3 US Income Stocks for Low Rate World

The Federal Reserve has kept interest rateslow, despite a strengthening US economy. We reveal three US income stocks for investors looking for yield

Karen Kwok 28 July, 2016 | 4:19PM
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The US central bank yesterday chose to hold interest rates at the range of 0.25% to 0.5%. The news was widely expected within the industry, but the Federal Reserve’s statement did suggest greater confidence in the overall US economic outlook thanks in part to strengthening employment figures.

“Near-term risks to the economic outlook have diminished,” the Federal Open Market Committee said in its July meeting’s statement, adding that “job gains were strong in June following weak growth in May” and other labour market indicators point to “some increase” in labour utilisation in recent months.

Inflation has continued to run below the committee’s 2% objective, but they believes it will catch up over the medium term, putting pressure on households and indeed the interest rate decision.

Is a September Rate Hike Possible?

Rick Rieder, chief investment officer of fundamental fixed income at BlackRock said while the Fed recognises that US economic data remains stronger than that seen in much of the rest of the world, it is adopting a “wait and see” approach. He said the Fed “leaves the door open to some small degree” for an interest rate rise this year, possibly in September.

David Kelly, chief market strategist at JP Morgan agrees, holding the same view of a possible September rate hike.

“Near-zero rates are incongruous with the Fed’s positive view of the economy. By maintaining a near-zero policy rate while economic growth is improving and the labour market is strengthening, the Fed faces the risk of eventual inflation or asset price bubbles,” Kelly said.

“For now, inflation appears benign and equity valuations still look reasonable, suggesting moderate increases in both stock prices and long-term interest rates over the next few quarters.”

However, he argued that an interest rate rise would require a continued steady stream of positive economic data and calm markets.

Salman Ahmed, chief investment strategist at Lombard Odier echoes Kelly’s views, saying that a rate hike will happen on the condition that data strengthens in the interim period. 

“The market is already pricing around 50% likelihood of another hike by year end. In our view, the Federal Reserve is likely to hike once more this year and most likely in December,” Ahmed said, adding that Janet Yellen’s speech at Jackson Hole annual economic conference in August will be the key to asset how close the Fed will raise rate.

The S&P 500 index closed down 0.1% at 2166.58 on Wednesday as the Fed signalled a rate hike in September.

3 US Income Stocks

While the US investors are likely to suffer from an ultra-low interest rate environment a little longer, high yielding stocks might become an attractive alternative for them – and investors on this side of the pond – to seek a more attractive income. 

For this reason, we have identified income stocks below with a dividend yield above 3.5%. There are 83 stocks fitting that criterion in Morningstar Select. However, income investors should be wary of simply opting for the highest yielding stocks as this pay-out is often unsustainable, as a stock’s yield can look artificially inflated by a recent drop in the share price. Therefore we pick three stocks that Morningstar analysts are confident have sustainable cash flows, indicating their ability to cover the dividend over the long term.

Valero Energy Corp (VLO) is the largest independent refiner in the United States. It operates 14 refineries with a total throughput capacity of 2.9 million barrels a day in the United States, Canada, and the United Kingdom. Its stock yields at 4.02%. Morningstar analyst Allen Good expects that the company will increase its free cash flow and potentially increase distributions to shareholders via higher dividends and repurchases.

In 2015, the company repurchased almost $3 billion worth of shares and increased its dividend, Good said, and he expects it to continue repurchasing shares and steadily increasing its dividend over the next few years as market conditions remain favourable. The company stands to benefit from its ability to capture a wide variety of crude discounts, Good added.

Spectra Energy Partners (SEP) is engaged in the transmission, storage and gathering of natural gas, the transportation and storage of crude oil and the transportation of natural gas liquids. It owns all of its general partner and corporate parent Spectra Energy’s U.S. long-haul natural gas and crude oil pipelines. SEP is also one of the largest natural gas infrastructures, with a very attractive slate of projects to propel future distribution growth, Morningstar analyst Peggy Connerty said. The stock yields at 5.3%. The company’s balance sheet is solid, and the company is one of the most stable cash generators analysts cover and a refuge during volatile times, Connerty added.

HollyFrontier Corp (HFC) is an independent petroleum refiner that owns and operates five refineries serving the Rockies, midcontinent, and Southwest. The company stock yields at 5.4%. Good said HollyFrontier steadily and generously returns cash to shareholders through special dividends or share repurchases. He added that the company is one of the biggest beneficiaries of domestic crude discounts.

“Holly took advantage of the weak refining environment in 2009-10 to acquire additional refining capacity in the midcontinent region at attractive valuations, which increased its exposure to discount crude,” Good said.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk