2 Undervalued Stocks That Just Raised Dividends

While the broad US stock market has maintained its upward momentum through the third quarter and into the fourth, dividend-paying stocks continue to lag. This underperformance could present opportunities for long-term investors to put money to work.

Dividend investing comes in various forms. Investors can look for stocks with the highest yields, those with a history of stable dividend payouts and strong finances, or those raising dividends. We screened US stocks covered by Morningstar that have increased quarterly dividends, which can signal a company’s confidence in its future finances.

Here are two undervalued companies covered by Morningstar analysts that increased dividends in October:

• Huntington Ingalls Industries HII
• MSC Industrial Direct MSM

Screening for Undervalued Stocks That Raised Dividends

We started with the full list of US-based companies covered by Morningstar analysts, then looked for names that pay a quarterly dividend to investors and declared a dividend payment in October. We then tracked changes from previous dividend payouts and filtered for increases. Stocks with dividend yields under 2% were excluded. Lastly, we picked companies rated 4 or 5 stars by Morningstar analysts, meaning they are considered undervalued. These stocks offer investors the potential to benefit from increased dividend yields and the possibility that their investment values will grow.

Two undervalued companies with dividend increases made it through. A list of stocks covered by Morningstar that raised dividends can be found at the bottom of this article.

Here’s a closer look at the two undervalued companies that raised dividends:

Huntington Ingalls Industries

• Morningstar Rating: 5 stars
• Fair Value Estimate: $326.00
• Uncertainty Rating: Medium
• Economic Moat Rating: Wide

“We think Huntington Ingall’s balance sheet is sound. Net debt/EBITDA has averaged less than 2 turns over the past five years, which we think is very manageable for a steady defense prime. The firm took on some debt to finance the acquisition of Alion, a defense services provider, but we expect the firm to pay it down fairly quickly. We expect 2024 debt/EBITDA to come in at about 2.5 turns, which we think is manageable. We note that the company does not have material maturities coming due until after our explicit forecast.

“We assess the company’s investments as fair. The company faces a dilemma in how to invest capital generated by its wide-moat shipbuilding business, even though further investment opportunity in shipbuilding is limited by fairly stable demand for warships. The firm’s major recent capital allocation decision was the acquisition of Alion, a provider of IT services to government agencies. While such businesses require specialized talent and security clearances like other forms of defense contracting, we generally don’t see government services businesses as offering the same kinds of durable profitability that long-cycle manufacturing contracts do.

“Management expects revenue synergies from enhanced capabilities in intelligence processing and an expanded customer base as well as capability synergies with the shipbuilding side of the business. We think these are reasonable expectations, but we do not see how this business will add to the company’s profitability or competitive advantage in the near to medium term.”

—Nicolas Owens, equity analyst

MSC Industrial Direct

• Morningstar Rating: 4 stars
• Fair Value Estimate: $99.00
• Uncertainty Rating: Medium
• Economic Moat Rating: Narrow

“We think MSC’s shareholder distribution policy is appropriate, given the firm’s solid and dependable free cash flow generation. The company began paying a regular dividend in 2003. Since then, it has increased its regular dividend every year (except in fiscal 2021, when the annual dividend remained at $3.00 per share, or $0.75 quarterly) and paid out special dividends in 2005 ($1.50 per share), 2011 ($1.00 per share), 2015 ($3.00 per share), 2020 ($5.00 per share), and 2021 ($3.50 per share). The company recently announced a 5% raise in its dividend to $0.85 per share. MSC regularly pairs dividends with share repurchases. We expect MSC will continue its balanced and shareholder-friendly capital allocation strategy.

“We assess MSC’s investment strategy as fair. Outside of organic growth investments, which we think have generated solid returns, MSC has made two major acquisitions since 1996: Kennametal’s J&L Industrial Supply in 2006 for $350 million (1.4 times 2005 sales and 11.8 times 2005 EBITDA excluding synergies) and Barnes’ North America distribution business in 2013 for $550 million (1.8 times 2012 sales). We view both acquisitions as a prudent use of shareholder capital.

“The J&L acquisition bolstered MSC’s position in metalworking and gave the firm exclusive distribution rights to Kennametal’s branded carbide cutting tools for many years. Although MSC no longer has an exclusive relationship with Kennametal, the company is the only national distributor of Kennametal’s premier brand tooling. The Barnes acquisition greatly strengthened MSC’s inventory-management capabilities (95% of the Barnes business was through the vendor-managed inventory channel) and extended the firm’s addressable market into Canada.”

—Brian Bernard, sector director