Showing posts with label dividend stock analysis. Show all posts
Showing posts with label dividend stock analysis. Show all posts

Friday, March 21, 2014

Diageo (DEO) Dividend Stock Analysis

Diageo plc (DEO) produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. This international dividend company has increased dividends for 15 years in a row.

The company’s latest dividend increase was announced in January 2014 when the Board of Directors approved an 8.80% increase in the interim dividend to 19.70 pence /share. The company’s peer group includes Brown-Forman (BF.B), Beam (BEAM), and Constellation Brands (STZ).

Over the past decade this dividend growth stock has delivered an annualized total return of 12.40% to its US ADR shareholders.


The company has managed to deliver an 8.90% average increase in annual EPS in British Pounds since 2004. Diageo is expected to earn $6.82 per share in 2014 and $7.27 per share in 2015. In comparison, the company earned the equivalent of $6.19/share in 2013. Each American Depository Receipt (ADR) that you can purchase on the NYSE is equivalent to four shares that are traded on the London Stock Exchange.

Between 2004 and 2013, the number of shares decreased from 3.03 billion to 2.52 billion.

Diageo owns a portfolio of strong brands, with wide consumer appeal, which are usually number one or two in their respective categories. A few include Smirnoff, Johnnie Walker, Guinness, Baileys, and Captain Morgan. The company also has a wide distribution network on a global scale, which might be difficult for a competitor to replicate. Diageo is the largest spirits company in the world, which provides it with the advantage of scale, relative to its competitors.

Future growth could be driven by organic growth of its premium brands as well as through strategic acquisitions. The company has also focused on its core competencies, by disposing of Pillsbury and Burger King in the early 2000s. North America accounts for one third of sales but over 40% of annual profits. Emerging markets in Asia, Africa and Latin America account for 40% of sales. Continued investments in strategic emerging markets could translate into higher sales in the future, particularly as the number of middle class consumers who will be able to afford premium drinks rises significantly.

The annual dividend payment has increased by 5.80% per year over the past decade, which is lower than the growth in EPS.

A 6% growth in distributions translates into the dividend payment doubling every twelve years on average. The expected dividends in 2014 are roughly double the dividends paid in 2003.

Dividends on the ordinary shares are normally paid twice a year: an interim dividend in April and a final dividend in October. The approximate split between the two payments is 40:60.

The dividend payout ratio has decreased from 56.50% in 2004 to 45.50% in 2013. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The company has really high return on equity, which is common for most high quality dividend payers that do not require a lot of equity to operate the business. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.


Currently, the stock is attractively valued, as it trades at a P/E of 18.20 and yields 2.60%. I am analyzing the company because I believe it is quality dividend growth stock, which is very good addition to my portfolio when it is below a P/E of 20 and at a current yield above 2.50%. I currently find Diageo to be a much better value than Brown-Forman (BF.B), at 29.60 times earnings and yield of 1.60%. I recently purchased Diageo shares for my taxable and tax-deferred accounts.

Full Disclosure: Long BF.B, DEO

Relevant Articles:

International Dividend Stocks – Pros and Cons
Brown-Forman (BF.A)(BF.B) Dividend Stock Analysis
Strong Brands Grow Dividends
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Friday, March 14, 2014

Clorox Company (CLX) Dividend Stock Analysis

The Clorox Company manufactures and markets consumer and professional products worldwide. It operates in four segments - Cleaning, Household, Lifestyle and International. This dividend champion has paid dividends since 1968 and has increased them for 36 years in a row.

The company’s latest dividend increase was announced in May 2013 when the Board of Directors approved a 10.90% increase in the quarterly annual dividend to 71 cents /share. The company’s peer group includes Procter & Gamble (PG), Colgate Palmolive (CL), and Kimberly Clark (KMB).

Over the past decade this dividend growth stock has delivered an annualized total return of 10.10% to its shareholders.


The company has managed to deliver a 6.40% average increase in annual EPS over the past decade. Clorox is expected to earn $4.46 per share in 2014 and $4.77 per share in 2015. In comparison, the company earned $4.31/share in 2013.

In addition, between 2004 and 2013, the number of shares decreased from 214 million to 132 million. The reason for the steep decline in shares is because in 2004 the company exchanged of its ownership interest in a subsidiary for approximately 61.4 million of its shares held by Henkel KGaA, which represented about 29% of CLX's outstanding common stock prior to the exchange. Since then, the company’s owners’ equity is negative, which throws off many novice dividend investors. There is a major difference between owners’ equity on the balance sheet and the value of the business to a private buyer. The reality is that while accounting is the language of business, it has certain limitations. The value of a high margin consumer staple business like Clorox is based mostly on earnings power, and not on the value of its assets as reported on the balance sheet.

Clorox has a portfolio of products with strong brand names, that are number one or two in their respective product lines, which helps in having pricing power. As a result, it should be able to pass on commodity price increases to customers. Future earnings growth could be driven by innovation, new product launches, cost containment initiatives, as well as international expansion.

As part of the company’s recently introduced 2020 Strategy, Clorox aims to continue delivering total stockholder returns in the top third of Clorox's peer group by driving economic profit (EP). In addition, the company's long-term financial goals include:

• Growing net sales 3-5 percent annually
• Expanding earnings before interest and income taxes (EBIT) margin 25-50 basis points annually
• Generating free cash flow of 10 percent to 12 percent of sales annually

The three pillars of the strategy include expansion in a geographic, category and channel direction, continued reinvestment in its brands as well as cost containment initiatives. A key driver of the strategy is to accelerate sales by growing existing brands, including expanding into adjacent categories, entering new sales channels and increasing penetration within existing countries. Increased exposure to emerging market economies could further drive increase in sales through 2020. The company also anticipates using its strong cash flow to pursue growth opportunities and increase shareholder returns. In addition to that the company will be targeting sales growth through product innovation, which helps its pricing power. Clorox will also target margin expansion and maximizing cash flow through implementation a continued robust cost-saving program and maintaining price increases the company has taken. The strong focus on cost, has provided the company with a relative cost advantage versus competition. In addition, Clorox continuously reinvests money in its brands, which helps it maintain its market position.

One of the risks behind Clorox is that it generates a large portion of revenues from the US – 78%. It is more exposed to the US economy than other global consumer staples companies, which could also be an opportunity as well. The other risk I see is that Wal-Mart (WMT) accounts for a quarter of sales for Clorox. Wal-Mart is notorious for trying to keep costs low, by squeezing vendors to sell at lower prices. This is bad for pricing power, and could impact profitability. This over reliance on Wal-Mart could be mitigated through continued international expansion.

The annual dividend payment has increased by 10.70% per year over the past decade, which is higher than the growth in EPS. This was accomplished through the expansion of the dividend payout ratio. Future growth will be limited by any growth in earnings per share.

An 11% growth in distributions translates into the dividend payment doubling every six and a half years on average. Since 1986, Clorox has been able to double dividends almost every seven years on average.

