2 Cash Cows to Buy From One of 2022’s Best-Performing ETFs

I did a stock screen to find dividend ETFs that delivered positive returns in 2022. Of the 152 U.S.-listed ETFs in my screen, the Pacer Global Cash Cows Dividend ETF (GCOW) was the best of the bunch. 
Year-to-date through May 25, GCOW has a total return of 10.31%. Of the ETFs with “Dividend” in the fund name -- excluding theme-based, leveraged, or inverse funds -- only 22 had a positive return. Of those, GCOW had the best performance so far in 2022. 

It’s clear from my screen that investors are leaning heavily on dividend stocks in 2022. While that’s not unexpected, what is unusual is that GCOW is a global fund. It tracks the performance of the Pacer Global Cash Cows Dividend Index. 

The index’s constituents are selected based on projected free cash flow (FCF), earnings, free cash flow yield, and dividend yield. It’s looking for companies from the FTSE All-World Developed Large Cap Index with high free cash flow and dividend yields.

While the U.S. is represented in the ETF -- 33.1% of GCOW’s $472 million in total assets -- the rest of the stocks are companies based outside the country. That means the UK, Japan, France, and many others. 

For me, free cash flow is one of the most accurate ways I know to evaluate a company’s overall financial strength. Companies with positive free cash flow generate more cash than they need to invest in and keep the business running. 

While all 101 stocks held by GCOW have positive attributes, two caught my fancy.

British American Tobacco

Like all large cigarette manufacturers, British American Tobacco (BTI) throws off a lot of free cash flow. In the trailing 12 months ended March 31, BTI generated $9.0 billion in FCF and $25.7 billion in sales for an FCF margin of 35% and an FCF yield of 8.9%. Anything over 8% is considered value territory. 

However, like all large cigarette manufacturers, the risks are apparent. The lawsuits will not stop until they stop selling what many call “cancer sticks.” If you can get past this reality, the cash it throws off gets put into dividends and share repurchases. 

Over the past five years, BTI has generated 40 billion British Pounds ($50.5 billion) in FCF. In fiscal 2021 it was 7.4 billion British Pounds ($9.3 billion). It paid out 4.9 billion British Pounds ($6.2 billion) in dividends in the past year. It did not buy back any of its shares last year. However, in February, it announced a 2 billion British Pounds ($2.5 billion) share repurchase for 2022. 

The company is transforming from combustible products such as cigarettes to reduced-risk products such as vapor (Vuse), tobacco heating (THP), and oral nicotine pouches (Velo). 

In 2021, these products saw revenues increase by 51% over 2020, with reduced losses. By 2025, it expects these products to account for 5 billion British Pounds ($6.3 billion) in revenue and generate an annual profit.

Overall, thanks to the growing contribution of the reduced-risk products, it plans to grow revenues by 3-5% in 2022 with high-single-digit earnings per share growth.

Down 39% over the past five years, the company’s 8.1% dividend yield is a quarterly rent check from the company that pays you to wait for its transformation to be complete. 

Long-term, the new British American Tobacco will generate more profits from less revenue. It will be an even greater free cash flow machine.

BP

If you put aside the $24.4 billion post-tax impairment charge BP (BP) took in the first quarter to exit its ownership stake in the Russian oil company Rosneft, the integrated energy company had an excellent quarter, generating a replacement cost profit of $6.2 billion, 51% higher than Q4 2021 and 138% higher than Q1 2021. 

As a result of higher oil prices and profits, BP had FCF in the first quarter of $4.1 billion, 37% higher than Q4 2021 and 142% higher than Q1 2021. In 2022, it plans to use 60% of its FCF to buy back up to $2.5 billion of its stock. The remaining 40% will go to paying down some of its debt. 

BP is currently transforming its business by diversifying the types of energy it produces while reducing its oil and gas production and reducing emissions. Things like solar, wind, carbon capture and hydrogen will step in to replace these legacy assets. The company plans to be net-zero across all of its operations by 2050.

It plans to have developed 20 gigawatts (GW) of renewable generating capacity by 2025 and 50GW by 2030. One GW could power 12 billion hours of TV annually. Of the 24.9 GW in its development pipeline, 79% is solar, and 21% is wind.

As for the electrification of transportation, BP had installed 7,500 charging stations by the end of 2019. By 2021, it was more than 13,000. By 2030, it plans to have installed more than 100,000 worldwide.

Steve Cohen, the New York Mets and Point72 Asset Management owner, owns 3.8 million shares of BP. In the first quarter, the hedge fund added 3.3 million shares of its stock. Cohen believes the combination of legacy oil and gas with a growing renewables portfolio is a winning combination in this economic climate.

Based on its trailing 12-month FCF of $15.3 billion, revenue of $172.5 billion, and a market cap of $105.8 billion, BP has an FCF margin of 8.9% and a 14.5% FCF yield, which puts it in deep value territory. 

BP is a cash cow buy.