home or hybrid work schedule, CAG’s food products should continue to see sales increase.

Compared to the expected adjusted EPS of $2.50 for fiscal 2022, CAG is currently trading around a P/E ratio of 12.7x, also at the low end of its range in recent years.

Between CAG’s roughly 4% dividend yield, mid-single-digit EPS growth and rising valuation, we believe CAG shareholders should see total returns of 12-15% from here. .

Conclusion

Paradoxically, the most difficult periods of inflation for physical goods companies could turn out to be the best time to buy their stocks. Rising input costs are currently weighing on margins and profits, but assuming these companies are able to raise prices enough to gradually repair their margins, profits should rebound strongly.

These are exactly the kinds of opportunities we like to pursue at High Yield Investor: temporarily depressed companies that have all the tools they need to grow out of their current malaise over time. AMCR and CAG are two such opportunities that look interesting to us right now.


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