The dividend payout ratio increased from 42% in 2004 to almost 59% in 2013. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The company’s Return on Assets has decreased slightly over the past decade. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return over time.

Currently, the stock is fairly valued, as it trades at 19.50 times forward 2014 earnings and yields 3.30%. I am analyzing the company because I believe it is quality dividend growth stock, which will be a very good investment on dips below $86-$87.

Full Disclosure: Long CLX, PG, KMB, CL

Relevant Articles:

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Friday, March 7, 2014

Altria Group (MO): A Smoking Hot Dividend Champion

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, smokeless products, and wine in the United States and internationally. This dividend champion has managed to increase dividends to shareholders for 44 years in a row.

Many databases show reductions in dividend payments in 2007 and 2008, which is due to the spin-offs of Kraft Foods and Philip Morris International (PM). As a result, Altria was kicked out of what I used to believe was the elite dividend aristocrat index. The investors in Altria from early 2007 would have received shares in Kraft and Philip Morris International, and therefore their total dividend income would not have suffered at all. It actually increased, because all three companies raised dividends in 2008. Those original Kraft shares were further split into Mondelez International (MDLZ) and Kraft (KRFT). This is why one should not focus on purely quantitative characteristics, but also take the time to understand companies by analyzing them in detail one at a time. By focusing too much on screening, you might miss out on important information.

Since the spin-off of Philip Morris International in 2008, quarterly dividends per share have increased from 29 cents/share to 48 cents/share in 2013.

Altria Group pays a very high portion of net income as dividends to shareholders. However, it has limited needs to reinvest large portions of its net income, which is why this ratio is not as troubling as it would be for Coca-Cola (KO) for example. In the old days, Altria used its strong cash flows to diversify into food and spirits, but I do not think this is the case nowadays. Back until the early 2000s, Altria was known as Philip Morris. Now, it has a 26.90% economic and voting interest in SABMiller. Altria earned $402 million in dividends from its stake in SABMiller in 2012. It’s share of SABMiller’s profits was $1.224 billion. This stake is worth approximately 20 – 21 billion dollars at current prices. In comparison, Altria’s market capitalization today is $73 billion.

Earnings per share increased from $1.48 in 2008 to $2.26 by 2013. The company expects to earn $2.57/share by 2014 and $2.76/share by 2015. While I take forward analyst estimates with a grain of salt, I have a high degree of confidence that Altria can achieve decent earnings growth in the long-run, fueled by price increases which are higher than declines in volume and cost restructurings. This could translate into quarterly dividends hitting $2.05/share in 2014 and $2.20 in 2015.

The future for tobacco consumption in the US is bleak. I would estimate that amount of cigarettes sold will decline by 3% - 4%/year for the foreseeable future. There are bans on smoking in public, buildings, parks, bars etc.

However, there is a difference between the future for tobacco consumption, and the future for tobacco companies. The reason behind this variance is stemming from the fact that demand for cigarette products is relatively inelastic. This means that an increase in the price of cigarettes typically results in declines in the amount of cigarette consumption. The increase in prices however is usually higher than the declines in consumption, which results in higher revenues overall.

The market for tobacco companies is inefficient, because there are some investors who are biased against tobacco companies, regardless of valuation or future business prospects. This does not mean these investors are morally right or wrong – they have the right to their own opinions. However, they are not being rational in evaluating tobacco companies as investments.

Most know about the terrible facts about tobacco use. This has led to depressed valuations for tobacco companies in almost all of the times. This means that if you can reinvest those fat dividends at low valuations, your future returns have a very high chance of being pretty good.

Governments need tobacco companies, because it provides them with a healthy stream of revenues through excise taxes for example. Furthermore, it is much more popular to tax the evil tobacco conglomerates, rather than increase taxes on middle class voters, or reduce education expenditures for high-schools

The positives behind companies like Altria includes strong brand loyalty, the fact that consumers are addicted to the product, efficiencies of scale and strong pricing power. It would be almost impossible to start a competing tobacco company today, because of the ban on advertising.

However, the emerging opportunity and threat are e-cigarettes. It seems that these are advertised, and could convert a portion of regular smokers to e-cig smokers. Unfortunately, e-cigarettes could be more disruptive than regulation threats, and they carry slimmer margins. On the positive side, for those legacy tobacco companies that are building up their e-cigarette business, this could be a growth kick to their otherwise stable tobacco revenues. Plus, I would not be surprised if advertising of e-cigarettes reminds consumers about regular cigarettes, thus leading to increase in tobacco consumption. Most recently Phillip Morris International and Altria created an agreement to exclusively commercialize two of Altria’s e-cigarette products outside the U.S.. At the same time, PMI will make available to Altria two of its heated tobacco products for sale in the US.

Recent news about CVS (CVS) dropping tobacco products from its stores may have upset some investors, but those headlines are an example of investment noise out there. It is noise because consumers who were used to purchasing tobacco products at CVS would likely take their business elsewhere. Of course, the real risk is if other retailers follow suit, and decide to stop selling  tobacco products altogether. I see this scenario having a very low likelihood however, since these retailers could lose out not only on tobacco revenues but on incremental revenues that tobacco customers bring with them. For example, if you buy your gasoline at the place that you also buy your pack of  cigarettes, you might simply take all of your business elsewhere if your Marlborough is not available.

For Altria, it has a dominant position in the US tobacco market with Marlboro brand having a very loyal following amongst smokers. The sheer scale of operations allows Altria to exert higher influence on vendors and distributors. The company is also a leader in US the smokeless market, with a 50%-55% market share. The smokeless tobacco segment is expected to generate single digit volume growth.

Currently, this dividend champion sells for 16.10 times earnings, yields 5.30%, and has a high payout ratio. Given the economics of the business, and the expectation for future earnings growth in the mid single digits, I find it attractively valued today. I plan on adding to my position in the company sometime in 2014, subject to availability of funds.

Full Disclosure: Long MO, PM, KRFT, MDLZ

Relevant Articles:

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Friday, February 21, 2014

Colgate-Palmolive (CL) Dividend Stock Analysis

Colgate-Palmolive Company, together with its subsidiaries, manufactures and markets consumer products worldwide. The company operates in two segments: Oral, Personal and Home Care; and Pet Nutrition. This dividend king has paid dividends since 1895 and has increased them for 50 years in a row.

The company’s latest dividend increase was announced in March 2013 when the Board of Directors approved a 9.70% increase in the quarterly annual dividend to 34 cents /share. The company’s peer group includes Procter & Gamble (PG), Clorox (CLX), and Kimberly Clark (KMB).

Over the past decade this dividend growth stock has delivered an annualized total return of 12.60% to its shareholders.


The company has managed to deliver a 9% average increase in annual EPS over the past decade. Colgate-Palmolive is expected to earn $2.83 per share in 2013 and $3.09 per share in 2014. In comparison, the company earned $2.58/share in 2012.

