When a new year starts it is common for investors and even financial experts to take what happened last year and extrapolate those results into their expectations for the new year. It’s human nature to view events as linear, when the reality is that they move in cycles.
2017 was the year of tech stocks, and an overall upward trend in stock values that never took a break.
2018 started off with stocks continuing to “melt up” as the financial news talking heads like to say. Another theme is that there will be a stock market correction in 2018, which means a 10% or greater decline in the market averages. It is impossible to predict when the next correction will occur, but I do expect that investors who have not felt the pain of a steep decline to act irrationally. The result could be very steep drops in popular, low profit, non-dividend paying stocks like Amazon.com (Nasdaq: AMZN), Netflix, Inc. (Nasdaq: NFLX), and Tesla Inc. (Nasdaq: TSLA).
I expect that the trends which drive stock prices in 2018 will be different. Also, since I focus on dividend paying stocks, I look for potential among companies that pay dividends and where the economic trends could lead to nice share price gains. Here are three trends to watch out for and stocks that will benefit from the trends.
Rising Interest Rates. The Fed is going to increase short term rates at least three times in 2018. Also, long term rates, as tracked by the 10-year Treasury Note yield are starting move higher. Higher economic growth should lead to higher rates all along the yield curve. With rising rates, there will be companies with lots of adjustable rate debt that will see profit margins squeezed. We don’t want to own that type of stock. (See my recent article, 3 High Yield Stocks to Sell on the Fed Rate Increase, for the names of popular ones you’ll want to clear out you’re your portfolio sooner than later.)
Then there are companies that issue adjustable rate debt. These will see expanding profits and are the stocks to own in a rising rate environment.
The primary business for Blackstone Mortgage Trust (NYSE: BXMT) is to make mortgage loans on commercial properties. They make loans up to $500 million on a single property, which puts them in a very small group of financial companies that will write very large loans on commercial properties. The company is structured as finance real estate investment trusts (REITs). The commercial mortgages issued by Blackstone Mortgage are retained in the company’s $10.7 billion investment portfolio.
This is a conservatively managed business, with an average loan-to-property value of 61% and 2.6 times debt to equity leverage. Income is the interest earned from the mortgage portfolio minus the cost of the debt. The portfolio is 92% floating rate loans, with debt rate matched to each loan. The result is that as interest rates increase, so will Blackstone’s profits. Management estimates that for each 1.0% increase in LIBOR, net income goes up by $0.26 per share. BXMT currently yields 7.8%.
Economic Growth and Corporate Profits will be Stronger. The decrease in business regulations from the federal government and the corporate income tax rate reduction will be strong tailwinds for business results in 2018. Hotels are a business sector where profits fluctuate with economic and business activity. After three years of flat profit margins, hotel owners could see profits move dramatically higher in 2018. Hotel/lodging REITs own hotel properties that are managed by third party companies. These REITs do participate in revenue increases. The hotel REIT shares pay attractive yields with the potential for significant dividend increases in 2018.
Host Hotels and Resorts Inc (NYSE: HST) is the largest lodging REITs with a $15 billion market cap. The company owns a diversified portfolio of 89 premium hotels with over 50,000 rooms. These include upscale central business district locations, resort locations, and prime airport lodging facilities. Third party management contracts are with Marriott, Sheraton, Hyatt, Hilton and other premium hotel operators.
For 2017, the company generated adjusted FFO of $1.65 per shares. Out of that dividends of $0.85 per share were paid. FFO per share was basically flat compared to 2016 and the dividend stayed level. Host Hotels did declare an additional $0.05 per share dividend in December. Third quarter 2017 RevPAR was $176.87, down 1.5% from $179.63 for Q3 2016. These numbers are a good indication of how lodging revenues and profits have been very flat. A shift to increasing RevPAR will allow the company to grow the dividend and propel the share price higher. Full year 2017 results come out on February 22. HST currently yields 4.7%.
Ecommerce sales will continue to grow. Continued growth in ecommerce is one trend from 2017 and earlier years that will continue into 2018. Amazon is the 800 lb. gorilla in ecommerce but operates on a business model that puts sales growth over profits. This is a stock that has a P/E of 355, and a share price held up by investor faith. If investors start to doubt the Amazon model, the share price could crater badly. However, a big drop in the Amazon stock price won’t stop the double digit annual growth in ecommerce sales. The profitable winners from this growth are warehouse owners. One study shows that ecommerce fulfillment requires three times the warehouse space compared to traditional brick-and-mortar retail operations.
Prologis, Inc. (NYSE: PLD), with a $33 billion market cap, is a global logistics giant. The company owns or partially owns properties and development projects across 676 million square feet in 20 countries spanning four continents. The Prologis portfolio is concentrated in population centers where consumption and supply chain reconfiguration (to better serve ecommerce fulfillment) drive logistics demand.
Despite the recent pullback in REIT values, industrial/warehouse REITs have been one of the hot REIT sectors. Industrial/warehouse properties in prime urban and transport hub locations have very high barriers to new competition, and vacancy rates are at all time lows. There is plenty of potential for Prologis to increase rental rates.
The company has increased its dividend by 57% over the last five years. I forecast continued double digit annual dividend growth. The stock yields 2.8%.