Dividend Kings Analysis: 3M Stands Out

Overview

In this article I analyze the 29 Dividend Kings, an exclusive group of stocks that have increased their dividend for 50+ consecutive years. I discuss the top performing stocks in my ranking model, which tends to have more of a momentum tilt based on trailing earnings and dividend growth but does consider dividend safety and valuation. The top five stocks in the ranking have changed. Nordson Corp. (NDSN) has dropped out of the top 5 and was replaced by 3M Co. (MMM). There were two stocks with major moves in the rankings. California Water Service Group (CWT) has trended down. On the other hand, Lancaster Colony Corp. (LANC) has trended up. 3M now has the second highest yield of the Dividend Kings and currently the yield is even higher at ~3.8% due to recent price declines. On a dividend yield basis, the stock is clearly undervalued. The last time the yield was near 4% was during the Great Recession. Furthermore, on a forward P/E ratio basis the stock is undervalued relative to the historical average. Hence, in my opinion 3M is currently a buy of all the Dividend Kings.

Source: Seeking Alpha

Background

In these analyses I use nine criteria that permit rapid quantitative screening based on the dividend, earnings growth, dividend growth, dividend safety, and valuation. The nine criteria used in quantitative screening are:

  • History of increasing dividends
  • Dividend yield
  • 5 Years EPS growth rate
  • 5 years dividend growth rate
  • 10 years dividend growth rate
  • Payout ratio
  • Long-term debt-to-equity ratio (D/E)
  • 5-year Beta
  • P/E Ratio for trailing twelve months

The goal here is to identify stocks for further research not make buy or sell decisions. There are often qualitative factors for each stock that must be researched before making an investment decision. For instance, I also evaluate P/E ratio relative to past 5-years or 10-years and dividend-to-FCF ratio. Other qualitative factors can also include management history, recent M&A activity, and effect of tariffs and trade wars on revenue.

Top 5 Dividend Kings In Each Criteria

The table below lists the 29 Dividend Kings in order of number of years of paying a growing dividend. These stocks come from a wide range of industries but there are quite a few industrial, consumer staples, and water utility stocks in the table. The green highlighted rectangles in each column list the five stocks that rank the best in that criteria. The red highlighted rectangles indicate negative growth rates. The yellow highlighted rectangles indicate that the data was not available or applicable. For example, Colgate-Palmolive Co. (CL) has negative equity, so the D/E ratio is undefined.

List of Dividend Kings

List of Dividend Kings

Source: Data from dripinvesting.org as of September 30, 2019, Seeking Alpha, and Morningstar

Similar, to last month, the Dividend King that is noticeable based on this analysis is Hormel Foods Corp. (HRL), the consumer staples company focused on protein. The company ranks well in five of the nine criteria due to high earnings and dividend growth rates, low D/E ratio, and low beta. But on the other hand, the stock has a high valuation relative to the broader market and the dividend yield is low. But at the right price, Hormel is generally a sound investment. A second stock to note is Parker-Hannifin Corp. (PH), the industrial conglomerate that focuses on aerospace systems, engineered materials, filtration, fluid connectors, instrumentation, motion systems, and electromechanical components. This company also ranks highly in five of the nine criteria due to high earnings and dividend growth rates, number of consecutive years increasing the dividend, and relatively low valuation. But with that said, the yield is still low for this stock and it is a volatile stock with a beta of over 1.5, which may limit interest from some investors.

Graphical Analysis of Yield Versus Other Criteria

In the following sets of graphs, I plot the dividend yield versus the other criteria. The individual data points are labeled according to their yields and can be cross-referenced with the table above. Stocks that I highlight in this discussion are labeled in the graphs.

In the first graph I compare dividend yield versus 5-year EPS growth rate. The stock with the highest dividend yield and the highest EPS growth rate is Altria. Altria has a substantial dividend yield of about 8% and low valuation. However, Altria’s stock price has been trending down for over 2-years now due to declining cigarette sales, potential for increased FDA regulation, competition from e-cigarettes, and poor capital allocation. Despite the rising yield, I think that the negatives far outweigh the positives for Altria at the moment. There is just too much uncertainty about the regulatory landscape and e-cigarettes. 3M is the stock with the second highest dividend yield at 3.5%. Since the end of September, the stock price has fallen further and simultaneously the dividend yield has increased to about 3.8%. This is the highest dividend yield since the Great Recession. At that time, the yield was almost 5%. Today, we are not yet in a recession. But saying that, global manufacturing is slowing, and 3M is a supplier to many manufacturers, so market sentiment is highly negative for this stock.