In addition, between 2004 and 2013, the number of shares decreased from 1135 million to 937 million.
Colgate generates over 80% of its sales from outside of the US. The growing emerging markets in Latin America and Asia and the rising middle class in these markets could present an excellent opportunity for Colgate Palmolive. Latin America accounts for one third of sales, while Asia/Africa accounts for over one fifth of sales. The issue with overexposure to Latin America is that the continent has been prone to currency devaluations, which could impact profitability. Another issue could come from rising commodity costs, which could pressure margins and profitability despite expectations for rising volumes. Given the strong brand names of many of Colgate’s products however, the company could mitigate this by passing on cost increases to consumers.

The toothpaste market is characterized by high penetration by branded products, as few people are going to save a few cents and put an unknown paste for their teeth. In addition there is brand loyalty, which results in recurring revenue streams from millions of customers worldwide. The company also has wide global reach, and large scale of operations. The strong brands, customer loyalty and global scale of operations are indicative of a wide moat by this company.

In 2012, Colgate-Palmolive initiated a four year Global Growth and Efficiency Program, in an effort to simplify and standardize work processes, reduce structural costs, and increase sales globally. The company is expected to spend anywhere between $1.1 to $1.25 billion through 2016, with annual benefits expected in the $365-$435 million annually. These benefits will be reinvested in items such as new products and in brand building. As a result of the program, 6% of global workforce will be laid off by 2016.

In general, earnings per share will increase through emerging market sales growth, share buybacks, cost restructurings. I can foresee sales to grow by 5 – 6 %year, which could easily translate into earnings per share growth of 9- 10% for the foreseeable future.

The annual dividend payment has increased by 11.40% per year over the past decade, which is higher than the growth in EPS. This was accomplished through the expansion of the dividend payout ratio. Future growth will be limited by any growth in earnings per share.

An 11% growth in distributions translates into the dividend payment doubling every six and a half years on average. Since 1985, Colgate-Palmolive has been able to double dividends every seven years on average.

The dividend payout ratio increased from 37% in 2003 to almost 47% in 2012. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The company enjoys really high returns on equity, which is common for most high quality dividend payers that do not require a lot of equity to operate the business. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Currently, the stock is overvalued, as it trades at a P/E of 22.60 and yields only 2.10%. I am analyzing the company because I believe it is quality dividend growth stock, which will be a very good addition to my portfolio on dips below $55-$56.

Full Disclosure: Long CLX, PG, KMB, CL

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Friday, February 14, 2014

Brown-Forman (BF.A)(BF.B) Dividend Stock Analysis

Brown-Forman Corporation (BF.A) (BF.B) engages in the manufacturing, bottling, importing, exporting, marketing, and selling alcoholic beverages. It provides whiskey, ready-to-drink products, vodka, tequilas, champagnes, wines, liqueur, and other distilled spirits. This Dividend Champion has paid dividends since 1960 and has increased them for 30 years in a row.

The company’s latest dividend increase was announced in November 2013 when the Board of Directors approved a 13.70% increase in the quarterly annual dividend to 29 cents /share. The company’s peer group includes Diageo (DEO), Beam (BEAM), and Constellation Brands (STZ).

Over the past decade this dividend growth stock has delivered an annualized total return of 14.80% to its shareholders.


The company has managed to deliver an 11% average increase in annual EPS over the past decade. Brown-Forman is expected to earn $2.96 per share in 2014 and $3.26 per share in 2014. In comparison, the company earned $2.75/share in 2012.


In addition, between 2004 and 2013, the number of shares decreased from 229 million to 215 million.

The company has several strong brands such as Jack Daniels Tennessee Whiskey, which accounts for a large portion of its revenues. Other brands include Finlandia and Southern Comfort. There is strong customer loyalty for company’s products, particularly for its Jack Daniels line of whiskeys, which results in strong pricing power. If you want Jack Daniels, and the store doesn’t sell it, you will likely go to another store. This is an example of a wide-moat. Another example include the high returns on equity and capital that the company has been able to generate over the past decade.

Besides growth in Jack Daniels whiskey, which has recorded 21 years of consecutive volume increases, the company grows sales through brand extensions, such as Gentleman’s Jack.

Another venue for growth includes international expansion. Currently 59% of sales come from international versus 15% that were generates 20 years ago. About 30% of sales were generated in Europe, 14% Australia, and 15% in other countries such as Mexico and Japan. As a result, I believe there is plenty of room for growth in emerging countries such as China, Brazil, and Russia, to name a few obvious opportunities.

The company owns its distribution in many markets such as Australia, Brazil, Canada, China, Mexico, Turkey etc. In other markets such as Russia ,Japan, South Africa, it operates under fixed term contract with distributers. In the UK,which accounted for 9% of sales in 2013, Brown-Forman has a cost sharing agreement with Bacardi. The company is focused on investing in its distribution network, which allows it to focus on its brands and improve margins. In 2014, it will start operating its own distribution network in France.

Other room for growth could include strategic acquisitions. Previous acquisitions include Finlandia Vodka, Southern Comfort, Casa Herradura and Chambord Liqueur Brand. Interesting enough, Jack Daniel's Tennessee Whiskey was acquired in 1956 for $20 million.

Management has been very shareholders friendly, as it has deployed capital intelligently, in order to maintain high returns on capital invested. In addition, they distributed special dividends in 2010 and 2012, when preferential tax treatments on qualified dividends were set to expire. They rank each of the company's brands according to its return on investment. The adherence to  intelligent capital allocation means that they pour dollars only into their most promising brands.

There are a couple risks that I see with Brown-Forman. The first risk is that the Brown family exerts a lot of control over the company through the dual-class shareowner structure. For example, the A shares have voting rights, while the B shares have no voting rights, although they do share same proportionate amounts of dividends. The Brown Family has over 66% of the voting power, through its ownership of A shares either directly or through family controller entities. Hence the company is classified as a “controlled company”.

The other risk is that there is too much reliance on Whiskey sales, which could be bad for revenue growth if consumer tastes change. Jack Daniels category accounts for over half of product volumes.

The annual dividend payment has increased by 10.20% per year over the past decade, which is slightly lower than the growth in EPS. The growth in distribution payments over the next decade will likely be equal to or slightly higher than the growth in earnings per share.

A 10% growth in distributions translates into the dividend payment doubling every seven years on average. Since 1988, Brown-Forman has been able to double dividends every eight years on average.

Not included in the chart are special dividends of $4/share in 2012 and $0.67/share in 2010.

The dividend payout ratio has largely remained in a range between 32% and 39% over the past decade. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.


The company has a really high return on equity, which is common for most high quality dividend payers that do not require a lot of equity to operate the business. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.


