Introduction
Some people on Wall Street are so powerful that whenever they are interviewed, people drop everything to hear what they have to say.
One of these people is JPMorgan (JPM) CEO Jamie Dimon, who has a reputation as one of the best banking CEOs in modern history.
Since January 1, 2000, his bank has returned 681%, beating the S&P 500 by roughly 220 points. That's a huge deal as it includes the Great Financial Crisis, the pandemic, and last year's banking woes.
With that said, Mr. Dimon came out earlier this week with a few fascinating comments on the economy, which made headlines across the financial industry.
I'm bringing this up because his comments do not reflect what I consider to be the consensus - he also brought up some points that I cover quite consistently on Seeking Alpha.
As reported by Bloomberg, Jamie Dimon is "worried more about inflation than markets appear to be."
The JPMorgan Chase & Co. chief executive officer said significant price pressures continue to influence the US economy and may mean interest rates will be higher for longer than many investors are expecting. He cited costs linked to the green economy, re-militarization, infrastructure spending, trade disputes and large fiscal deficits. - Bloomberg (emphasis added)
Personally, I could not have said it any better, as he perfectly captures all of my favorite big themes:
- Inflation and interest rates are likely to remain higher for longer.
- Secular drivers have changed the economic environment.
- These drivers include the energy transition (including improved supply/demand dynamics in fossil fuel industries), geopolitical issues, infrastructure spending, and large deficits/debt levels.
According to Dimon's bank, the Federal deficit is expected to remain close to 7%, with the net debt rising to 124% by 2034.
Even worse, this year, the government is expected to spend almost as much on interest expenses than on its defense capabilities.
Odds are the favorable period between 2009 and 2021 for inflation in developed nations is over.
While I do not expect hyperinflation or any doomsday scenarios that require people to build bunkers in their backyards, I believe we need to prepare for what could be many years of above-average inflation.
Moreover, as I have written in prior articles, I expect the Fed to abolish its 2% inflation target in a coordinated effort with its "partner" central banks in the West.
So far, all of it is speculation, but most of the insiders and professionals I listen to expect a meaningful policy shift to be announced later this year.
Although this would be devastating for unprepared consumers and people who are already struggling financially, it makes sense as a 2% target is hard to reach.
As the chart below shows, the 2009-2021 period was truly special. We enjoyed so many structural tailwinds that made life easy.
Ever since the pandemic hit, we have been faced with structural issues that made us realize just how good these years were.
That said, I'm not doing anything crazy when it comes to positioning myself for what could be a prolonged period of elevated inflation.
When I buy dividend (growth) stocks, I put more emphasis on value.
- I look for undervalued opportunities in a market with a lofty valuation.
- I want companies with pricing power and some form of economic moat.
- I want companies with strong business models capable of capturing long-term growth in attractive industries.
- I want companies with important positions in major supply chains, which adds a lot to their appeal and long-term safety (they are required to keep certain supply chains running).
“Stocks are very high, and I think the chance of inflation staying high or rates going up are higher than people think,” the CEO said. “My view is whatever the world is pricing in for a soft landing, I think it’s probably half of that. I think the chances of something going wrong are higher than people think.” - Jamie Dimon via Bloomberg
Hence, in the remainder of this article, I present three undervalued stocks with fantastic business models and other benefits, including juicy dividend yields from two of the three picks.
Topaz Energy Corp. (TPZ:CA) (OTCPK:TPZEF) - One Of The Best Energy Income Plays On The Market
Topaz Energy is a stock I have never discussed on Seeking Alpha.
So, this is a premier.
Most of my more frequent readers may know that I love energy stocks.
Specifically, I have started to like low-cost operators that benefit from potentially elevated energy prices without being prone to inflationary pressures.
I believe these stocks are perfect inflation protectors.
Hence, I made Texas Pacific Land (TPL) my largest investment, accounting for 12% of my entire portfolio value.
TPL owns land in the Permian Basin, where it allows oil and gas producers to extract commodities in return for royalties on produced oil and gas (that's the short version of what it does).
In other words, it "produces" oil and gas without the capital expenses that come with these operations.
