The next recession is coming.
OK, so the next recession is always coming and, no, I don't know when it will happen. But I do know that the most successful investors are the ones who have a plan for the next recession in place now.
An important part of my recession-readiness strategy is to own a solid collection of high-yield dividend stocks that you can count on to continue paying investors during a recession. Not only does that promise of cash make it easier to hold during the downs of a recession-driven market crash, but the cash itself is a powerful tool you can reinvest during a downturn to supercharge your long-term wealth.
Three that I own that you might find surprising are Retail Opportunity Investments Corp., and Ford, and CenturyLink. Yes, all three pay high yields, between 4.3% and 8.8% at recent prices. But beyond that, there are very real reasons investors might shy away from them. Here's why they make the cut as worthy investments during the next recession.
The right kind of retail for a recession
It would be easy to assume that Retail Opportunity Investments Corp. -- a real estate investment trust whose name starts with the word "retail" -- might not be a good company to own in a recession. After all, traditional retail is already struggling under the weight of the growth of e-commerce. The burden of a recession would only make things worse, right?
Well, that's not necessarily the case, particularly for the kind of real estate ROIC owns. The company specializes in high-traffic, grocery-anchored shopping centers across the U.S. West Coast. Supermarkets carry the kinds of consumer staples that people rely on just as much during a recession as in an economic boom. Taking it a step further, the consistent traffic that supermarkets drive to these shopping centers makes them attractive to other retail tenants. This includes beauty salons and spas, restaurants, gyms, and lots of other retail categories that are also minimally impacted by e-commerce.
Lastly, ROIC has top-notch, experienced leadership. CEO Stuart Tanz has navigated multiple economic cycles while holding the reins of a REIT, and over the past couple of years, he's been steadily cleaning up ROIC's portfolio of properties. Revenue declined slightly in the third quarter and could decline again as the company works through a couple more asset sales, but it continues to boast a very high rate of leased properties, well above 97% every quarter for more than five years straight.
If there's one thing to monitor with ROIC, it's leverage. Its 48% debt to assets is reasonable, but its debt-to-EBITDA ratio of 6.8 is on the higher side. Management has said lowering leverage is a priority, and over the past 18 months has done so:
With a cash dividend payout ratio around 75%, a strong, cash-generating collection of properties, and an experienced management team, Retail Opportunity Investments is a retail REIT that looks worth owning in any economy.
Fording the economic cycles with a boatload of cash
Automakers are just about the textbook case of a business that's heavily exposed to economic cycles. People still buy groceries and keep paying the power bill when money is tight, but buying a new car goes out the window if there's even a whiff of financial trouble coming. Moreover, Ford's business is unlikely to prove immune from a decline in car sales when the next recession hits.
So what makes Ford worth buying now and owning through a recession? In short, because it's a business that's built to continue paying a high yield in good times and bad. Through the end of the third quarter, its balance sheet included more than $37 billion in cash, with $14.8 billion in long-term debt related to its operations (the vast majority of Ford's debt is tied to its auto lending business and secured by vehicles).
This substantial cash position serves a few important purposes for Ford, including giving it financial flexibility to invest in its operations, a margin of safety for its lending business, and as a hedge against financial weakness during future downturns in auto sales. Management says that Ford would be able to maintain the current dividend, which yields more than 6% at recent prices, in nearly any economic environment.
That's why it has a place in my stable of high-yield stocks I'll be happy to own in a recession.
Not your father's regional telecom
Of the three companies discussed here, only CenturyLink has the kind of business that tends to hold up well during a recession. The problem is, much of CenturyLink's core telecom business is also losing relevance as people cut the cord. This is evident in the company's revenue and cash flows this year:
So that's the bad news. The good news? CenturyLink is steadily moving away from its history as a regional telecom, following its merger with Level 3 Communications in 2018, which brought it into the 21st century as a provider of high-value services, including a global supplier of high-speed fiber.
In the third quarter, we started to really see some of the benefits of the Level 3 merger. Revenue fell 4%, but margins improved as costs fell 8% as the company focused on high-value services, while the continued integration of the two businesses resulted in a 15% drop in SG&A -- sales, general, and administrative -- expenses.
The result so far this year is $2.1 billion in free cash flow, enough to cover the current dividend and leave more than $1 billion it can apply toward debt reduction.
Lastly, even as its legacy business continues to decline, CenturyLink's new services are growing in demand, more profitable, and should also prove to be recession-resistant. It's been an ugly few years for CenturyLink shareholders. But looking forward, I expect it will prove worth owning, particularly when the next recession hits.
10 stocks we like better than CenturyLink
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and CenturyLink wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of June 1, 2019
Jason Hall owns shares of CenturyLink, Ford, and Retail Opportunity Investments and has the following options: long January 2020 $17 calls on CenturyLink. The Motley Fool owns shares of and recommends Retail Opportunity Investments. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.