Can You Believe there is a 30% Rebate on Toothpaste?

 

Summary:

52 years of consecutive increasing dividend payment makes CL a strong dividend growth stock

Strong currency headwinds may reduce its double digit dividend growth trend

Dividend Discount Model used shows CL trading at a 30% discount

DSR Quick Stats

Sector: Consumer – Defensive

5 Year Revenue Growth:  2.42%

5 Year EPS Growth: 4.81%

5 Year Dividend Growth: 10.55%

Current Dividend Yield: 2.15%

What Makes Colgate-Palmolive (CL) a Good Business?

Colgate-Palmolive is a consumer products company. The Company provides products for oral care, personal care, home care and pet nutrition:

cl1

CL is the world’s leading producer & manufacturer of toothpaste with 44.8% of the worldwide market share. This is a very important competitive advantage as the world won’t stop brushing their teeth and toothpaste is a highly repetitive buy for any household. CL doesn’t only show a strong market share of toothpaste but it shows a similar profile with regards to toothbrushes with a 33.8% worldwide market share.

Colgate Palmolive is also focusing on employee equity and environmental concerns. They can also claim to promote health with their Oral and Personal care products (who would argue that they can’t help with hygiene in emerging markets through their toothpaste?). In their financial reports, they outline their “Sustainability Strategy” aiming at 5 principles:

  1. Promoting healthier lives
  2. Contributing to the community
  3. Delivering products that respect our planet
  4. Reducing water consumption
  5. Reducing impact on climate and environment

Ratios

Price to Earnings: 26.78
Price to Free Cash Flow: 58.86
Price to Book: 133.37
Return on Equity: 181.40%

Revenue

cl2

Revenue Graph from Ycharts

CL revenue has been greatly affected by currency headwinds. However, the company continues to show strong emerging market sales growth in constant dollars with a +9.5% in 2014 and +6.5% for the first quarter of 20115.

How CL fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve gone through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing . The first four principles are directly linked to company metrics. Let’s take a closer look at them.

cl3

Source: Ycharts

Principle #1: High dividend yield doesn’t equal high returns

I’ve never been a big fan of high dividend yielding stocks. They usually show very small dividend growth as they are imprisoned with a high payout ratio. And if they don’t, their high yield is linked to higher risk (there is no free lunch in finance). Overall, I tend to look at companies with dividend yields between 2% and 4% historically, these are the ones which tend to perform the best.

cl4

Source: data from Ycharts.

While CL has aggressively increased its dividend payment over the past 5 years, the dividend yield has remained relatively low. However, the yield is high enough to fit my first criteria.

Principle#2: If there is one metric, it’s called dividend growth

According to my own experience and much financial research, dividend growth is the most important metric for a dividend investor. Strong dividend growth is a sign of a healthy business generating important cash flow.

CL is showing a strong dividend growth history of 52 consecutive years of increasing its payment. Therefore, the case is pretty much closed regarding this criteria.

Principle #3: A dividend payment today is good, a dividend guaranteed for the next ten years is better

Past dividend growth is very important, but not as important as future dividend growth. In order to determine if a company is able to continue increasing its dividend in the future, I look at the dividends paid and payout ratio trend over the past 5 years:

cl5

As you can see, the payout ratio has increased by 10% over the past 2 years while the dividend payment consistently increased. A part of the reason why the payout ratio is higher today is the strong currency headwinds CL has faced since 2012. However, the payout ratio is far from being a source of concern at the moment. There is plenty of room for the company to continue increasing its payment. The only thing that might change is that it may become a challenge to maintain double digit growth.

Principle #4: The Foundation of a dividend growth stock lies in its business model

I like a company that has a solid economic business model with a relatively wide moat. This is the case with CL where the oral care segment that generates near 50% of its sales is well secured. CL is a leader in this industry and is present across the globe with an even more dominant presence in high growth countries in emerging markets.

This dividend aristocrat shows the perfect profile of a steady money making machine with positive free cash flow each quarter. There is no doubt CL has its place in a dividend growth portfolio.

What Colgate-Palmolive Does With its Cash?

Since 2009, CL has been generating over 2 billion in cash flow each year. More recently, its yearly cash flow is around 2.5 billion (for 2013 and 2014). The first thing management does is to make sure it doesn’t break its 52 years streak of increasing dividends.