Topaz is similar.
The company owns six million royalty acres in Canada, a nation with one of the biggest oil and gas reserves in the world. This year, it is expected to generate 60% of its revenue from oil and liquids royalties, 18% from natural gas royalties (currently pressured by subdued natural gas prices), and 22% from infrastructure assets.
The company, which is a spin-off from Tourmaline (TOU:CA), Canada's largest natural gas producer, has spent the past years after its spin-off to massively improve its business:
- 78% of its revenues come from royalties. That's up from 58% in 2020.
- Higher-margin liquids account for almost a third of total royalties, which is up from just 7% in 2020.
- Tourmaline accounts for roughly half of its revenue - down from 95%.
Like other royalty stocks, the company benefits from oil and gas prices without having to deal with production costs.
Let me share some "mind-blowing" facts with you.
- The company has a 99% operating margin in its royalty business.
- It has an 89% infrastructure operating margin.
- In the 2020-2023 period, its operators replaced 120% of production, meaning its reserves grew despite rising output.
- By 2028, the company expects 30-40% production growth without additional capital spending!
In fact, 18% of Topaz's acres are in the underdeveloped NEBC Montney, where more than 90% of reserves are undeveloped.
With regard to its dividend, 38% of the dividend is covered by infrastructure revenue (assuming $0 natural gas and $0 oil).
After seven dividend hikes, TPZ currently pays C$1.28 per share in annualized dividends. This translates to a yield of 5.7%.
Thanks to a fantastic low-cost business model, the dividend and all corporate costs are covered at C$0.50 per Mcf natural gas (AECO) and $55 WTI!
Dividend growth will depend on production growth and the pricing environment, with steeper hikes in times of strong pricing and production growth.
[...] we're not just going to increase the dividend to increase the dividend. If you've noticed over the last two to three dividends, they've been small, sustainable. Dividend increases, and that's by design as the business grows, the dividend should grow alongside it. And so if we see 6% production growth in a year, we should -- you can anticipate that we're going to try and increase the dividend 6% in that year as well. - TPZ:CA 4Q23 Earnings Call
At C$3.50 AECO and $80 WTI, the company generates close to $140 million in incremental free cash flow over a C$0 AECO and $55 WTI market. That's 7.5% of its market cap!
Every $2 change in WTI adds $5.8 million in revenue based on 2024 production estimates.
As I'm bullish on both natural gas and oil, I believe Topaz Energy is a fantastic play with a very attractive valuation, given its free cash flow earnings power at elevated energy prices.
Hence, TPZ has become one of my favorite dividend and energy stocks, which means you'll hear a lot more from me on this stock in the future.
Lamb Weston (LW) - Not A High-Yield Play, But Very Cheap
Lamb Weston may not have a high yield, but it's a highly interesting play with an anticyclical demand profile and a very attractive valuation.
On April 6, I initiated coverage of this stock, using the title "Over 20% Crash, 60% Upside? A Deep Dive Into Lamb Weston's Dividend Potential."
Lamb Weston is one of the world's largest producers of fries and other forms of fried potatoes. It's the supplier of McDonald's (MCD), which accounted for 13% of the company's sales last year.
The company benefits from the simple fact that everyone loves fries (it's the favorite food of every generation, as I wrote in my article) and its ability to exploit this by offering really good fries.
In fact, when I published my LW article, I got a load of messages from restaurant owners and investors who all had something to say about the fantastic quality of their fries.
This helps, as the company's target market is strong.
While the market for fries is highly saturated, it still saw 5% annual growth before the pandemic. Even including the pandemic, annual global demand growth for fries was 3% through 2022, as we can see below.
In many emerging markets, annual growth is in the high-single-digit to the low-double-digit range, with a similar fry order frequency compared to developed nations like the United States and the United Kingdom.
With that said, the company, which is a spin-off from frozen foods giant Conagra Brands (CAG), dropped after earnings as it saw weakness due to elevated inflation. This hurt volumes in certain areas.
However, that wasn't the main issue.
The biggest issue was a transition to a new enterprise resource planning system, which caused supply chain disruptions, forcing some customers to temporarily buy from other sources.
