It looks like the long-awaited coronavirus vaccine has finally arrived. That’s great news all around. It’s also a huge benefit for stocks. A vaccine could mean the end of this pandemic. The end of lockdowns means that the economy can free the other arm that is still tied behind its back and absolutely boom next year.
While the market indexes have already recovered, the bull market has been very uneven so far. Technology stocks are thriving as people rely on technology more than ever during the lockdown. That sector is driving the market higher while many other sectors are still wallowing in bear market oblivion.
Travel and hospitality stocks have been decimated. The energy sector is down 45% YTD and financial stocks are also well entrenched in negative territory for the year. There is great opportunity in the market on the cusp of better days. Despite the high valuation of the market indexes, great bargains and high yields can still be had.
The day of the vaccine announcement, those sectors that depend on a full recovery came alive. Hospitality stocks soared. The energy and financial indexes had one of their best days in history. The mere suggestion that the pandemic might be over soon prompted these sectors to make up for lost time.
Of course, the rally could be a little premature. There could be setbacks ahead. But we got a taste of what lies ahead on the other side of this pandemic. And the pandemic will end. It’s just a matter time. Now, it looks like that time will be sooner rather than later.
It’s time to start investing for the other side of the pandemic. There are two particularly great opportunities for dividend investors right now—one is conservative and the other is more aggressive. Let’s take a look:
Realty Income (O)
Realty Income (O) is perhaps the most popular and successful REIT of all time. While people buy REITs primarily for income, Realty has amassed a track record for reliable income that is second to none. In fact, the company actually refers to itself as “The Monthly Dividend Company”.
Realty generates reliable income from a portfolio of 6,500 properties rented to over 600 tenants in 49 states, Puerto Rico and the U.K. The business model is a “sale-leaseback” arrangement whereby Realty Income buys established properties and rents them back to the tenants under long-term leases of 10 to 20 years. Most are “net leases,” which means the tenant pays all the expenses, removing unpredictability for Realty.
It’s worked. The REITs IPO was in 1994, but it has been operating since 1969. Since then it has paid 604 consecutive monthly dividends and the payout has been raised in 92 consecutive quarters. Since the IPO, it has provided an average annual return of about 15%, compared to less than 10% for the overall market. And that’s after recent lousy performance.
This is a great income stock, but it’s had a rough year, down more than 15%. It’s also down almost 30% from the 52-week high. That means the stock is cheap. That’s good. But why is it cheap?
The entire REIT sector has underperformed this year primarily because it has been dragged down by hospitality, leisure, office and retail properties that have taken it on the chin as people are forced to stay at home. That’s were Realty comes in. About 85% of the portfolio is retail properties. And the retail subsector is down over 35% for the year.
That said, the overwhelming majority of properties are in essential services and discount retailers that are doing fine. The service properties are having a harder time, particularly movie theaters and fitness centers. But in October, Realty still collected 93% of rents under contract. That put the REIT into positive earnings growth for the quarter.
In the first nine months of this year, revenues were actually 20% higher and earnings per share are actually up 3.7% over the same period last year. Even in a severe recession, earnings are still growing.
First of all, the service properties will bounce back when the pandemic ends. Secondly, the stock is down way more than the operational performance justifies because of its association with a group under pressure in the pandemic.
The pandemic will fade. And investors will be attracted to one of the very best income securities ever at a time when the 10-year Treasury is paying just 0.92%.
Valero Energy (VLO)
Valero Energy (VLO) is the largest petroleum refiner in the U.S. The San Antonio-based refiner operates 15 petroleum refineries in the U.S., Canada and the U.K., with a capacity of about 3.1 million barrels per day (MMbpd). It markets products in 43 states, Canada, the U.K., Ireland and Latin America and has over $100 billion in annual revenues.
It also operates 14 ethanol refineries, a rapidly growing renewable diesel business, and midstream piping and storage assets. But the main event is still petroleum products.
This is a cyclical business and this is not a good stock to own in a recession. The refining business has been particularly hard hit during this pandemic-induced recession as demand for gasoline and diesel crashed during the lockdowns.
The lockdown economy has taken a toll on VLO. The stock is down 50% YTD and over 60% from the 2018 high. Of course, demand has bounced back strongly since the strict lockdowns of last spring and demand for gasoline and diesel got back to about 90% of pre-pandemic levels. But there was still a huge excess of inventory to work off and the dark days for the business lasted through the third quarter.
Let’s take a step back. Valero is the most technically advanced and cost efficient refiner in the country. The business is highly cyclical. Oil refining stocks perform badly in recession but typically fly much higher in the part of the economic cycle when the recovery takes hold. And that’s where we are now.
The recovery so far has included technology and consumer staples to the exclusion of the more mainstream economy companies in energy, finance and industrials. But, as I mentioned above, the next phase of the recovery will indeed boost these neglected industries. It has to. There can be no complete or robust economic recovery without gasoline and diesel.
We got a taste of what lies in store for VLO after the vaccine announcement. When the market sensed the other side of this pandemic sooner rather than later, VLO stock soared 32% in one day. Sure, the market may have gotten ahead of itself. It may be a while longer before we reach the Promised Land.
It could still be early for VLO. There may still be some downside volatility ahead. But it’s a great bet that the stock price will be a lot higher six months to a year from now. In the meantime, if pays you a 7.8% yield to wait. And the CFO recently referred to maintaining the dividend payout as “the number one financial priority.”