To The Moon

Summary

• The high-yield space has recovered somewhat recently.
• However, there are still numerous compelling opportunities that are trading way below their highs.
• We share two of some of our favorite opportunities of the moment in this article.

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While the high-yield sector (SCHD) has largely recovered in recent weeks, several high-quality, high-yield dividend growth stocks remain well below their all-time highs. These stocks currently offer compelling combinations of safe and attractive current income, strong dividend growth potential, and significant valuation multiple expansion potential moving forward. We are loading up on several of these in our portfolio. In this article, we will discuss two of our favorites at the moment.

#1. TC Energy Stock (TRP)

TC Energy is a well-diversified midstream business (AMLP) with a very low-risk profile, given its strong investment-grade balance sheet and its highly contracted and regulated exposure in its asset base. Moreover, its assets are some of the best in the industry, and the strength of its business model and growth opportunity should be further increased by the expected spin-off of its liquids pipeline business later this year. Q1 results were quite strong, with its first-quarter comparable EBITDA up by 11% year over year, and its 2024 comparable EBITDA is expected to be meaningfully higher than in 2023. The company is also maintaining its dividend growth outlook of a 3-5% CAGR over the long term, which will build on its 24-year consecutive dividend growth streak. Additionally, TC Energy is advancing its asset sales program, which should help deleverage its balance sheet and further strengthen its financial position, resulting in an increasingly low-risk profile.

The stock offers an attractive 7.5% dividend yield and is trading on the low end of its historical average valuation range on an enterprise value to EBITDA basis. Moreover, analysts expect the company to grow its EBITDA at a 6.1% CAGR through 2028 and its adjusted earnings per share at a 7.3% CAGR through 2028. This offers investors a very attractive combination of utility-like defensiveness with attractive growth rates and a very attractive dividend yield. As a result, it remains an attractive buy for us. While its peer Enbridge (ENB) offers a similar dividend yield and also has a very conservative cash flow profile, we prefer TRP because:

1. We like its assets a bit more
2. It is not diversifying outside of its areas of core competence, like ENB is into renewables and regulated natural gas utilities.
3. It is increasing its ability to specialize and focus by spinning off its liquids pipelines later this year.

As a result, we are happy to keep it as one of our largest positions and would not hesitate to add more to it should the market make it worthwhile to do so. While our conviction in TRP is not quite as strong as it is with Enterprise Products Partners (EPD) due to its weaker balance sheet, our conviction in it is still quite high.

#2. W. P. Carey Stock (WPC)

We really like W. P. Carey because it is a diversified triple net lease REIT that is heavily weighted towards industrial warehouse properties. It also has some exposure to personal storage and essential services retail properties. In addition to its high-quality real estate portfolio, its balance sheet is in strong shape with a recent upgrade to a BBB+ credit rating from S&P. This is backed by significant liquidity due to the recent sale of most of its office assets and its mostly untapped revolving credit facility. WPC is also getting attractive interest rates on its debt issuances through its exposure to the European bond market, which is likely to improve even further as the European Central Bank is expected to cut interest rates in the near future. For example, WPC's most recent bond issuance raised €650 million at a 4.25% fixed interest rate, not due until 2032. Given that they are able to buy assets at 7%+ cap rates, this is a very accretive debt issuance.

As management stated on their latest earnings call:

In Europe, we've seen bid-ask spreads come in significantly, creating more opportunities in the region compared to last year. Year to date, about 70% of our investment volume has been in Europe. Our European presence also gives us a cost of debt advantage given our ability to issue euro-denominated bonds. Currently, that advantage has moved closer to where we've seen it historically, at rates around 150 basis points tighter than where we could issue US bonds... Our investments year to date had a weighted average going-in cash cap rate of approximately 7.4%, providing initial accretion average yields of around 9%, reflecting rent growth over the life of the leases.

Additionally, WPC generates the majority of its rent from CPI-linked escalators on its leases. This means that while interest rate expenses will likely be higher if we remain in a higher-for-longer environment, much of this headwind, if not all of it, will be offset by higher rent escalations from WPC's inflation-linked rent escalators.

Another big reason to like WPC right now is its attractive valuation. Its dividend yield of 6.2%, combined with expectations of mid-single-digit annualized FFO per share growth over the next five years or so, looks promising. With its office exit headwinds largely behind it and progress being made on a couple of property vacancies, WPC is well-positioned for improved growth rates moving forward. Its lower payout ratio, now in the 70%-80% range, strong CPI-linked rent escalations, and attractive spreads on new investments should further bolster its growth.

Moreover, WPC's price-to-AFFO ratio is a mere 11.8x, which is well below its three-year average of 14.23x. Its price to NAV of just 0.96x compared to its three-year average of 1.1x implies significant valuation multiple upside potential. Combining the 6.2% dividend yield, the 4-5% expected annualized AFFO per share growth, and the potential for significant valuation multiple expansion provides a clear path to double-digit annualized total returns, backed by a recession-resistant, battle-tested business model and a B+ credit rating.

As a result, we think WPC is a very attractive investment for risk-averse, income-focused, dividend growth investors.

Investor Takeaway

While the number of attractive high-yield investments has diminished recently with the strong recovery in the high-yield space over the past few weeks and months, there are still several attractive opportunities, including TRP and WPC. Both offer investors very defensive business models, very attractive and safe dividends, and solid long-term dividend growth potential along with valuation multiple expansion. This should result in both TRP and WPC providing investors with outsized risk-adjusted income and total returns over the long term.