Profit Sell Alert: Fresenius Medical (FMS)

When we launched Fortress Portfolio, we included a special report called “Money in the Bank.”

This report contained five undervalued high-yield dividend aristocrats. And we suggested using these picks as alternatives if you were not interested in some of our primary Fortress Portfolio picks for any reason.

Aristocrats are companies that have grown their dividends for 25+ consecutive years. They are the gold standard of dividend dependability – companies with strong balance sheets, stable businesses, and income-friendly, battle-tested management.

However, aristocrat status doesn’t ensure a dividend is safe, just safer than those outside the category.

For instance, during the COVID-19 pandemic and market volatility, 4% of aristocrats cut their dividends. That’s compared to 25% of companies with five- to nine-year dividend growth streaks.

Today, we’re writing to tell you that one of our “Money in the Bank” recommendations, Fresenius Medical (FMS), is planning to cut its dividend by 17%.

It won’t be official until May when the board announces the annual dividend. But this breaks our original investment thesis for including this company in our bonus portfolio.

That’s why today, we’ll be removing it from our Money in the Bank portfolio.

We’re currently up 20% on the position since we bought it just three months ago on January 17. So we’ll take those profits and put them to work in far better, undervalued aristocrat opportunities.

For now, I’m diving into research on a great low-risk, high-yield aristocrat alternative opportunity for you to consider as a replacement in that bonus portfolio. And I’ll share all the details of this new recommendation in a future Fortress issue or special alert.

In today’s alert, let me tell you briefly what happened with Fresenius and how it ended its 25-year dividend streak. The unique reasons behind it show me that this was a company-specific situation, and the other dividend aristocrats across our portfolios remain safe and in good shape.

Fresenius Medical is the world’s largest operator of kidney dialysis centers. And two things are primarily responsible for killing its 25-year dividend growth streak.

First, the COVID-19 pandemic was responsible for the deaths of 7 million people, mostly the elderly. Since kidney failures primarily affect this age group, this impacted Fresenius’s key customer base.

However, the company probably would have recovered if not for the second major problem: its debt-funded mergers and acquisitions (M&A) strategy.

For 15 years, Fresenius took advantage of 0% or negative (in some parts of the world) interest rates. That’s what helped it acquire smaller rivals and build its 4,100-dialysis center portfolio.

But we now live in a very different world. Thanks to the worst inflation in 42 years, central banks all over the world have been hiking rates, averaging more than one hike per day, for over a year now.

Fresenius has $1 billion in bonds maturing in 2023 and 2024. And because of much higher interest rates, the cost of refinancing this debt will be much higher. In fact, the 10-year bonds it sold in 2016 at 1% now yield 3.5%.

At these levels, credit rating agency S&P is worried Fresenius might have trouble managing its debt. That’s why it cut the credit rating outlook from BBB to BBB- on February 23.

Effectively, S&P is saying it estimates an 11% chance that Fresenius Medical could fail and go bankrupt. If it gets a credit downgrade, that risk will be 14%. 

Faced with restructuring, credit guarantees and paying down debt, and decoupling from its parent company, Fresenius simply doesn’t have the cash flow on hand to pay a growing dividend to shareholders at this stage.

The board has decided to change its dividend policy to pay whatever it thinks is prudent in a given year. Not only does that mean a 17% dividend cut this year… It also means Fresenius may potentially never again become an aristocrat.

While management is talking a big game, predicting 24-25% earnings growth in two years... And rating agencies, analysts, and the bond market think they will ultimately succeed with the turnaround...

The decoupling from its parent company, Fresenius SE, indicates to us that it has doubts about that turnaround.

We don’t want to stick around to find out.

As I like to say, stock price is vanity, cash flow is sanity, but dividends are reality.

Fresenius kept growing its dividend through three recessions, the tech crash, the Great Recession, and the Pandemic.

Now, the board recommends abandoning its previous dividend policy and cutting the dividend because things have never been tougher.

Over the last 50 years, $100 invested in dividend cutters and eliminators has become $80, or $11 adjusted for inflation. That’s an 89% real loss.

This is why our policy is, “When the dividend is cut, it’s time to sell.”

When we bought Fresenius, it was trading at 10 times its earnings, compared to its historical 19 times. It was 50% undervalued and had a high margin of safety. So high that even if something went wrong and the thesis broke, you would likely not lose a lot of money or would even make money.

And that’s worked out for us. Anyone who bought Fresenius when we recommended it can get out with a 20% profit in just three months.

Looking ahead, there are 135 dividend aristocrats and champions (non-S&P companies with 25+ year streaks). And many are highly undervalued and far safer investments than Fresenius.

Unlike dividend cutters, $100 invested in dividend growers over the last 50 years became $14,405 or $2,208 adjusted for inflation – a 2,108% gain.

Those are the kinds of safe, smart long-term gains we look for, even if they start out small. We stick to the facts, fundamentals, and truth with our investments. If those change, we cut our ties and find something that will serve us better.

I look forward to bringing you a new recommendation to do just that soon.

In the meantime, because the fundamentals of Fresenius have changed and its thesis is broken, we’re removing it from our model portfolio. Thanks to buying it at a 50% discount, you can walk away with a 20% profit to buy a much better high-yield aristocrat later.

Action to Take: Sell Fresenius Medical (FMS) for a 20% gain.

Safe investing,

Adam Galas Chief analyst, Fortress Portfolio