These 3 Companies Are Set For A Horror Story

For investors, the end of October is quite a busy time of the year. With several earnings reports coming out every day, your head could be spinning if you tried to follow all of them. Today, I’m doing you a favor by highlighting 3 stocks you should seriously consider selling now that I have read their earnings report. And I’m not going after some small names here; I’m going for popular dividend stocks that have blinded investors either with their yields or promises. I’m talking about AT&T (T), IBM (IBM) and Polaris Industries (PII).

AT&T is a zombie disguised as Snow White

Behind its perfect reputation of a long time dividend payer and its high yield hides a hideous dead company.

Source: T Q3 2017 presentation

Great! Some will tell me free cash flow has increased by 13% compared to last year. But this is only because the company spent less money in CAPEX. The company is generating the same level of cash flow as it did in 2016. The problem is that the cash flow stagnation has been around for a while now:

Free cash flow hasn’t moved a dime over the past decade. How can you explain that? The company is getting bigger and bigger, but the cash flow isn’t. A known problem for all telecoms is the increasing amount of money required to build the strongest network possible. We all know future spending will happen to manage various situations:

  • 5G is coming.
  • Competition is growing with T-Mobile (TMUS) and Sprint (S) going after AT&T and Verizon (VZ) customers.
  • The integration of Time Warner.
  • Something to do with DirecTV.

Speaking of DirecTV, this acquisition doesn’t seem to be going anywhere. Although T-Mobile offers free Netflix packaged with its unlimited data plans, AT&T thinks it can do better by offering its own service. However, what I see is that AT&T is killing DirecTV and hopes DTVnow will fill the empty space and generate growth in the future.

Source: AT&T Q3’17 Investor Briefing

In the good news department, AT&T’s yield will shortly reach 6% as the stock drops like a rock. With rising debts and a payout ratio around 90%, I think it’s time to wonder how many years T will be able to sustain its current dividend raise streak. After all, management keeps raising its payouts year after year, but you can’t really call an 8.89% total growth over 5 years a dividend growth policy.

In the end, I’m afraid AT&T will be more preoccupied with figuring a way to integrate Time Warner and DirecTV into its activities than building its 5G network. At some point, the company will not have enough cash to support all its projects.

IBM is making promises it can’t keep

IBM celebrated its 22nd consecutive quarterly report with declining revenue. 22 quarters means 5½ years of poor results. What did the market do to celebrate with IBM? Yup, it threw up a party and the stock soared by 9%. But the enthusiasm is rapidly fading away:

Source: Ycharts

Strategic imperatives revenue was up by 10% and cloud revenue was up by 12%. Ah! That’s a reason to boost share value through the roof isn’t it? While I totally get that it’s good news that management has finally found a way to get the business growing again, its other business segments are still decreasing faster. Considering the choices you have in the techno sector, I think you are way better off with Microsoft (MSFT), which didn’t need 5 years to figure out to make money with the cloud business.

On the dividend side, once could argue that buying IBM at a 4% yield is a unique opportunity (similar to buying AT&T at a 6% yield, I suppose). The problem is that IBM is buying back shares and increasing its payout to seduce income seeking investors.

Source: Ycharts

Please note this graph shows the variation in %, not the actual payout ratios. As shares are being bought back and dividends being raised, you can see management is not following its earnings growth. While IBM’s payout ratios were around 20% 5 years ago, they have doubled since then. As they are getting closer to 50%, you can expect a smaller dividend growth rate in the years to come, not to mention the rising debts siphoning future money away from its bank account.

Polaris Industries is not out of the woods yet

Polaris is making a strong comeback after 2 years of desolation. Sales weren’t good and many recalls hurt Polaris’s brand (and earnings). However, the stock is now back up with a strong quarter showing sales increases of 20%. PII stock price surged on earnings by $ 16 on a single day. The stock is now up almost 50% since the beginning of the year (as of October 25th at closing). Unfortunately, this hype is not about growth, but rather about hope:

Source: Ycharts

Polaris benefits more from a PE expansion than a growing business. Although investors tend to forget, there were still many recalls in 2017 and I’m not convinced Polaris is done dealing with its quality issues.

Polaris Industries has increased its dividends for 22 consecutive years. This make it part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone.

Based on its strong dividend growth history, I was willing to give PII a second chance. I then used the dividend discount model to find its fair value. I’ve been more than generous with dividend growth rates of 8% and 7% and I still can’t get a value that makes sense with today’s price:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$ 2.32

Enter Expected Dividend Growth Rate Years 1-10:

8.00%

Enter Expected Terminal Dividend Growth Rate:

7.00%

Enter Discount Rate:

10.00%

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$ 162.30

$ 107.85

$ 80.64

10% Premium

$ 148.78

$ 98.86

$ 73.92

Intrinsic Value

$ 135.25

$ 89.88

$ 67.20

10% Discount

$ 121.73

$ 80.89

$ 60.48

20% Discount

$ 108.20

$ 71.90

$ 53.76

I understand that I would have gotten a better valuation if I had used a 9% discount rate but this just seems wrong considering the numerous issues Polaris just went through with the quality of its 4wd. The company may turn around and achieve more success with its motorcycle business. However, if I were a shareholder, I would take the 50% gain this year and run.

Final Thought

There have been many major reactions towards earnings over the past 2 weeks. We have seen several companies going up or down by 10% or more. In both cases, I think investors are over reacting. A single quarter won’t change the entire business and doesn’t justify such fluctuations. However, it creates buying and selling opportunities for some.

Disclaimer: I do not hold T, IBM or PII in my DividendStocksRock portfolios.

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Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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