Currently, the stock is overvalued, as it trades at a P/E of 27.20 and yields only 1.60%. I am analyzing the company because I believe it is a quality dividend growth company, which will be a very good addition to my portfolio on dips below $60. I will still keep holding onto my existing shares, which I believe have a value of approximately 30 times earnings to a private owner. As earnings will increase over time, that value should increase as well. To put it in Warren Buffett terms, this is an excellent business, but unfortunately the price is too rich to justify an investment at present terms.

There has recently been M&A activity in the industry, as Beam Inc (BEAM) is in the process of being acquired by Japanese company Suntory at 30 – 32 times earnings. It is possible that Brown-Forman shares could have been bid up because they could be a potential acquisition target by a larger competitor. However the dual-class shareholder structure, and the fact that voting power is concentrated in the Brown family, makes a successful acquisition of Brown-Forman by someone like Diageo (DEO) highly unlikely. This could be a plus however, as acquisitions of quality dividend companies rob shareholders of the acquisition target from the dividend growth potential they could have enjoyed, had the company not been bought out. If earnings per share double every decade, and dividend payout ratios are maintained, long-term investors will do just fine.

I currently find Diageo (DEO) to be a much better value, at 18.70 times earnings and yield of 2.40%. Therefore, I recently purchased Diageo shares.

Full Disclosure: Long BF.B, DEO

Relevant Articles:

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Friday, February 7, 2014

McCormick & Company (MKC) Dividend Stock Analysis

McCormick & Company (MKC), Incorporated engages in the manufacture, marketing, and distribution of spices, seasoning mixes, condiments, and other flavorful products to retail outlets, food manufacturers, and foodservice businesses. It operates in two segments, Consumer and Industrial. This dividend champion has paid dividends since 1925 and has increased them for 28 years in a row.

The company’s latest dividend increase was announced in November 2013 when the Board of Directors approved an 8.80% increase in the quarterly annual dividend to 37 cents /share.

Over the past decade this dividend growth stock has delivered an annualized total return of 11.60% to its shareholders.


The company has managed to deliver a 9.20% average increase in annual EPS over the past decade. McCormick is expected to earn $3.13 per share in 2013 and $3.45 per share in 2014. In comparison, the company earned $3.04/share in 2012.

In addition, between 2003 and 2013, the number of shares decreased very slightly from 142 million to 134 million. Given the fact that shares are frequently overvalued, I would not want management to be repurchasing stock at rich prices.

This wide-moat company is the leader in global spices and seasonings with over one fifth of the market, which ensures advantages of scale. It is four times larger than its next competitor. Besides scale, the company also has strong brand names such as McCormick and Lowry, which face limited pricing threats. Almost 60% of revenues are from the US, with 20% from Europe, Middle East and Africa and the remainder from the rest of the world.

Revenues are derived from two segments, Consumer with 60% and Industrial with 40%. The Consumer segment offers spices, herbs, seasonings, and dessert items directly, as well as through distributors or wholesalers to various retail outlets, including grocery stores, mass merchandise stores, warehouse clubs, and discount and drug stores, as well as supplies private label items. The Industrial segment provides seasoning blends, natural spices and herbs, wet flavors, coating systems, and compound flavors directly, as well as through distributors to food manufacturers and foodservice customers. The largest customers are Wal-Mart Stores (WMT) and PepsiCo (PEP) with 11% of McCormick’s sales each. Other major customers include McDonald’s, Sysco, General Mills, Kraft Foods, Yum! Brands etc.

Most of the company’s revenues are derived from its branded spices. Private label spices account for a low amount of revenues, but can solidify relationships with retailers, and provide a foot in the door for the company.

Future growth in earnings per share can be generated through organic growth, acquisitions, innovation, and cost saving initiatives. McCormick invests in its brands and has pricing power in them and also has the scale to be the lowest cost producer in its market. While spices are expensive, their cost relative to the price of a meal. The goal of the company is to grow sales by 4%- 6%/year in the long run. The company also wants to increase earnings per share by 9 – 11%/year.

The company has been active in the acquisitions front, in order to generate sales and expand its product and geographical reach. For example it purchased Chinese company Wuhan in 2013, Polish company Kamis in 2011, and started a joint venture with Indian company Kohinoor Ltd. The company is targeting faster growing regions with these acquisitions, and it is also trying to capitalize on difference in tastes in different countries.

McCormick also invests in innovation, in an effort to bring new products to the marketplace. In its 2014 product pipeline includes grill mates steak sauce, Zatarain’s microwaveable rice in the US.

The annual dividend payment has increased by 11.40% per year over the past decade, which is higher than the growth in EPS.

An 11% growth in distributions translates into the dividend payment doubling every six and a half years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the 9%-11% range annually.

The dividend payout ratio increased from 33% in 2003 to almost 48% in 2006, before decreasing to 41% in 2012. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The company has a high return on equity, which has decreased slightly over the past decade. This indicator seems to have bottomed out and is on the rebound as of recently. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Currently, the stock is slightly overvalued, as it trades at a P/E of 20.10 and yields only 2.30%. I am analyzing the company because I believe it is quality dividend growth stock, which will be a very good investment on dips below $63, which is equivalent to a P/E of 20 and a current yield above 2.50%. If the stock price remain around $69/share however throughout 2014, rising earnings per share would eventually result in a P/E of 20 simply by waiting. A wonderful business like McCormick will compound earnings and dividends for its investors over time, which is why it is frequently overvalued. I always want to have some margin of safety in case things do not turn out as expected, as I try to avoid getting overly excited about any individual security.

I initiated a half position in McCormick & Co, after the market dropped on Monday. While entry yield is lower than my criteria of 2.50%, I bought this compounding machine because I believe it will be able to grow and provide sustainable dividend growth in the future. I have also found it helpful to monitor quality companies I am interested in much better, when I have skin in the game. If the stock price keeps sliding down, I will keep adding.

Full Disclosure: Long MKC

Relevant Articles:

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Friday, January 31, 2014

3M (MMM) Dividend Stock Analysis

3M Company operates as a diversified technology company worldwide. The company operates in five segments: Health Care, Industrial, Safety & Graphics, Consumer, Electronics & Energy. This dividend king has paid dividends since 1916 and has increased them for 56 years in a row.

The company’s latest dividend increase was announced in December 2013 when the Board of Directors approved a 34.60% increase in the quarterly annual dividend to 85.50 cents /share. The company’s peer group includes General Electric (GE), Carlisle Companies (CSL), and Raven Industries (RAVN).

Over the past decade this dividend growth stock has delivered an annualized total return of 8% to its shareholders.


The company has managed to deliver a 9.70% average increase in annual EPS over the past decade. 3M Company is expected to earn $6.72 per share in 2013 and $7.46 per share in 2014. In comparison, the company earned $6.32/share in 2012.

In addition, between 2003 and 2013, the number of shares decreased from 795 million to 692 million. 3M expects to spend somewhere in the range of $17 billion to $22 billion on share repurchases through 2017.

