Forget The Fed, These Big Dividends May Win No Matter What
The key question facing investors today revolves around the Federal Reserve’s next moves. Will they cut interest rates this year as many have expected for some time, or maintain the current levels for a lengthy period of time until inflation nears their 2% target? Some even think a rate hike is likely at some point if inflation continues to rebound instead of slowing down. At the moment, the U.S. economy is sending mixed signals, with several inflation metrics suggesting a resurgence of price increases and there are still no clear signs of a recession on the horizon.
At the same time, the labor market has softened recently with unemployment rising to nearly 4%, and debt levels in corporate, commercial real estate, and consumer sectors are at unprecedented highs, potentially leading to spikes in property defaults and possible bank failures, which could further increase unemployment and slow economic activity. Additionally, major economies like China, the United Kingdom, and Japan face significant challenges, adding further headwinds to the U.S. economy.
Moreover, with the 2024 presidential election approaching, there may be additional pressure on the Fed to cut rates sooner. However, the Fed has also stressed that it is not politically motivated in order to maintain credibility with the public.
It isn’t just retail investors that are struggling to make sense of these complex data points: Ares Capital (ARCC), a blue-chip business development company (BIZD) recently admitted that it is struggling with making capital allocation decisions due to the uncertain interest rate outlook. On their recent earnings call, management stated:
we’re in a little bit of a tricky position as you can probably appreciate, because…the trajectory for rates going forward is reasonably uncertain. I think if you ask around the table, folks would have very different views.
Therefore, it would seem that the most prudent strategy for investors might be to select stocks likely to perform well regardless of the Federal Reserve’s next move on interest rates. With that in mind, this article will highlight three stocks positioned to offer attractive long-term risk-adjusted returns, regardless of what the Fed does next.
#1. Enterprise Products Partners Stock (EPD)
Enterprise Products Partners – known for its robust track record of generating double-digit returns on invested capital and stable cash flows in various macroeconomic scenarios, including the energy sector downturns of 2018 and 2020 – is quite defensive given that a significant portion of its cash flows are secured through contracts. This makes it relatively immune to fluctuations in commodity prices and energy demand. Moreover, its strong balance sheet, characterized by a sector-best A- credit rating, a low 3.0x leverage ratio, and well-laddered debt maturities, positions it even better to weather any meaningful downturn. Additionally, if the economic situation worsens and interest rates drop, Enterprise Products Partners is also likely to maintain steady cash flows given its significant growth pipeline that it will be bringing online in the coming few years and substantial financial capacity for strategic buybacks that it could execute in the event that its unit price dipped substantially.
Meanwhile, if inflation remains persistently high, leading to a higher-for-longer interest rate environment, EPD will likely do just fine as well, just as it has over the past several years through a rising interest rate and elevated inflation environment. This is because it has very well-laddered debt maturities (a nearly 19-year weighted average term to maturity on its debt, 48% of its debt does not mature for 30+ years, 80% of its debt does not mature for 10+ years, with 87% of its debt does not mature for 5+ years), it fully funds its growth with retained cash flow, and between inflation escalators on its pipeline contracts and the portion of its cash flows that are commodity price sensitive, it also enjoys some tailwinds from elevated inflation.
As a result, regardless of what the Fed does next, there is a high probability that EPD – with its 1.7x DCF distribution coverage ratio – will likely continue to grow its distribution each year, just as it has done for the past quarter decade.
#2. Brookfield Renewable Partners Stock (BEP)(BEPC)
Brookfield Renewable Partners also stands out as a great high-yield investment choice that is poised to thrive regardless of what happens to interest rates moving forward. A likely scenario that would prompt the Fed to cut rates is if the economy went into a recession. However, given that its assets are highly contracted, providing essential energy services, and it boasts a sector-best BBB+ credit rating, it is a defensive business that should do well even if the economy declines. Moreover, the long-term nature of its contracts and its diversification across geographies and asset classes further solidify its defensive nature, as does its backing from its A- rated parent Brookfield Asset Management (BAM) (BN).
Additionally, in a lower interest rate environment, BEP would likely benefit from valuation expansion due to the fact that it is often valued based on its yield as a bond proxy. On top of that, its cost of debt would also go down, enabling it to accelerate its growth due to being able to opportunistically refinance some of its higher-cost debt while also having a lower cost of capital to invest in its large growth runway.
Conversely, if elevated inflation persists – which is the scenario that would prompt the Fed to keep rates higher for longer – its inflation-indexed contracts would boost its organic growth, and it would likely continue to buy back its own units at suppressed valuations, supporting its growth trajectory even if it was not able to raise capital as inexpensively to finance acquisitions and development projects.
On top of that, it already has a very large development pipeline, it is enjoying strong tailwinds from its recent deal with Microsoft (MSFT) to power its artificial intelligence projects, and it has very low near-term refinancing risk, so it has very strong growth tailwinds that should support its growth trajectory regardless if interest rates remain higher for longer or not.
#3. Mid-America Apartment Communities Stock (MAA)
Mid-America Apartment Communities is also well-suited for various interest rate and inflation scenarios. Its short-duration multifamily leases allow it to adjust rental rates in line with inflation, and its strong balance sheet (A- credit rating, low 3.6x leverage ratio, and very well-laddered debt maturities) minimizes the negative impact of elevated interest rates.
Meanwhile, in an economic downturn, its business model of providing shelter combined with its strong balance sheet, diversification by property type (59% exposure to A-, B+, B, and B- class multifamily assets), and focus on sunbelt markets with strong population growth tailwinds in states like Texas, Florida, Georgia, North Carolina, and Tennessee position it well for continuing to generate attractive long-term growth. While it may experience lower rental rate growth and slightly weaker occupancy in a down economy, these headwinds would likely be at least partially offset by the fact that interest rates would also likely drop, enabling management to opportunistically refinance some of its debt.
Investor Takeaway
Despite current uncertainties and conflicting macroeconomic data clouding the outlook for the Federal Reserve’s future actions, investing in companies like Enterprise Products Partners, Brookfield Renewable, and Mid-America Apartment offers investors a chance to secure attractive yields and valuations in high-quality businesses that should thrive regardless of where interest rates go. As a result, these investments should allow investors to weather economic uncertainty with confidence while focusing on the long-term compounding of total returns and dividend income.