Dividend Yield versus 5-Year EPS Growth Rate

Source: Dividend Power

In the second and third graphs I compare dividend yield the versus 5-year dividend growth rate and also versus 10-year dividend growth rate. The two companies with the highest dividend growth rates over 5-years are Hormel and Lowe’s Companies (LOW), and over 10-years are Lowe’s and Target Corp. (TGT), but Hormel is a close third. Hormel has demonstrated the ability increase EPS and the dividend over time due to organic growth and bolt-on acquisitions. The company remains one of my favorites in the consumer staples sector. 3M stands out due to its high yield and relatively high dividend growth rate over 5-years and 10-years. The company has been able to sustain growth rates of ~16% and ~10% over the past 5-years and 10-years, respectively. However, 3M may not be able to sustain this rate in the foreseeable future due to slowing top line growth resulting from slowing global manufacturing. Earlier this year, 3M missed estimates and cut guidance for 2019. Roughly 60% of 3M’s revenue comes from overseas and manufacturing in Europe is contracting with a PMI below 50 since early 2019. In addition, manufacturing in China and Asia-Pacific has slowed considerably due to the ongoing tariff and trade war situation. 3M derives about 31% of total revenue from this region so a slowdown there negatively impact the company.

Dividend Yield versus 5-Year Dividend Growth Rate

Source: Dividend Power

Dividend Yield versus 10-Year Dividend Growth Rate

Source: Dividend Power

In the fourth graph I compare dividend yield versus D/E ratio as a measure of safety. Stocks with too much long-term debt may not raise the dividend significantly. In the worst case, the dividend may be frozen or cut due to high interest payments or principal payments. In general, D/E ratio of 2.0 or greater is considered to be too high. Several stocks including Hormel have little to no long-term debt. Other stocks on this list include Lancaster Colony (LANC), and Tootsie Roll Industries (TR).

Dividend Yield versus DE Ratio

Source: Dividend Power

In the fifth graph I compare dividend yield versus dividend payout ratio as another measure of dividend safety. A stock with a high yield with a low payout ratio is a reasonably safe dividend. Genuine Parts Company (GPC) is the only company currently on the chart with a yield over 3% and a payout ratio less than or equal to 65%. Last month both Target (TGT) and Emerson Electric (EMR) were on this list but higher stock prices and thus lower yields dropped them from the list. Target’s stock price has surged due to recent good results. Emerson’s stock price popped since the company may breakup. 3M was also previously on this list, but the trailing payout ratio has trended up and is now over 70% due to lower trailing EPS.

Dividend Yield versus Payout Ratio

Source: Dividend Power

In the last graph I compare dividend yield versus trailing P/E ratio as a measure of valuation. In this graph a stock would ideally be located toward the top left corner. I would like to buy stocks with good yields but low valuations and hold forever. From this perspective, 3M, and Genuine Parts perform well. Again, Altria stands out as an outlier with very high dividend yield combined with relatively low valuation. After screening, one could compare a stock’s current valuation relative to the historical P/E multiple. 3M’s valuation is one that has been subject of much discussion. The TTM P/E ratio is now 20.0. This seems high but it is low relative to the broader market’s valuation of ~22.0. This valuation is also low relative to the 5-year average of 23.2. With that said, the forward P/E ratio is only 16.2, which is reasonable and even below the company’s 10-year average that is slightly over 17.0.

Dividend Yield versus Trailing PE Ratio

Source: Dividend Power

Dividend Power’s Ranking Model

In this section I present a scaled ranking model using the aforesaid nine criteria and weight each one according to their importance to me. The model tends to reward stocks with better dividend growth characteristics. But saying that, stocks with low dividend safety or high valuation multiples tend to rank low.

The model also accounts for a stock’s criteria rising above or falling below a critical value. If a criterion is above or below the critical value, then that criterion would be zero. For example, I want stocks that have a payout ratio below 100% but sometimes the payout ratio goes above 100% due to a drop in EPS resulting from economic headwinds or company specific short-term issues. The model assigns a zero for that specific criteria for these stocks. It is not a sell signal, but the stock will rank low and thus it may not be suitable for adding to the position at that time. Similar logic applies to other criteria.

The top five stocks in the ranking model in order are Hormel, Target, Parker-Hannifin, 3M, and Commerce Bancshares. Note that Nordson dropped out of the top five this month and was replaced by 3M. Again, the lowest ranked stock using my ranking methodology is Coca-Cola due to the negative 5-year EPS growth rate, relatively low dividend growth rates, high payout ratio, and high D/E ratio. Of interest is that Lancaster Colony has moved up five spots in the ranking and is now No. 7 due to a declining stock price resulting in a higher yield and a lower valuation multiple. On the other hand, California Water Service moved down to No. 13 in the rankings due to a drop in the 5-year EPS growth rate and higher valuation relative to the other Dividend Kings.

This month I provide a summary analysis of Lancaster Colony since it is trending up. I also provide a summary analysis of 3M since it reentered the top 5.

Lancaster Colony Corp. (LANC) – Lancaster Colony is a consumer staples company that focuses on specialty foods. Almost all of the company’s revenue is generated in the U.S. Lancaster Colony’s major brands include Cardini’s, Girard’s, Marzetti, New York Brand Bakery, Mama Bella, Sister Schubert’s, Mary B’s, Amish Kitchen, Reames, and Aunt Vi’s. About 53% of revenue is from retail sales and 47% of revenue from food service sales. Total revenue was roughly $1.4B in FY 2019. The dividend is well covered from an earnings perspective with a forward payout ratio of 49.6% based on a forward dividend of $2.60 and consensus FY 2020 EPS of $5.12. Free cash flow coverage is solid as well. In FY 2019, the dividend required $70.11M and FCF was $126.72M giving a dividend-to-FCF ratio of 55.3%, which is well below my threshold of 70%. The company is one of the Dividend Kings that is debt free. Lancaster Colony carries about $200M in cash, cash equivalents, and short-term investments. Hence, the stock does well from a dividend safety perspective. Lancaster Colony was able to grow the bottom line at an average rate of 8.1% over the past 5-years. This led to a dividend growth rate of 6.2% and 4.9% over a 5-year and 10-year period, respectively. The company is able to generate growth organically and through bolt-on acquisitions. Recent acquisitions include Angelic Bakehouse, Bantam Bagels and Omni Baking. On the negative side, the dividend yield is low at only about 1.9% and the current valuation is higher than the broader market’s average of ~22.0. But with that said, the valuation is less than the trailing 5-year average of about 28.4.

3M Company (MMM) – 3M Company is an industrial conglomerate that has four business segments: safety and industrial, transportation and electronics, healthcare, and consumer. About 60% of revenue is from overseas and 40% is from the U.S. the company sells over 60,000 products. This number continues to increase over time through research & development and acquisitions. The company has many well-known brands including Scotch, Scotch-Brite, Scotchgard, Post-Its, ACE bandages, Filtrete, and Thinsulate. Total revenue was roughly $32.8B in 2018. The dividend is reasonably well covered. The forward payout ratio is 59.5% based on a forward dividend of $5.76 and consensus 2019 EPS of $9.34. The dividend is also decently covered by cash flow. In 2018, free cash flow was $4.86B and the dividend required $3.19B giving a dividend-to-FCF ratio of 65%. This is near my threshold but still below 70%. Debt is not much of an issue as the company is able to meet its obligations. Interest coverage is over 16X and 3M had almost $3B in cash, cash equivalents, and short-term investments at end of Q2 2019. The company faces several well publicized head winds including tariffs, trade wars and the slowing global economy. But the 3M is also facing quite a bit of litigation over its products and chemicals. From this perspective, the sum total of all liabilities reportedly may be several billion dollars. However, the company has made some moves to settle lawsuits on chemicals in drinking water, and military earplugs. 3M has also recently won a large lawsuit on medical warming system.

Final Thoughts On The Dividend Kings

Although Hormel continues to top the ranking I am not adding to shares at the moment. The stock is trading at an elevated valuation relative to historical averages and I continue to track it. Regarding Lancaster Colony, the top and bottom lines did not do well in the last recession likely due to exposure to the food service market segment. In fact, the P/E ratio was as low as ~11.0, much lower than today, and the yield was about 3%. Hence, I am taking a wait-and-see approach to Lancaster Colony. I continue to like 3M. The price has dropped further since the end of September and the yield has simultaneously risen to about 3.8%. I recently added to my shares despite the risks to the top and bottom lines from contracting manufacturing in Europe and a slowing global economy. The company is also facing headwinds from tariffs and trade war that is unlikely to subside in the near future, and litigation. However, 3M does well over time due to its broad array of products and investments in R&D and when manufacturing recovers 3M’s stock price should recover.

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Disclosure: I am/we are long CL, MMM, HRL, KO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.