The strength of 3M’s business model is largely driven by three key strategic levers: active portfolio management, investing in innovation, and business transformation. Management believes that these levers, combined with more aggressive capital deployment, will drive enhanced value creation.
The company’s financial objectives through 2017 include 9 – 11% growth in earnings per share, fueled by 4 – 6% annual revenue growth. In addition, 3M expects to make 5 – 10 billion in acquisitions over the next 3- 4 years.

The company generates 35% of revenues from emerging markets, which could increase to 40 – 45% by 2017, driven by strong growth in developing economies of the world. In fact, emerging market revenues are expected to increase by 8 – 12% over the next four years, versus a more modest 2 – 4% growth for developed markets.

The company spends over 5% of revenues on R&D, and has been able to discover innovative products to bolster its bottom line. 3M expects to increase R&D expense to 6% of revenues by 2017. 3M keeps careful track of new product development, using a measure called the New Product Vitality Index (NPVI), which quantifies the percentage of 3M’s sales from products that were introduced during the past five years. In 2013, the NPVI was 33%. The company is trying to increase this index to 37% by 2017.

In addition, the company is investing $700- $800 million in a new globally integrated ERP IT system, the implementation of which should be completed by 2017. The system is estimated to result in annual operational efficiencies of $500 million/year, plus an improved working capital management of an equal amount.

3M has maintained a high level of return on equity over the past decade. However, the indicator has decreased slightly from 34.60% in 2003 to 27% in 2012. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.


The annual dividend payment has increased by 6.80% per year over the past decade, which is lower than the growth in EPS. This was driven by the slow growth in dividends per share between 2007 and 2010, which was in the range of 2 – 4% per annum. In hindsight, it looks that dividend growth rates fluctuate over time, and one should not be scared away from temporary slowdown in income growth.

A 7% growth in distributions translates into the dividend payment doubling every ten years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high-single digits.

The dividend payout ratio has increased from 41% in 2003 to almost 67% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 57%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently 3M is attractively valued at 19.10 times estimated 2013 earnings, yields 2.60% and has a sustainable distribution. I like the story for 3M, but would definitely appreciate it better if I can add to my position at lower prices from here.

Full Disclosure: Long MMM

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Friday, January 24, 2014

Coca-Cola: A wide-moat dividend growth stock to buy and hold

In the past month, I purchased several hours of freedom, by adding to my position in the Coca-Cola Company (KO). I believe that Coca-Cola is a core holding for long-term dividend investors. This one time effort of investing in Coca-Cola will result in a lifetime of dividend payments which increase annually above rate of inflation. I like situations where most of the work is in the initial set-up, after which I receive cash in the mail every 90 days, for many decades to come.

I view buying shares in quality businesses such as Coca-Cola similar to purchasing time. For example, if you are an average person earning $20/hour, and you purchase 100 shares of Coca-Cola that generate $102 in annual dividend income, you essentially purchased 5 hours of time per year. That is five hours per year you will never have to spend working again. It gets even better - your dividend income raises will likely be much better than inflation and salary increases.

Everyone knows about what Coca-Cola does. Not everyone knows that this dividend king has managed to reward shareholders with higher dividends for 51 years in a row. It is one of only 17 companies in the US that has ever done it. Over the past decade the company has managed to raise distributions by 9.80%/year. In comparison, earnings per share have increase by 12.30%/year. The company has managed to reduce the amount of shares outstanding from 4.924 billion in 2003 to 4.498 billion in 2013, through regular share buybacks.

One of the largest investors in Coca-Cola is Warren Buffett’s Berkshire Hathaway (BRK.B). Coca-Cola fit the four filter criterion that Buffett and his partner Charlie Munger look for in a quality businesses, when they initiated their stake between 1988 – 1993. The four filters include:

1) Understandable quality businesses
2) Sustainable Competitive Advantages
3) Able and Trustworthy Managers
4) Margin of Safety in Valuation

Coca-Cola is a business that is not too difficult to understand. The company essentially sells drinks to consumers, and has a distribution network that allows it to reach consumers in as far out places as possible. The company sells several hundred brands of carbonated and non-carbonated drinks, to the tune of 1.8 billion servings/day. Coca-Cola sells high margin syrup concentrate to independent or partially owned bottling plants throughout the world, who then distribute it in their respective areas. Coca-Cola has significant bottling interests in the US, after acquiring operations from Coca Cola Enterprises (CCE) in 2010.

The competitive advantages of Coca-Cola include strong brands, and a distribution network that spans across the globe. For example, consumers who like Coca-Cola the drink, are going to keep drinking Coca-Cola and not drink PepsiCo (PEP) or put a generic brand Cola in their mouths. Coca-Cola also spends a lot of money on advertising, in order to create a positive association with the brand and strengthen the company’s image. The consumer loyalty also results in some pricing power, which should bode well for profits in the long-run. It would take a competitor a lot of money to take away the business of a company like Coca-Cola. In order to create the same type of brand loyalty, and distribution system, one not only needs a lot of money, but also a lot of time to earn customer trust. Therefore, I would say there are high barriers to entry. People would always need refreshments, which is why I think that Coca-Cola products would still be relevant to consumers 20 – 30 years from now.

I believe that Coca-Cola has able and trustworthy managers. It has a history of constantly executing its strategy in an otherwise very competitive food and beverage industry. Management has been able to diversify product line away from carbonated soft drinks and into things like waters, juices, etc. In addition, management is not focused on empire building for the sake of empire building, but seems to be intelligently allocating capital. They have done some diworsification deals in the past, such as the acquisition of Columbia Pictures in 1982, which was promptly sold a few years later, but by and large they have avoided the stupidity that other corporate managers have succumbed to. I like the fact that management is committed to paying and raising dividends to loyal long-term shareholders. I also like the fact that the shareholder friendly management is buying out weak hands, through consistent share buybacks. This makes each share that I own more valuable over time, particularly because net income and revenues are also growing.

In addition, I would think that the firm would sell for more than what it is selling for to a private buyer. In his analysis of Coca-Cola, Charlie Munger estimated a future value of $2 trillion for the company by 2034. When Buffett bought in 1988, he estimated that the value for a private business owner was twice the price he paid. Based on my understanding of global trends, consumption of Coca-Cola products will increase over time, as it is riding the wave of prosperity around the world. There are going to be hundreds of millions of people that will be lifted out of poverty over the next 20 years, and they would all want to engage in the same type of consumerism that most citizens of developed countries enjoy today. The level of consumption in places like China, India and Russia is much lower than that of places like US, which could translate into growth in volumes for a very long time. In fact, my conservative estimate for earnings growth is 7%/year for the next 20 years. If you add in 3% dividend yield, I would say that Coca-Cola can easily generate total returns of 10% for the next 2 decades. This of course is not a slam dunk, but I think this is a very likely scenario. A more bullish scenario would be for earnings per share to grow by 10%/year, using a 7%-8% net income growth, and 2- 3% in growth from share buybacks.