While this wasn't great for existing shareholders, it tremendously sweetened the deal for new and potential investors.
After hiking its dividend by 28.6% on December 13, the stock currently yields 1.6%.
While that may not be a lot, the company aims to maintain a low payout ratio in the 24-35% range and has increasingly focused on buybacks in recent years.
The current payout ratio is just 22%, which suggests aggressive dividend growth down the road, especially because earnings growth is expected to remain high.
Using the FactSet data in the chart below, analysts expect 19% EPS growth in FY2024, potentially followed by 12% and 8% growth in FY25 and FY26, respectively.
Due to its recent stock price sell-off, LW trades at a blended P/E ratio of 16.1x, which is below its normalized P/E ratio of 24.6x.
However, even if we apply an 18x multiple, as I did in my prior article, we get a longer-term price target of $121, 36% above the current price.
Going forward, I believe LW offers a great mix of value, dividend growth potential, and improving pricing power in an anti-cyclical consumer segment.
We started buying LW for a family account last month.
AbbVie (ABBV) - A Wide Moat, 4% Yield, And Undervalued
AbbVie was the first healthcare stock I bought for my dividend growth portfolio.
I consider it to be one of the best high-yield stocks on the market across all segments.
While it did have some issues after its blockbuster drug Humira lost its patent, the company is doing very well when it comes to paving the road for elevated future growth.
In the first quarter of this year, for example, ex-Humira revenue growth was 15%. Key contributors to this growth were Skyrizi and Rinvoq, which (combined) grew by more than 50% in their fifth year on the market.
In fact, these two blockbuster drugs are expected to have a combined revenue of $27 billion in 2027 - 68% above 2024 guidance!
- Skyrizi achieved global sales of $2 billion with a growth rate of 48%. This allowed it to secure a leading position in the U.S. biologic psoriasis market with a prescription share above 35%.
- Rinvoq, with global sales of roughly $1.1 billion, saw 61.9% growth. According to AbbVie, this drug established an in-play share leadership in almost 20 key international markets for rheumatoid arthritis.
Moreover, the recent acquisition of ImmunoGen has accelerated AbbVie's move into the solid tumor market and improved its oncology pipeline, which now has more than ten drugs in Phase 3 studies - as of February 2, 2024.
Adding to that, over the past ten years, ABBV has returned 350%, beating the S&P 500's 235% return by a wide margin.
On top of that, after its spin-off from Abbott Laboratories (ABT), the company has hiked its dividend every single year.
Due to recent stock price weakness, it now yields 3.9% with a 55% payout ratio. It has a five-year dividend CAGR of 8.3%.
Analysts expect EPS to accelerate after the Humira shock. While EPS is expected to grow by just 1% this year, 2025 and 2026 are expected to see 6% and 12% growth, respectively.
Using its 10-year normalized P/E ratio of 13.2x, the company has a fair stock price target of $177, 11% above its current target.
That said, I expect growth to accelerate on a consistent basis as patent loss risks are subdued with the potential of new drugs entering the market.
Especially if the market continues to rotate from growth to value, I expect ABBV to be a wide-moat haven with elevated income, consistent growth, and an attractive valuation in a low-risk sector.
Hence, I'm adding to my ABBV position with almost every correction.
Takeaway
Jamie Dimon’s recent comments on persistent inflation and higher interest rates support my views on the economy.
I believe we’re in a new era defined by green energy transitions, geopolitical shifts, expensive infrastructure investments, and substantial fiscal deficits.
This environment demands strategic investment, for example, in undervalued dividend stocks with strong business models and pricing power.
Here, Topaz Energy stands out with its royalty-based revenue model, high operating margins, and robust dividend yield, making it an ideal inflation hedge.
Lamb Weston, despite recent setbacks, offers significant upside due to its resilient demand and strong growth potential.
Meanwhile, AbbVie continues to be a powerhouse in the healthcare sector, benefitting from a wide moat, consistent dividend growth, and promising new drug developments.
These plays are not just safe havens, but I'm convinced they are poised for long-term growth - even in a challenging economic environment.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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