Alert: Sell VF Corp. (VFC), Buy Brookfield Renewable (BEPC)

Dear Reader,

Here at Fortress Portfolio, our goal is to build a portfolio that can withstand market volatility, recessions, record-high inflation, interest rate hikes, and other economic or personal setbacks better than the broad market.

To do that, we use our strict 1,000-point safety metrics to select the best dividend-paying investments our research indicates for the long term. These safety scores are based on historical dividend cut probabilities since WWII.

However, there are no guarantees in the market. Even the safest dividend has a 1 in 200 chance of being cut. And rather than holding on to positions for too long because of emotional attachment, we follow where the fundamentals lead.

This week, one of our recommendations, VF Corp. (VFC), broke our cardinal rule of increasing benefits for shareholders.

It cut its dividend, ending its dividend growth streak of 51 years. That means holding it in our portfolio no longer makes sense for our investing thesis.

So today, we’ll be removing it from our model portfolio. We’ll record a 14% loss.

While this is something we don’t like to see, holding only the strongest dividend-growing blue-chip stocks is the best way we know to safeguard your portfolio from market volatility (based on decades of back-tested history, as we laid out in our Manifesto).

In today’s alert, I’ll explain what happened and what makes VFC’s dividend cut a rare occurrence.

Plus, to keep our portfolio well-diversified and equally allocated, we’ll be adding a new play to fill VFC’s position.

Read on below to see how it is a better match for our portfolio… and how it can help us reach an even safer retirement than the projections currently coming out of VF Corp….

We like to target Dividend Kings – companies that have raised their dividend for 50 years in a row or more – for a couple of reasons at Fortress Portfolio.

Compared to the average S&P 500 company (which has a dividend growth streak of about 12 years). They showed:

And VF Corp. is only the third Dividend King to cut its dividend in the past 15 years.

Here’s what happened with the company…

VF Corp. is a global clothing and footwear company. It owns names like Vans, Timberland, The North Face, Supreme, and more. We liked it for its market dominance and growth potential in popular markets.

The basis for VFC's safe dividend thesis was simple. This is a company with strong brands and a skilled and adaptable management team.

VFC's previous free cash flow guidance was for about $700 million, slightly below its $790 million annual dividend cost.

With analysts and rating agencies confident that free cash flow would recover strongly in 2024 and beyond, making the dividend sustainable, VFC was facing just two years in which it would have to borrow modestly against its BBB+ credit rating. It also had $2.2 billion in cash and short-term borrowing facilities.

In fact, VFC has $552 million in cash, which was more than enough to cover the $90 million free cash flow shortfall management had been previously expecting.

However, in recent quarters, some of VFC's flagship brands, like Vans, have been struggling with 13% sales declines in America.

VFC was hoping that adjustments to its supply chain (now mostly complete) and enhanced online sales efforts would boost sales, but that hasn't happened so far.

That’s putting pressure on its free cash flow and borrowing prospects…

Previously, VFC’s debt/cash flow ratio, or leverage ratio, was expected to hit 3.7 in 2023, already above the 3.0 or below rating agencies consider safe.

But based on management's initial 2023 guidance, it now appears VFC’s leverage ratio might hit 4.8 in 2023. That could result in a credit rating downgrade, possibly to BBB or BBB- within the next two years.

Why is management tightening its belt? Because as I've explained in recent weeks, the job market is boosting the risk of inflation continuing to rise. And the bond market thinks the Fed is going to hike interest rates to 5%.

Facing rising economic uncertainty in 2023 and 2024 – and fears that a recession will be longer and more severe than expected – management chose to protect the balance sheet and support the spending required for the turnaround. Simply put, it wasn't willing to cover a much larger cash flow shortfall.

So it reduced its dividend by 40%, to an annual cost of $466 million.

While it's disappointing to see a former A-rated dividend king give up its 51-year dividend growth streak… Based on updated projections from management, we still would have downgraded VFC’s safety score.

“Adjusted cash flow from operations** approximately $0.7 billion, compared to the previous outlook of at least $0.9 billion; Capital expenditures approximately $200 million versus the previous outlook of $230 million.” – VFC management

Here is VFC's updated safety and quality score for the new 40% lower dividend.

We recently downgraded VFC's safety score to 80% from 100% on deteriorating fundamentals.

And if the recession is longer or deeper than expected, future guidance cuts might be necessary. Meaning VFC might protect its balance sheet with further dividend reductions.

So we’ll remove VFC from our portfolio today and use that space to replace it with a better alternative…

Fortunately, those who used sound risk management, such as our 5% or less risk-cap recommendation, have lost a small fraction of their money, 2% or less.

