A Tale Of Two Stocks – One Headwind, One Tailwind

As a dividend growth investor with an eye towards the long-term I mostly ignore short-term noise. I don’t pay too much attention to macroeconomic news like interest rate changes and fiscal policy in Germany. I simply focus on what I know works: buying ownership positions in high quality companies that have a proven history of rewarding loyal shareholders with rising earnings and dividends.

However, that does not mean that I simply buy shares in wonderful businesses and completely forget about them. Quite the contrary. I actually spend a great deal of time reading up on the companies I own a piece of, not because this is completely necessary but rather because I quite enjoy it.While I certainly advocate ignoring slight quarterly misses or daily and monthly fluctuations, what I hope to garner from perusing over the results companies provide on a quarterly and annual basis is changes in the companies fundamentals, for better or worse.

Recently researching some of my holdings after some unusual market fluctuations I ran into some interesting news. One company has some significant tailwinds with great prospects over the next 3-5 years, while one company has some serious headwinds that could hamper growth over the long haul.

Tailwind – Oneok Inc. (OKE)

Oneok, Inc. (OKE) is a company I purchased shares in back in early June. I analyzed the company and pointed out that they operate in three segments, including: Oneok Partners, Distribution and Energy Services. Well, the Energy Services segment is being discontinued on April 1, 2014. And news just broke today that OKE is going to spin-off the Distribution segment, leaving the company to focus on Oneok Partners, L.P. (OKS), of which they own 100% of the General Partner and 43.4% of the outstanding Limited Partner units. The stock popped over 25% today on this news. On top of that they raised the dividend by 5.5%, from $0.36 quarterly per share to $.038 quarterly per share. A hell of a day!

OKE will plan on spinning off the natural gas distribution into a stand-alone publicly traded company. This business serves more than 2 million customers throughout Oklahoma, Texas and Kansas. OKE shareholders will retain their current ownership in OKE, and will also receive a new ownership stake in the publicly traded natural gas distribution company by way of a stock dividend. You have got to love companies that create shareholder value like this. I really like this move. I don’t always like spin-offs, as I sold my entire stake in Abbott Laboratories (ABT) and Abbvie, Inc. (ABBV) after the company spun-off the pharmaceutical business because I thought the company was better served whole as a diversified medical and pharmaceutical company. However, OKE now focusing solely on the fast-growing underlying OKS MLP and the $4.5 billion in projects bodes well for business and shareholders alike. The natural gas build-out is really taking off in this country and I think OKE stands to do well in that arena.

I currently view OKE shares as fairly valued here, but there remains significant upside with the planned upcoming spin-off. Also, the dividend growth is projected to be quite large over the next few years. OKE is targeting dividend growth of 65%-70% between 2012 and 2015. The next few years could be very kind to OKE shareholders based on the view today.

Headwind- Lorillard Inc. (LO)

Lorillard Inc. (LO) is another company I have a stake in and, as always, I like to check in to see how things are going at my company, especially now that earnings season is upon us. On Tuesday,the U.S. Food and Drug Administration (FDA), which oversees the tobacco industry, published a report that found that menthol flavored cigarettes are likely associated with greater addiction and greater nicotine dependance and a reduced ability to quit smoking.

When I last purchased shares in LO back in March of this year, I noted that the talk of potential further FDA regulation regarding menthol cigarettes was a possibility, and the talk of such was increasing in intensity and frequency. However, I pointed out that regulation would be unlikely due to potential tax revenue hits and the possibility of a black market springing up for these products. I am actually starting to view the tax argument as weaker as time goes on. It seems that the government is increasingly becoming less concerned about negative tax consequences from further regulation on tobacco companies. Regulations have been pretty heavy over the last 10+ years and volumes are down year after year. It seems fiscal policy really matters little here. Although, I do view the black market possibility as great and think that could be a big mitigating factor against an FDA ban against menthol products.