Along with a juicy dividend increase each year, the company also spends lots of money on advertising and brand-building activities. Their main focus is emerging markets since there is plenty of room for them to keep growing.

Finally, a good portion of the money is dedicated to improve the current brand portfolio and enhance existing products. This is how CL created its “whitening mega brand” from Colgate products.

Investment Thesis

CL sells primarily consumable products that continually reappear on the buy list of any household. The company is working hard to gain market share in its dominant market and makes sure it offers a variety of products reaching all price points. For example, Colgate toothpaste product is offered in 5 different package/options from the cheapest to the priciest in order to block all entry for possible competitors. Finally, the company makes additional efforts to partner up with dentists to improve dental care awareness around the world. It ensures two complementary goals; to have dentists on their side and to increase the number of individuals caring for their mouths.

Since 1998, the company gross margin has been superior to 50% and has been consistently over 58% since 2011. This is a huge money making machine that has found a way to be highly profitable over the years. The gross margin is even better in emerging markets where its growth rate is the most important.

Finally, the company is present in over 200 countries and has a major leadership position in all fast growing markets. CL is well positioned to benefit from its vast distribution channel in order to penetrate any market.

Risks

CL is making several efforts to develop new products but its range of knowledge is highly limited. Since 46% of its sales come from oral care, there is a limit of numbers of different toothpastes and toothbrushes a household will buy. Chances are the new products within the Colgate brand will only serve to cannibalize a part of their sales + earn a few bps in the market share battle. Their long term growth opportunity is limited by the size of the population at the moment.

Since 80% of CL sales are made outside the US, the company is highly vulnerable to currency volatility. Lately, this has been a major challenge since the US dollar seems to gain more strength each day.

Should You Buy CL at this Value?

In order to determine CL’s value, I will use 2 different methods. The 10 year PE ratio history will tell me how the company has been perceived by the market recently:

cl6

As you can see, there is a growing interest for the company lately. The strong dividend payment increases doubled with miserable bond interest rates might have seduced more than one income seeking investor. So far, the stock seems overpriced but let’s use a more detailed way to value the company.

The dividend discount model (DDM) is often used by dividend investors as it helps to ascertain a value considering the dividend payment potential of a company. Since the company is evolving in a defensive industry and shows strong cash flow, I will use a discount rate of 9%.

Due to strong currency headwinds and the volatility that comes with emerging markets, I will use a dividend growth rate that is lower than what the company has shown more recently. I will conservatively use a 9% growth rate for the first 10 years and reduce it to 7% after. With these numbers, I think I can’t go wrong in the company valuation:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $233.21 $115.82 $76.73
10% Premium $213.77 $106.17 $70.34
Intrinsic Value $194.34 $96.52 $63.94
10% Discount $174.90 $86.87 $57.55
20% Discount $155.47 $77.22 $51.15

Source: Dividend Toolkit calculation spreadsheet.

Wow… 30% discount rate for a company that currently trades over 26 PE… I’ve played around with the numbers and the model gives me a fair value of $64.75 with a 6.50% dividend growth rate. This is far below what has been offered to investors for the past 10 years. Therefore, there is definitely a bargain to be had on CL at the moment.

Final Thoughts on CL – Buy, Hold or Sell?

After doing the DDM calculation, it seems obvious that CL is a good buy for any dividend growth portfolio. The compounding strength of dividend growth will be expressed within these shares and will reward the investor.

The margin of safety is big enough for most investors for anyone to enter in a position even if the PE ratio seems high.

Disclaimer: I do not hold shares of CL at the moment.

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Clorox has never traded at a higher PE valuation, yet it’s still a bargain

Summary:

Clorox has focused on innovation to generate future growth;

The company shows a portfolio of premium brands providing stable cash flow;

While the PE ratio is high (23+), the company is still trading at a 10% discount.

DSR Quick Stats

Sector: Consumer Defensive

5 Year Revenue Growth: 0.51%

5 Year EPS Growth: 2.07%

5 Year Dividend Growth: 9.07%

Current Dividend Yield: 2.79%

What Makes Clorox (CLX) a Good Business?