Currently, the stock is at the high end of my buy range, as it trades at 20 times estimated 2013 earnings. I managed to make my latest investment at an effective price of $38.20, because I had sold January 2014 puts at a strike 40 a few months ago. The puts were assigned over the weekend. I also have January 2015 puts with the same strike, which I hope to get exercised as well. I did purchase some stock over the past 5- 6 years when prices and valuations were lower, but I focused more on PepsiCo (PEP). Now I am working my way on building out my Coke position also. Everyone knows Coca-Cola is a quality company, which is why it demands a premium price.

After all, would you rather buy a business that is likely to deliver 7-10% dividend growth for the next 20 years at 20 times earnings, or would you rather buy a business at 10 -15 times earnings, which has the potential of dividend cuts during one of the next recessions?

Full Disclosure: Long KO, PEP and BRK.B

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Friday, January 17, 2014

Should income investors give General Electric a second chance?

Back in December, General Electric (GE) raised its quarterly dividend to shareholders by 15.80% to 22 cents/share. This marked the fourth consecutive annual dividend hike for this conglomerate, which is organized in the Oil & gas, Power & Water, Energy Management, Aviation, Healthcare, Transportation, Home & Business Solutions and GE Capital segments. The company has now raised dividends for four years in a row, since the decision to cut distribution in 2009.

I was one of the investors of General Electric back in 2009, who sold immediately after the dividend cut was announced. The quarterly dividend was cut from 31 cents/share to 10 cents/share, which was the first reduction in distributions since 1938. Prior to that event, management had continuously reassured investors that the dividend was safe for at least 4 – 5 months. Unfortunately, the credit markets froze in 2008 – 2009, and the company obtained a $3 billion vote of confidence from Warren Buffett. As it also sold stock to other investors, it became apparent that maintaining adequate liquidity might get a higher priority than the dividend.

I lost money on General Electric, but this is not the reason I have not bought back the stock. I had found other attractive opportunities for several years that were easier to understand, and I thought had repetitive sales to customers that were more durable in nature. I had purchased my stock at $28.97/share and sold it at $8.63/share. The tax credits on my loss of approximately 30%, add in another $6.10 to the sale price. Later on, I reinvested the proceeds into Abbott Laboratories (ABT) at $45.06/share. If GE had simply kept the dividend, I would have likely kept the stock, but allocated distributions elsewhere. Back when I was building my portfolio in 2008, I held a small position in M&T Bank (MTB), whose dividend was growing prior to that. For the past six years however, the dividend has been flat, yet I kept holding on to the security. I have recovered almost 20% of my purchase price merely from the dividend in 5 years. This fact proves the point that dividends serve as cash rebates on your purchase price.

General Electric (GE) has had a pretty terrible timing of its share buyback plan over the past decade. The company spent billions between 2005 and 2007 repurchasing 513 million shares at average prices of $34.99, $35.92 and $38.83/share. By 2009 the company had issued 517 million shares at $22.25/share, in order to obtain liquidity in the wake of the global financial crisis. This does not look like intelligent capital allocation. Of course, the world economy experienced an unprecedented liquidity crunch at the time, which executives could not have reasonably forecasted between 2005 and 2007. Currently, the company is planning on repurchasing up to 700 million shares, and bringing the number of shares outstanding to 9.5 billion.

Over the past decade, earnings per share have increased from $1.55 in 2003 to $2.20 in 2007, before falling to $1.03 in 2009. General Electric earned $1.39/share in 2012, and is expected to earn $1.63/share in 2013 followed by an increase to $1.73/share by 2014. The forward annual dividend of 88 cents/share translates to a roughly 50% payout ratio, which is sustainable.

The factors that could trigger growth in earnings per share over the next five years include:

1) Industrial backlog – The company’s backlog has increased to $229 billion, up almost 14% from prior year levels, as a result of expansion in equipment and service businesses. The company has a large installed base, where it provides its customers the ability to service their equipment. This large installed equipment base creates the opportunity to generate recurring service revenues from maintaining and servicing the equipment, which the client is happy to do, in order to avoid the hassle.

2) Cost cutting initiatives – The company plans to reduce administrative costs by $1.5 in 2013 and by $1 billion in 2014. Overall, General Electric is trying to simplify its business, and reduce the proportion of SG&A to revenues from 15.50% - 16% to 12% in 2016.

3) Share buybacks – The company has managed to reduce the number of shares outstanding from 10.678 billion in 2010, to 10.368 in 2013. The company is also planning to further reduce number of shares outstanding to 9.50 billion by 2015.

4) Strategic acquisitions – The Company is planning to make strategic acquisitions whose size does not exceed $4 billion. However, the dilutive effect of shrinking the Finance operations will more than overshadow the acquisitions portion of GE’s growth strategy.

5) Increasing demand for its core products and services – As the economy keeps expanding, and as the company brings in new solutions to its existing markets, chances are very high that revenues will be increasing over time. In addition, GE expects that the industrial segment should account for 70% of earnings by 2015, from 55% at present levels.

6) Scale – The scale of the company operations makes it more difficult for competitors to match General Electric, given the breadth of business units over which it could spread costs for R&D and expenditures. In addition, business units in different sectors can leverage best practices that are learned in other sectors.

7) Macro trends – The increased buildup in global infrastructure, growth emerging markets such as China etc

The company is reducing is reliance on GE Finance for its long-term growth, which is based on the difficult lessons it learned during the financial crisis. This is going to reduce earnings per share growth by anywhere between 0 to 5%/year for the next few years. I generally do not like to see shrinking in the major profit generators of a business, which account for 1/3 of profits. However, this seems to be offset by growth in other areas such as Industrial for example.

General Electric constantly changes the mix of businesses under its umbrella, a strategy pioneered by former CEO Jack Welch. The company tries to be number one or two in a given sector, and is also looking for growth in that segment of the business as well. As a result of this policy, one of the most important factors to evaluate with General Electric is management. They have to be able and honest, otherwise the capital allocation decisions they make could have a pretty bad outcome on your investment. Overall, I believe that Jeff Immelt to be a decent manager, who unfortunately was dealt two bad cards. He took reigns at GE at a time when the stock was very overvalued in 2001, and he also managed to preside over the worst recession since the Great Depression. Of course, the culture at General Electric is another important advantage for the company. If you are a long-term holder, you should realize that you are betting more on management to make the smart decisions on which businesses to keep, which to buy and which to dispose of in an intelligent manner. As a result, the type of business units within General Electric would be different 20 – 30 years from now.

Despite the fact that the company has only raised dividends for four years in a row, it looks attractively priced today at 16.50 times estimated 2013 earnings and a nice yield of 2.80%. I would be the first one to admit that it looks like a decent value at current levels. In addition, it also looks like the company is recovering and earnings per share could grow at 4-7%/year for the next five years. It is very likely that GE should do fine for a long-term holder with a 20 – 30 year horizon. Depending on the availability of ideas at the time of capital availability, I would consider GE for potential inclusion to my dividend portfolio. Of course, if I find a company that has grown dividends for ten years in a row, yields around 3%, sells for less than 17 times earnings, and can grow dividends by 6 – 7%/year for the next five years, chances are I might choose the other company instead.