Action to Take: Sell VF Corp. (VFC) for a 14% loss.

Brookfield Renewable (BEPC) is a yieldco, the renewable energy version of a real estate investment trust (REIT) or midstream oil and gas corporation.

Yieldcos own operating assets to generate predictable cash flows.

Brookfield has been running global utilities since its founding in 1902. It owns the world's largest green energy power-generating portfolio on four continents in 20 countries and serves 30 energy markets.

It generates:

For context, one gigawatt can power 750,000 homes.

Brookfield Renewable employs 3,200 people to run its 8,700 green power facilities. And 140 of the world's best green energy executives run the company. It’s also backed by the global king in infrastructure investing, Brookfield Corp. (BN).

BEPC's portfolio of renewable energy assets is 90% under long-term contracts – called power purchase agreements – with utilities, most of which are investment grade.

70% of those contracts automatically adjust for inflation, so BEPC’s cash flows are automatically hedged for inflation. The average remaining contract is 14 years, creating predictable cash flow to support its safe and steadily growing dividend.

It also has strong geographic diversification, with no single market representing more than 10% of revenue.

It is the only yieldco with an investment-grade credit rating at BBB+. Meaning the fundamental risk of losing all your money with BEPC is just 5%.

BEPC has $4 billion in cash and short-term borrowing capacity to help it execute on its growth plans. It also has $20 billion worth of partner capital from Brookfield to put to work.

And those growth plans are impressive.

BEPC has a 13-year dividend growth streak and has been growing its dividend at 6% annually since 2000 when it was formed.

Its cash flow per share has been growing at 10% annually. And it's delivered 17% annual returns for investors over the last 20 years, turning every dollar invested into $32.

For comparison, $1 invested in utilities would be worth $5.40 today. While $1 in the S&P 500 would be worth $4.43. And $1 invested in the Nasdaq would be worth $5.80 today. In other words, BEPC has outperformed the S&P 500 by more than 7 times over the last two decades and the Nasdaq by 5.5 times.

Brookfield expects to grow at double-digits through at least 2027, just as it's done for the last 22 years.

And given that the global investment opportunity for green energy is approximately $3 to $5 trillion per year for the next three decades, this growth runway is both long and strong.

8% of that 10+% long-term growth guidance is already secured and funded. And management plans to grow the dividend at 5% to 9% over time. That’ll bring down its payout ratio and allow it to reinvest more into this business.

Speaking of payout ratios, rating agencies consider 90% safe for yieldcos, just like REITs. That's because of their long-term contracts with utilities.

BEPC’s payout ratio for last year and projected ratios are:

BEPC's dividend is well covered by its stable cash flow, supported by the strongest balance sheet in the industry, and operated by the world's most experienced green energy management team. And it's getting safer every year.

Analysts expect 13.2% long-term cash flow growth, meaning it offers a 4.6% safe yield today and 17.8% long-term return potential. Management is guiding for 14.6% or more.

That's better than just about any utility on earth and better than the Nasdaq's historical and future expected returns.

Action to Take: Buy Brookfield Renewable (BEPC)

Buy-up-to Price: $33 per share

Position size: 4.4% of your Fortress Portfolio. Up to 7.5% in individual portfolio.

If you want to retire rich and stay rich in retirement, you need to be prepared to own world-class blue-chips for decades.

During that time, all companies will face challenges. And sometimes our original thesis for owning one will break entirely. One to three Dividend Aristocrats (dividend raisers for 25 years-plus) will cut their dividends in any given year, which is usually a signal to sell.

The goal of Fortress is not to chase "sucker yield" but to strive for the maximum safe yield we can recommend to subscribers.

Not every recommendation will work out. But by focusing on diversification, previous history, thousands of data points, likely future models, and risk management… We can set ourselves up to outperform the broad market every year.

Rest assured that we remain eternally vigilant, always monitoring fundamentals that impact dividend safety and your long-term success.

There are no sacred cows here. When the facts change, we change our minds. To do otherwise would be foolish.

VFC's dividend cut is a signal from management that the turnaround is going a lot worse than expected.

And while the stock remains highly undervalued, personally I'm not willing pass up opportunities in far better companies. Companies like Brookfield Renewable, which is firing on all cylinders.

Blue-chip high-yield bargains are plentiful in all markets, but especially bear markets. And now that VFC's thesis is broken, now is the best time to take advantage of one of those bargains and move on to better a better opportunity.

Safe investing,

Adam Galas Chief Analyst, Fortress Portfolio