The Clorox Company (Clorox) is a manufacturer and marketer of consumer and professional products. Basically, anything you find when you open a closet at home has a 50% chance to belong to CLX portfolio brand. The Company operates four divisions: Cleaning (Pinsol, Clorox), Household (such as bags & wraps… Glad anyone?), Lifestyle (Brita, Burts Bees) and International (to cover sales for the above three divisions outside the US of A). As you can see, their revenues are pretty well spread among the four divisions:

CLX sectors

What is even more interesting about Clorox is that 80% of their brands are #1 or #2 in their market. The size and variety of its brand portfolio enables CLX to scale their production and generate important synergy among its different brands. This is how CLX also shows a lower sales & administration cost as a percentage of sales vs their main competitors (14% compared to 21% in the industry according to a Clorox investor presentation: source)

Ratios

Price to Earnings: 25.10
Price to Free Cash Flow: 19.94
Price to Book: 46.09
Return on Equity: 291.40%

Revenue

CLX revenueRevenue Graph from Ycharts

Since 2013, CLX revenues have barely increased, this is why the 5 year growth is far from being spectacular (CAGR of 0.51%). This is mainly due to the difficult international context coupled with currency headwinds. In order to support revenue growth, CLX has put in place a massive innovation program to improve its existing products and create new ones.

The innovation program now has a 3% sales growth target for 2015 and the years to follow. This seems like solid growth for such a large and mature company.

How CLX fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve gone through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. The first four principles are directly linked to company metrics. Let’s take a closer look at them.

CLXSource: Ycharts

Principle #1: High dividend yield doesnt equal high returns

High dividend stocks systematically underperformed the market mostly because there is always a good reason why the dividend yield is so high. In general, the market requires a higher yield from company showing higher risk. Also, most companies with high dividend yield show very limited dividend growth capacity.

CLX TTMSource: Ycharts

The CLX yield has been relatively low over the past 5 years and it’s even more true ever since the stock price increased in valuation over the past 12 months. The yield is now around 2.75%. This is not a huge dividend yield, but I would rather buy shares of a company that shows strong dividend growth than a high dividend yield.

Principle#2: If there is one metric, its called dividend growth

As I just wrote, dividend growth is the mother of all solid companies held in my portfolio. The reason is simple; if a company shows strong dividend growth, it is driven by increasing sales and profits. Two very powerful factors to look at for any type of business.

CLX dividend paymentSource: CLX website

The dividend payment has more than doubled in the past 10 years. Enough said.

Principle #3: A dividend payment today is good, a dividend guaranteed for the next ten years is better

I think CLX’s dividend payment reputation is not to be discussed here. After 38 consecutive years of dividend increases, we can expect the company to continue. However, a quick look at the dividend payout ratio is always a good idea.

The company used to stick between 50% and 60% which leaves a very comfortable margin to increase it. Lately, the ratio has drifted higher than 70% and the aggressive dividend growth policy (9% over 5 years) might has to be reviewed in the long term.

Principle #4: The Foundation of dividend growth stocks lies in its business model

The Clorox business model is based on a very solid brand portfolio where most of their brands hold the #1 and #2 position in terms of market share. This makes it very hard for other competitors to enter the CLX playground.

Plus, since the company is selling consumer products, it generates constant cash flow helping the company pay ever increasing dividends while continuing to invest in the future.

What Clorox Does With its Cash?

As is the case for most consumer stocks, CLX is a real money making machine. The company focuses on free cash flow generation as demonstrated:

CLX cash flow

 

 

 

 

Last year, out of the $649 million in free cash flow, CLX paid $368 million in dividends. The company doesn’t only increase its dividend each year but also actively purchases its shares. The company bought nearly 40% of the outstanding shares over the past 10 years. This probably explains its relatively high PE ratio (over 25) but the company shows a smaller price to free cash flow evaluation (around 19).

As previously mentioned, CLX also spend and important part of its budget toward product innovation. The key to remain a leader in consumer products is to evolve continually and maintain a very strong brand portfolio. CLX has successfully done this over the years.

Investment Thesis

The reason an investor would pick CLX to be part of his portfolio is somewhat obvious: it is an ever increasing dividend stock. Clorox is part of the selective group of dividend aristocrats that has increased its dividend for at least 25 years consecutively. In 2015, they have reached their 38th consecutive year with a dividend raise.