While I view shares in LO reasonably appealing today with a P/E of 14.34 and a yield of 4.94%, it remains to be seen just how serious the FDA is about further menthol regulation. This is a large concern, as Newport, the flagship brand, accounts for over 85% of the company’s revenue. Although the e-cigarette business is growing quickly and the growth of the Blu Ecigs (~40% market share) brand helped LO book a 10% rise in net income for the second quarter, the overall sales of Blu is relatively small at $57 million compared to LO’s overall sales at $1.29 billion for this last quarter. While I’m still holding my LO shares, further FDA announcements are something that I will be paying attention to. That being said, even if the FDA were to announce unfavorable actions regarding menthol cigarette manufacture and/or distribution it would likely take years to take full effect. Overall, this has the potential to be a huge headwind for the company.

How about you? Think the above analysis is accurate? Any companies that you own facing headwinds or tailwinds of their own? 

Full Disclosure: Long OKE, LO

Thanks for reading.

Photo Credit: Darren Robertson/FreeDigitalPhotos.net

Comments

  1. says

    I do not think the FDA will ban menthol. They have been talking about it for years and nothing ever happened. I still think that tax loss will be significant, and not only tax, but lost labor – unemployed people, tax revenue from workers and black market. If it wasn’t an issue, FDA would do this years ago instead of just talking about it.

    As far as OKE, I was just looking at the stock considering it a new addition to my portfolio. But I didn’t know about their spin off (yet). That may bring a brake to my addition of the stock. Will you continue holding it or get rid of it before or after the spin off? I did the same with ABT and ABBV, but the reason was that the dividend yield after the spinoff dropped below my limit. I still may add ABT back if the yield grows back above 3%

    • says

      Martin,

      I’m actually not all that sure that the government is extremely worried about tax revenue losses relating to something like this. Regulations on tobacco companies by the government have been pretty strict over the last decade or so, and let’s not forget the government sued these companies (and won). They aren’t exactly buddies. Plus, governments have allowed increasing regulations regarding where you can smoke, increasing social stigma and thereby reducing sales and tax revenue. Plus, it’s not like we’re talking about a government that is ultra-efficient on fiscal policy, as we have a $16 trillion deficit.

      However, I would be more concerned about potential social unrest (riots) and a black market. That, I believe, would be the bigger mitigating factor. We’ll see.

      I was actually looking at adding to my OKE holdings in August, but the recent 25% pop has now abated any enthusiasm I had for that. What few opportunities I’ve been looking had have had any remaining value just evaporate. Rather unfortunate.

      Let’s hope we get a pullback here as August starts. :)

      Best wishes.

    • says

      Your argument sounds logical to me. We will see.

      As far as OKE, it is not the only stock inflated. It doesn’t look like we get any significant drop, although the market looks weak, it is still pushing up. We will see. Cheers

  2. Chad says

    OKE was on my short list for my August purchase. After the 25% run up today, I removed it as an option. I still like the company, but it’s too expensive for my tastes. Congrats on getting in on it when you did.

    I don’t believe that menthol will be banned base on what you posted. The loss of jobs and tax revenue will keep menthol legal. Will they keep making it harder and more expensive to be a smoker? Of course, but they won’t ban it. I’m a fellow owner of LO and I believe in the stock. I think the ecigs are the future.

    • says

      Chad,

      OKE was also on my list for August. Rather unfortunate it ran up so quick. I wish they would have waited to announce the spin-off around mid-August. :)

      I hope you’re right on LO. I’m long and wish to remain so. However, I’m not aware that the FDA has ever used language like “Menthol poses greater health risk”. By admitting that there is a health risk, I think there is some real danger there. Perhaps not a full ban, but some action is possible.

      However, any action taken would take years to fully implement. This isn’t something that would have a material effect on LO overnight.

      I agree with you on e-cigs. When I wrote my articles on my LO purchases I talked at length about that. I also feel there is a ton of growth ahead in that business. And LO is crushing it so far with Blu. I’m excited for the future there. However, it’ll be a few years before the e-cig business has a large impact on LO’s revenue since right now it’s just a fraction. It’s growing quickly though.

      I’m not ringing the alarm with LO, but this talk of public health risks is something to watch.

      Best regards!

  3. says

    Congrats on OKE. I don’t know much about the company, but the spinoff sounds like a good deal.

    I have trouble imagining a menthol ban. That would be an all out assault on our freedom and going too far. Perhaps regulation will tighten. Seeing as how states are legalizing marijuana, it would be laughable if menthol cigarettes received the ban hammer. Loss of tax revenue, black market, not to mention it could possibly upset a minority group (blacks) and be seen as racially motivated. I think increased regulation is more likely. But we can never know for sure. Best to stay diversified and not rely too much on LO.

    • says

      CI,

      I agree with you. It’s always best to stay diversified. That’s the only free lunch we really have.

      It is quite funny that the FDA is attacking menthol while marijuana is slowly being legalized. I don’t get it.

      I think there would be chance of social unrest if they seriously went after menthol, as you point out the demographic concentration on this. I don’t know how much of a concern governments really have about tax revenue loss anymore, but I do think the increase in black market products is a very legitimate worry.

      It’s a shame because LO is one of the more attractive opportunities on the market. Although my cost basis is significantly under the current price, I think it’s relatively attractive here considering the valuation, growth and yield.

      I’ll continue to stay long, but keep an eye on changes.

      Best wishes!

  4. Spoonman says

    Good job picking OKE! A pop like that can super charge your journey toward FI. A few years ago I owned Harlleysville Group (HGIC), which got bought out by Nationwide, and popped like 85% in a single day. I sold the shares and purchased AFL. The downside, of course, is that I no longer have that awesome company taking a spot in my portfolio. But, hey, can’t really complain can we?

    • says

      Spoonman,

      I remember the pop HGIC had. I was also a shareholder at the time. Nationwide is on our side! :)

      I’m with you. A company doing the right things and creating shareholder value will definitely greatly assist in the journey to FI. I hope that Oneok continues to make the right moves like this.

      I hope your journey is still going wonderful! :)

      Best regards.

  5. says

    DM, I’d like your thoughts on another portion of your portfolio that may be encountering some headwinds. As Verizon is making noise about dabbling in the Canadian wireless phone market, the major telcoms here in Canada have taken a beating over the last month. I remember that recently you added Rogers to your freedom fund, I was wondering what your thoughts were on this potential move?

    I have trouble seeing the business sense in it. I don’t think the Canadian wireless market is worth Verizon’s time. Yet the market has reacted as if it were a foregone conclusion that they will enter this market, subsequently BCE, Telus, and Rogers are all down substantially as a result.

    There may be an opportunity here, if you believe the current dividends are safe, that some of the Canadian telcoms may be reasonable values currently. Telus has reacted by doubling their stock purchase plan.

    • says

      chris,

      I actually do not own Rogers. I looked at Rogers, as well as Telus and Bell Canada a little while back. I concluded that I personally like Telus and Bell the best. While I really love the asset mix Rogers has, the debt load is just too much for me. I think Telus and BCE would make pretty decent purchases here right now for the entry yield and some moderate growth.

      I’m not sure if Verizon is really going to go after the Canadian market. While it makes sense logistically because of the geography, the market is relatively small (compared to the U.S.). I think the entire Canadian population is smaller than California’s. We’ll see what happens.

      Best wishes!

  6. says

    I don’t really expect an outright ban on menthol cigarettes from the FDA, most likely it’ll be a slightly higher tax on menthol as opposed to regular. This government absolutely confounds me. We already have a huge deficit, so why would you want to destroy one of the steady revenue streams that you have. Plus as you mentioned, marijuana is being legalized in more states, but they want to ban menthol cigarettes. What? The libertarian in me says marijuana should be legal and the government needs to get out of the business of looking after me. That’s my responsibility not theirs.

    I had started looking more at OKE after you purchased some and was liking what I saw. Now, not so much. A little too expensive now. Of course time will tell if it really is expensive because they have a lot of growth in the works.

    • says

      Pursuit,

      I hope you’re right. I think LO a fantastic company, and they’re growing market share both in their traditional cigarettes and e-cigs. The yield is great, the valuation make sense and I want to continue owning a piece of the company.

      I also don’t really get the government. The fiscal sense has been gone for a long time. While the taxes that come from cigarettes is something that shouldn’t be taken lightly, it seems like nobody really cares anymore. I don’t get into political discussions, but policy in Washington appears to be dysfunctional.

      I would agree on OKE. I think it’s fairly valued here. However, the new spin-off could create fairly significant shareholder value. We’ll see how it works out!

      Take care!

  7. says

    DM, awesome job on the OKE. That has got to be pretty fun.

    I feel pretty clueless regarding the Menthol thing. I was tempted to trim my LO position yesterday, but experienced investors seem to be pretty skeptical of the ban, judging from some of the feedback I’ve seen and read. So I am merely holding. There have been plenty of scares with big tobacco all across the board in the past years and generally it seems like they were buying opportunities. But you never know…I guess this speaks to the importance of diversification within the company. I know LO have been marketing their non-menthol cigs (Newport Reds) so they are trying to diversify a bit. It was a bit scary initially to read the news, but Wall St doesn’t seem to be that scared. So, I hold for now…

    Here is some scientific research for you:
    http://www.youtube.com/watch?v=Ku1eBYvCKdk

    Hey, don’t ignore UL…An interesting proposition for the yield, even with the high PE. You’re looking at nearly 3.5% yield for a very respectable consumer stock…That’s what it looks like to me, anyway…Good growth in emerging markets, too.

    Best wishes, great to read your blog as usual. Interested to hear what kind of project you are planning for next year with your excess cash. Guess I’ll read about it sooner or later!

    RO

    • says

      RO,

      Thanks for stopping by! I hope all is well. :)

      I’m just as clueless as you regarding menthol. While the logical side of me cannot imagine bans or further restrictions on menthol, but our government can be quite surprising. This issue does speak to the importance of diversification for an investor and for a company. And while LO has done well with diversifying into Reds and Blu (love those colors!), Menthol Newports still make up an overwhelming majority of sales. Like I said, even if restrictions were put in place it would take years to hash out. I’m not worried right now, but this has the potential to be a significant headwind.

      I’m with you on UL. That is on my watch list. The valuation is a bit strong, just like almost every other high quality consumer company. But I love the brands. They recently started marketing razors through the Axe brand to compete with Gillette.

      Thanks for the kind words and support! I really appreciate it.

      Best wishes!

  8. says

    Roger H,

    I do hope you’re right. LO is the oldest tobacco company still in operation here in the U.S. It would be a tremendous shame for Washington policies to get in the way of that. I really like LO, and it’s a fairly large position for me. I’m not selling because I like to ignore noise like this, but if the noise gets loud enough to the point where I can’t ignore it any longer than I’ll really start paying attention.

    Let’s continue to hope the FDA leaves things be. :)

    Take care.

  9. says

    I’m comfortable holding onto Lorillard for the time being. I have my doubts the FDA will get around to actually banning menthol cigarettes. From my understanding the concern is not that they are more harmful to health compared to other cigarettes but that they taste better therefore more popular with youth. Either way, the government moves so slow on anything I feel it will be years before they ever actually do anything.

    The important thing is to be diversified. That way if any type of ban does occur we can react accordingly without taking too much of a hit to our portfolios. In the meantime I’ll keep collecting my dividend checks.

    • says

      Dan Mac,

      I’m with you. I’m also comfortable continuing to hold on to my shares. It will definitely take years to hash out something if the government were to actually impose restrictions on menthol sales. I really can’t imagine them doing that, but the language the FDA is now using is a bit aggressive. We’ll see.

      I agree on diversification. This is a prime example of why it’s so important. Even one of the oldest companies in the U.S. can experience significant headwinds that maybe people don’t see coming. Diversification is an investor’s best friend when it comes to preventing major losses.

      Best wishes!

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