Full Disclosure: Long ABT and MTB

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Friday, January 3, 2014

The Security I Like Best: Philip Morris International (PM)

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has paid and consistently increased dividends every year since being spun-off from Altria Group (MO) in 2008. The last dividend increase was in September 2013, when the Board of Directors approved a 10.60% dividend increase in the quarterly distribution to 94 cents/share.

The company’s largest competitors include British American Tobacco (BTI), Imperial Tobacco (ITYBY) and Japan Tobacco.

Earnings per share have doubled over the preceding 7 years to $5.17 in 2012. The company expects earnings to reach $5.37-$5.42/share in 2013, followed by a 6-8% increase in 2014. Despite the near-term slowdown in earnings per share, the company is committed to growing currency neutral EPS by 10-12%/year after 2015.


The company spends a large portion of cash flow on stock buybacks. Between 2008 and 2013, the number of shares outstanding has decreased from 2.116 billion to 1.614 billion. When a company buys out one out of four shareholders at attractive prices, this makes remaining shares more valuable as each stock certificate has a higher share of the total earnings pie.

Growth in earnings per share could be derived from acquisitions or organically. Phillip Morris International has a high exposure to emerging markets, where number of smokers is increasing, along with their disposable incomes. This would offset decreasing volumes in developed countries in Western Europe, due to the Euro Crisis coupled with tough bans on smoking. The company can also squeeze out costs through efficiency containment programs.

Philip Morris International can also increase revenues by acquiring other companies in strategic markets. It has a proven track record of making acquisitions work, and making them accretive for shareholders. If the company manages to enter China on a large scale or through a partnership with the state owned company, this would be very beneficial for shareholders also. Unfortunately, the Chinese market is generally closed to foreign tobacco companies. It is estimated that a quarter of the Chinese population smokes, and that China’s mostly state owned tobacco industry accounts for 40% of the global tobacco market entirely through its domestic operations. China and Vietnam also present untapped opportunities for next generation products, such as Next Gen 1, which heats tobacco rather than burning it in order to derive the nicotine dose to the consumer.

As a company that reports in US dollars, but does business all over the world, Philip Morris International results are affected by fluctuations in currencies. Over time however, I view those as a wash.

PMI has a strong moat, because it would be extremely difficult for a new company to start and compete against the long established brands like Marlboro. Consumers generally stay with the brands they are used to buying. Cigarettes are an addictive product, which spots very good pricing power. In addition, PMI has the economies of scale which ensure that its costs stay low relative to the competition.

However, we have all heard that tobacco products could be dangerous to people’s health. Tobacco companies face a lot of hurdles such as increased restrictions on where people can smoke, increasing excise taxes, illicit smuggling of product, and increased hostility against it by governments. Those risks are widely known, which is why tobacco companies are usually cheap. That makes share buybacks particularly beneficial for long-term owners. The good part of PMI is that it generates revenues around the world, and therefore is not dependent on the actions of any particular government.

The plain packaging in Australia was a blow to the tobacco industry. The risk is that other governments could follow suit. The problem with plain packaging is that it could essentially destroy brands. Strong brands grow dividends, because they are sought after by consumers, and provide companies with solid pricing power.

However, this risk is mitigated by the fact that governments need the money paid by tobacco companies. It is much easier to tax the evil tobacco companies, than raise taxes across the board. Therefore, while governments have a love-hate relationship with big tobacco, they do need it at the same time. For example, when Australia started the plain packaging, this has resulted in lower tax revenues on tobacco products for the government, due to increase in illegal sales. By the way, Australia is not even mentioned when PMI discusses changes in annual volumes sold per region. So I do not see this as a big impact on PMI’s overall profitability thus far.

The company has managed to more than double quarterly dividends since it was spun-off from Altria in 2008. Quarterly dividends increased from 46 cents/share in 2008 to 94 cents/share by the end of 2013.

The dividend payout ratio is at 60% for 2012, and based on expected earnings for 2013 I see it at approximately 65% for 2013.

The thing I really like about PMI is that it is able to grow earnings organically, while also paying generous rising dividends to shareholders and consistently buying back stock. I am a firm believer that the company offers something that every serious dividend growth investor craves – solid underlying fundamentals, strong competitive advantages and a wide moat, widely recognizable brands, growth in net income, shareholder friendly management, decreasing number of shares and most importantly a commitment to increasing dividends. As a result, it is no surprise that Philip Morris International is one of the largest holding in my dividend portfolio at the time of this writing.

Currently, the stock is attractively priced at 15.80 times earnings, and yields 4.40%. If I were starting my dividend investment journey today, PMI would be high on my list for purchasing.

I am going to end up this article with the following quote from Warren Buffett :"I'll tell you why I like the cigarette business. It cost a penny to make. Sell it for a dollar. It's addictive. And there's a fantastic brand loyalty."

Full Disclosure: Long PM, MO

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Friday, December 27, 2013

Kimberly Clark (KMB) Dividend Stock Analysis

Kimberly-Clark Corporation, together with its subsidiaries, manufactures and markets personal care, consumer tissue, and health care products worldwide. The company operates in four segments: Personal Care, Consumer Tissue, K-C Professional, and Health Care. This dividend champion has paid dividends since 1935 and has increased them for 41 years in a row.

The company’s last dividend increase was in February 2013 when the Board of Directors approved a 9.50% increase in the quarterly annual dividend to 81 cents /share. The company’s peer group includes Procter & Gamble (PG), Colgate-Palmolive (CL), and Clorox (CLX).

Over the past decade this dividend growth stock has delivered an annualized total return of 11.20% to its shareholders.


The company has managed to deliver a 3.20% average increase in annual EPS over the past decade. Kimberly-Clark is expected to earn $5.72 per share in 2013 and $6.10 per share in 2014. In comparison, the company earned $4.42/share in 2012.

The company has maintained a very consistent stock buyback program over the past year. Between 2003 and 2013, the number of shares decreased from 509 million to 386 million.

Kimberly-Clark has focused on increasing market share through product innovation and increased marketing. The company has worked closely in streamlining operations in the sluggish North American market, eliminating positions and closing several facilities under its FORCE plan. Kimberly-Clark plans on realizing $400 – 500 million in annual cost savings through 2013 with its FORCE plan to streamline operations and focus on best practices.

Commodity prices could be detrimental to total costs at the company, as is the competitive nature of developed markets in which Kimberly-Clark does business. As with other consumer products companies, the growth is likely to come from developing and emerging markets, rather than developed markets. Developed markets could benefit from cost cutting and efficiency profits, which would decrease the total price of doing business. Under the company’s global business plan, announced in 2003, it is looking for annual sales growth in the 3%-5% range, EPS growth in the mid to high single digits and dividend increases in line with earnings growth. For more on the global business plan, check this document.