The company is currently driving its 2020 vision focusing on 4 key strategies:

#1 Engage our people as business owners

#2 Increase our brand investment behind superior products and more multi-targeted 3D innovation

#3 Keep the base healthy and grow into profitable new categories, channels and countries

#4 Fund growth by reducing waste in our work, products and supply chain

The company goals are to support a 3-5% organic sales, improve margins by 25 to 50 bps and to generate free cash flow of 10-12% of sales.

In other words; this consumer product giant will aim at reducing their costs, improving their sales and focus on high levels of cash flow in order to increase its dividend payment for the next 100 years.

Clorox’s ability to push new products through its distribution channel should support sales in the upcoming years.

Finally, the world is highly sensitive to potential disease spreading catastrophes. We had another example with Ebola last year. Cleaning and disinfecting products have become very important and CLX is in a leadership position to benefit from this robust trend.

Risks

When you look at the CLX sales growth, you will notice there isn’t any growth among its products. Since international sales represent 20% of total sales, we can’t blame everything on currency headwinds. The problem is that Clorox bleach and charcoal products are used by consumers on a daily basis but there aren’t many ways to make consumers buy more to support higher growth.

CLX spends massively on marketing in order to promote their products and it’s working perfectly as CLX usually enjoys a price premium over its competitors without hurting its sales too much. However, this requires a constant advertising effort and the brand differentiation factor is still very slim for the consumer.

Overall, the main risk around a company like Clorox is to see sales stagnate which would push the dividend payout ratio to higher levels. The dividend payment is far from being at risk, but the payment growth might be very thin in the years to come.

The company is well aware of this situation and this is why it is focusing on improving existing products and has created a strong product pipeline for the upcoming years that should increase sales and resolve the current sales stagnation situation.

Should You Buy CLX at this Value?

CLX has recently benefitted from a strong bullish thesis pushing its valuation through higher levels. You can see in the chart below how the CLX PE ratio has risen over the past 10 years.

CLX PE ratio

Considering the previous market valuation, the PE method shows there is a lot of enthusiasm for Clorox at the moment.

Going further, I’ll use the dividend discount model to determine stock value in terms of dividend distribution. Using a 10% discount rate and a dividend growth rate of 8% for the first 10 years and then 7% after, I get the following chart:

CLX intrinsic valueSource: Dividend Toolkit calculation spreadsheet

As the stock is currently trading around $105, it seems to be trading at a 10% discount.

Final Thoughts on CLX – Buy, Hold or Sell?

Buying shares of CLX will not make you double your investment within the next two years. It is relatively stable company evolving in mature markets. However, this doesn’t mean it’s a bad investment. For its solid dividend growth history, its premium brand portfolio and the fact the company is still trading at a discount considering its dividend payment; I think CLX is a buy.

 

Disclaimer: I do not hold shares of CLX at the moment.

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3M; Low Yield; Highly Interesting

3M Company (NYSE: MMM) is a diverse conglomerate that produces a broad array of products and materials for both consumers and businesses.stock report

-Seven Year Revenue Growth Rate: 4.46%
-Seven Year EPS Growth Rate: 3.97%
-Seven Year Dividend Growth Rate: 9.85%
-Current Dividend Yield: 2.56%
-Balance Sheet Strength: Extremely Strong

Overview

3M Company (NYSE: MMM), once called the Minnesota Mining and Manufacturing Company, was founded in 1902. The company, now with 80,000 employees, produces products like Scotch tape, projector systems, Post-it notes, Tartan track, and Thinsulate. This is a conglomerate that produces products for many industries and for both personal and business use, and their manufacturing, research, and sales offices are all over the world.

Business Segments

The company is divided into five business segments:

Industrial Business
This segment provides adhesives, abrasives, filtration systems, fasteners, and specialty materials to a variety of industries. This is the largest segment, accounting for about 34% of sales.

Safety and Graphics Business
This segment provides display films, reflective materials, projection systems, and the like. This segment accounts for about 18% of sales.

Electronics and Energy
This segment provides products for electronics and energy businesses including films for LCD screens and splicing products for signal cables, and accounts for about 17% of sales. Nearly two-thirds of sales from this segment come from the Asia Pacific region.

