The Federal Reserve is finally set to lower interest rates. When those 11 rate-hikes will be partially reversed remains up for debate, but the next 100 basis point move in rates is expected to be lower. And the financial markets are giving high odds that rates will be lowered from September to December of this year, and even lower by the end of 2025. Once investors have no more high risk-free rates of return from long-term and intermediate-term Treasuries, the lagging stocks that pay dividends should become much more attractive for long-term investors.
Companies which depend upon consumer spending carry a high degree of interest rate sensitivity. That’s true for retail, as well as restaurants and home improvements as their businesses are predominantly dependent on the flow of credit. Oggonomics is singling out some of the larger likely beneficiaries which should be more attractive than their peers’ stocks in a rate-cutting environment. One attribute has to be dividend coverage, but another attribute is that the stocks of these dividend payers had to be hurt by higher interest rates.
It would be very tempting to just take the cynical view Jerome Powell and the Federal Reserve have become so used to higher rates that there is no way they will cut rates right before the election. That said, the financial markets are forecasting that the next big move in interest rates will be lower by the end of 2024 and lower from there in 2025. Jerome Powell even fessed up in Jackson Hole on August 23 — “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.”
There are of course no guarantees that lower rates alone will make these great stocks. Some companies just manage to disappoint their investors. And this is in no way any form of investment advice. So, which companies with a high degree of dependence upon consumers and Joe Public appear to have more upside than peers as interest rates are soon to be heading lower?
THE CONSUMER DISCOUNTER
Dollar General Corp. (NYSE: DG) was a company that could do no wrong for years and years. Then came the wave of inflation and the eventual unwinding of post-Covid money in its customers’ bank accounts. By offering so many goods in the sub-$10 category and with a focus on low prices, Dollar General simply did not have enough room to adjust prices to protect its financial metrics because of stick-shock worries. And its customers were also paying about 5% more in interest rates of late compared to pre-inflation and interest rate hike years.
Dollar General shares at $123 presently are just under the $130 lows early in 2020 as the pandemic wrecked so many stocks. But in 2022 it was a $250 stock — so it has lost half of its value since that peak. One problem that dividend investors will have here is that a 1.9% dividend yield is just not that enticing right now. It has raised its dividend payout per share by more than 60% since 2021 and with estimates of more than $7.00 this year and over $8.00 in earnings per share Dollar General can keep raising its dividends (currently paying only 1/3 of income as dividends). We all have to consider that the current higher rate and higher operating cost environment are not helping its finances.
One current issue is that Dollar General’s debt-to-equity is handily above 2.2 and that is higher than most discount stores and major retail destinations. Ongoing competition in this space is always an issue, and the onslaught from Amazon, Walmart, other discounters and even the troubled drug stores and department stores cannot be overlooked. Analysts have a consensus price target of about $145 even though they have not started endorsing the stock with too many Buy/Outperform ratings. Dollar General should be one of the larger beneficiaries in the retail sector of a lower interest rate (and lower inflation) environment.
ALSO READ: 3 REITS TO THRIVE WITH LOWER INTEREST RATES
RESTAURANT LEADER
Darden Restaurants, Inc. (NYSE: DRI) is in the difficult position of being a restaurant owner. This sector has been pinched by higher labor and operating costs, higher rents and higher food costs. Remember when we used to joke about $20 burgers and $30 pizzas in the future – that is here already after tax and tip. Translation: major squeeze on margin metrics. It has nearly 200,000 hourly and salaried workers. What Darden still has going for it is that it’s $18 billion market cap is the culmination of the following brands and over 2,000 store locations: Olive Garden (almost half of its stores), LongHorn Steakhouse, Yard House, Ruth’s Chris Steak House, Cheddar’s Scratch Kitchen, The Capital Grille, Seasons 52, Eddie V’s and Bahama Breeze. It is very diversified and now Chuy’s Holdings, Inc. (NASDAQ: CHUY) is joining in that mix with a long-term aim of 350 possible store locations across the U.S. over time. This summer, Darden entered into an all-cash transaction with an enterprise value of $605 million to acquire the Tex-Mex chain.
Darden’s 3.6% dividend yield is the highest of the restaurant chains in the S&P 500. It is also a leveraged company because its debt-to-equity ratio is already about 3.0 and its ROI and ROA are both lower than many of its sit-down casual dining and fine dining peers even after you look outside of the S&P 500 that is dominated by fast-food chains. While the dividend was recently raised, Darden was also only about 8.5% of the way into a brand new $1 billion share buyback plan. Unfortunately, stock buybacks compete directly with dividends when it comes to returning capital to shareholders.
The May 2024 financials are the latest available. This was prior to announcing the Chuy’s buyout but after buying Ruth’s Chris a year earlier. Its total long-term debt without classifying hedges and discounts was up to $1.44 billion versus $939 million a year earlier. The company has not yet used its $1.25 billion revolving credit line, but as of May 2024 its total interest expense of $138.7 million was versus $81.3 million in 2023 and $68.7 million in 2022. We might not ever get back to expecting 2022 levels on rates, but as rates normalize and the company has higher debt it could potentially see a normalized $30 to $50 million lower interest expense in the years ahead relative to 2024.
ALSO READ: 2 FINANCIAL STOCKS THAT REALLY NEED LOWER INTEREST RATES
THE HOUSING MONSTER
Home Depot, Inc. (NYSE: HD) has not exactly had the world’s worst year, but at $372 the DJIA component has effectively been a nothing burger after peaking around $415 in 2021. All that free money and all that stay-at-home has run its course. The difference here with other consumer-facing stocks is that Home Depot is up 7% YTD and up 15% over the last year — but that is still down 11% from its all-time high. Rival Lowe’s Companies Inc. (NYSE: LOW) is up 11% both YTD and over a year ago.
The big rub for anything tied to housing has already surged in anticipation of a rate-cut cycle. Look at some of the homebuilder leaders performance just in 2024 (YTD) alone: Hovnanian +43%; Toll +39%; KBHome +34%; NVR +30%; and Pulte +28%. Many of the building products and equipment leaders are up 20% to 40% YTD, and that likely isn’t because a building boom in offices. Home Depot has been able to carry a lot of debt for years now, but its total long-term debt has grown from $42 billion as of Jan-2022 to almost $52 billion as of July 31. It’s assets have grown handily as well, but the biggest jump in assets was a $20 billion surge in Goodwill and Intangible Assets just in the last quarter.
Home Depot already pointed out in recent weeks that it expects tight demand to continue through 2024. It believes homeowners and renovations are being pushed to wait for lower interest rates, calling for a 3% to 4% decline in comparable-store sales.
Home Depot does of course have a huge dependency on builders and contractors, but those still ending up being dependent on the consumer one way or another. Home Depot’s balance sheet is leveraged, and higher interest rates make leverage more expensive. Lower rates will make Home Depot’s commitment to returning cash to shareholders via dividends (2.4% currently) and a long history of stock buybacks easier to continue.