The company recently announced its intention to spin-off its healthcare business. Existing Kimberly-Clark shareholders will receive shares in the K-C Healthcare unit through a tax-free distribution. The K-C healthcare unit had $1.6 billion in annual sales in 2012, and $229 million in operating income. It accounted for approximately 8.50% of Kimberly-Clark’s operating income in 2013. If approved by the board, this transaction could close by the third quarter of 2014.

Kimberly-Clark has maintained a high level of returns on equity over the past decade. The indicator never fell below 25% during our study period. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.

The annual dividend payment has increased by 9.50% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.

A 9% growth in distributions translates into the dividend payment doubling every eight years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the mid-single digits.

The dividend payout ratio has increased from 41% in 2003 to almost 67% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 57%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Kimberly-Clark is attractively valued at 18.40 times estimated 2013 earnings, yields 3% and has a sustainable distribution. However, if you manage to find a company with low P/E, and/or higher expected growth, you might want to purchase the shares of the other company. This assumes comparable yields, and dividend sustainability. I almost bought some Kimberly-Clark for my Roth IRA in early October at 16 times forward earnings, but unfortunately the shares took off before I had the cash to invest. While the company's business is pretty consistent, I would look for lower entry valuations before adding to my position there.

Full Disclosure: Long KMB, PG, CLX, CL

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Friday, December 20, 2013

Republic Services (RSG) Dividend Stock Analysis 2013

Republic Services, Inc. (RSG), together with its subsidiaries, provides non-hazardous solid waste collection, transfer, and recycling and disposal services for commercial, industrial, municipal, and residential customers in the United States and Puerto Rico. The company has paid dividends since 2003 and has increased them for ten years in a row.

The company’s last dividend increase was in July 2013 when the Board of Directors approved a 10.60% increase in the quarterly annual dividend to 26 cents /share. The company’s peer group includes Waste Management (WM), Waste Connections (WCN), and Veolia (VE).

Over the past decade this dividend growth stock has delivered an annualized total return of 9.90% to its shareholders. The largest shareholder with an approximate 25% stake is Bill Gates, through his holding vehicle Cascade Investment LLC.


The company has managed to deliver a 6.40% average increase in annual EPS between 2003 and 2012. The company is expected to earn $1.87 per share in 2013 and $2.01 per share in 2014. In comparison, the company earned $1.55/share in 2012.

The company is the second largest provider of waste management services in the US, after acquiring Allied Waste in 2008.

I like the economics of the waste management business, and believe that Republic Services has a few ways to grow revenues over time.

First, the nature of its business is to provide an essential service that is relatively recession resistant. Over time, I would expect that the amount of trash volumes to only increase, as a factor of increasing population and level of industrial and societal output.

Second, the company benefits from economies of scale, as of 12/31/2012 it owned 191 landfills, 195 transfer stations and 71 recycling centers. Trash collection services generate over three quarters of revenues ( 35% municipal and residential, 40% commercial & 25% industrial), while transfer services and landfill generate about one-sixth. Recycling services generate the majority of any remainders. Landfills are difficult to set up and operate, and require companies to go through a lot of government red tape to obtain proper permits/licenses. In addition, landfills require high costs in setting up, monitoring etc. Thus landfill ownership could be viewed as a competitive advantage.

Third, the company can grow through acquisitions, especially those that complement its geographic presence in a certain part of the country. Currently Republic Services and Waste Management (WM) generate approximately 60% of revenues in the industry combined. Through acquisitions, the company can leverage its economies of scale, and generate synergies such as reductions in capital requirements and in personnel. If you have relatively fixed costs in terms of landfills, transfer stations and truck fleet, any marginal increases in volumes can result in much higher increases in earnings. In addition, the company seeks to achieve a high rate of internalization by controlling waste streams from the point of collection through processing or disposal.

Fourth, a large portion of the company’s contracts also include price hikes tied to inflation. In addition, it could contain costs by standardizing the truck fleet it operates, and switching it from diesel to natural gas. The company operates under one – five years contracts with municipal, commercial and industrial customers.

Fifth, the company can also increase earnings per share through regular share repurchases. Between 2003 and 2008, shares outstanding decreased from 240 to 192 million. After the acquisition of Allied Waste in 2008, the number of shares outstanding has decreased from 381 million in 2009 to 363 million in 2013.

The company can also leverage its existing position to generate new revenue streams. Examples include recycling centers as well as using trash to generate energy. These are existing operations, which could potentially generate extra money for shareholders. Currently, 35% of trash is recycled, and this percentage is expected to increase.

Risks

While to compete with Republic Services requires a lot of capital, and there is limited pricing power. Contracts are due for renegotiation every few years or so, and subject to competitive bidding. If a competitor wants to gain market share, they can potentially lower prices to gain key contracts. Given the scale and vertical integration of Republic’s operations the chances of that are low, since it can probably outbid most of the smaller rivals in the industry. The company is also number one or two provider in 90% of the markets it operates in.

The second risk involves potential for environmental liabilities. The company needs to be really good at managing environmental issues, particularly as it relates to its landfills. After a landfill is filled up with trash, the company has to monitor it for at least 30 years.

If management does not do a very good job of continuously monitoring risks related to an environmental contamination on a systematic basis, the results could be terrible for communities affected and shareholders. Again, the possibility of this actually happening is likely low, but it is something to think about.

The third item is that I do not expect future growth in earnings per share might not exceed 5-6%/year over say the next 5 – 10 years. Therefore, the opportunity cost of owning Republic Services is missing out on a stock that yields 3% but grows distributions by more than 6%/year.

Republic Services increased Returns on Equity from 5.70% in 2003 to over 21% by 2007. There was a big drop during the financial crisis, and currently the ROE is standing at 7.40%. Based on forward earnings, I expect this ratio to increase above 10%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.

The annual dividend payment has increased by 12.80% per year over the past five years, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.

A 12% growth in distributions translates into the dividend payment doubling almost every six years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high single digits.

The dividend payout ratio has increased from 9% in 2003 to almost 59% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 56%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Republic Services is attractively valued at 18.50 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been a little slow in the past five years. If earnings per share grow by 2 – 3%/year based on organic growth (such as growth in population) and acquisitions, and 2-3%/year due to share repurchases, this could translate to total growth of 4 – 6%/year. Given the high dividend payout ratio, I am not sure if long-term dividend growth would be higher than 6%/year over the next 5 - 10 years. This is not too bad of course, given a starting yield of 3%. However, if I find a stock that yields 3% and expect it to grow distributions above 6%/year, I would likely buy that stock, rather than Republic Services.

Full Disclosure: None

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- Dividend Paying Stocks for Retirement Income
Dividends versus Share Buybacks/Stock repurchases
Reinvest Dividends Selectively

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