Health Care Business
This segments provides several products in the areas of wound care, oral care, drug delivery systems, and more. This segment accounts for about 17% of sales. The bulk of sales come mainly come from the U.S. and Europe, as the products are more targeted towards developed countries.

Consumer and Office Business
This segment provides solutions for the home and office, and includes well-known products like Scotch tape. This segment accounts for about 14% of sales. The U.S. accounts for over half of sales from this segment.

Ratios

Price to Earnings: 21.21
Price to Free Cash Flow: 19.85
Price to Book: 7.3
Return on Equity: 31.72%

Revenue

MMM revenue

MMM revenue trend is very strong. Since 2012, revenue doesn’t increase at the same pace mainly because the company faces currency headwinds. The organic growth is present (4.9% in Q1 2015), but the negative impact of a strong dollar reduces sales significantly.

Earnings and Dividends

MMM earnings and dividends

Approximate historical dividend yield at beginning of each year:

MMM div history

 

 

 

 

 

The company has been paying dividends each year for the past… 98 years. We can definitely talk about a strong dividend payer here. Most importantly, the dividend increase in 2014 and 2015 are stronger than its previous years. Nonetheless, the past 7 years shows an annualized dividend growth rate near double digits (9.85%). In other words, the company is nearly doubling its dividend payment every 7 years.

How Does 3M Company Spend Its Cash?

The company generates over 5 billion per year in free cash flow. The fact MMM is selling mostly consumable products makes its cash flow base stable and predictable. This enables the company to manage growth through R&D and acquisitions while returning a good amount of money to shareholders at the same time. In 2014, MMM used $1.5 billion for capital expenditures, $1.8 billion in R&D and $1 billion in acquisitions. At the same time, it has returned $7.9 billion to shareholders via a share repurchase program and dividend payments.

Investment Thesis

3M Company is definitely more diversified than a balanced mutual fund. It is present in various consumable product areas and the bulk of its sales comes from business-to-business transactions.

Roughly 50% of its products are consumable, which implies a very high rate of repeat business year after year. Product diversification is at the center of MMM business which offers continuous growth opportunities.

The company also allocates between $1 and $2 billion per year for acquisitions providing external growth on top of what is coming out of its own R&D department. MMM also benefits from top-of-the-line technology enabling to control costs like no other company. It can easily scale any production and each innovation means higher sales volume.

It is very hard to compete against MMM due to its size and investing power. Since the company keeps investing massively in R&D and buys other innovating companies, it ensures its sustainability over time.

Risks

When an investor buys MMM, he doesn’t expect to lose 40% of its value overnight. Product and geographic diversification enables the company to post predictable and stable numbers. However, these two advantages could also be linked to some other risks.

The fact MMM produces so many different products makes high digit growth difficult to generate. It is most likely to follow closely GDP growth instead of reaching high double digit figures.

MMM has increased its sales throughout the world in the past decade. This makes the company more at risk of currency headwinds.

As you can see, these are not the biggest concerns an investor could have while buying a stock. Overall, MMM shows a very strong profile.

Conclusion and Valuation

In my opinion, MMM should be part of most conservative (or core) dividend portfolios. While you shouldn’t expect incredible growth from this company, dividend payment increases will always be there each year. In order to verify if it’s the right time to buy MMM, we will look at the company 10 year PE history along with a Dividend Discount Model calculation.

MMM PE Ratio

As you can see, the strong dividend increase in the past 5 years hasn’t been ignored by the market. The P/E ratio has continuously increased over the past 3 years.

Full Disclosure: As of this writing, I have no position in MMM. It seems the company hasn’t been highly valued as right now. Let’s use the dividend discount model to see how much the company worth according to its dividend payment ability.

MMM intrinsic value

 

 

 

 

Source: Dividend Toolkit

I’ve used a dividend growth rate of 10% for the first 10 years and reduced it to 7.5% afterward. Then, I used a discount rate of 9% since the company shows stellar numbers.

According to the DDM, the company trades at a discount of 15% or so with a fair value of $179. Strong dividend growth perspective justifies a higher P/E valuation at the moment.

Considering MMM product portfolio and the fact the company is making the bulk of its sales from consumable products in a business-to-business model, MMM seems fairly attractive at the current price. This is a “long-term-dividend-growth” stock for patient investors.

Disclaimer: I do not hold MMM in my portfolio.

 

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