The Dividend Monk is Back!

After a complete year of silence, the Dividend Monk is Back, but a few things will change.

 

On March 23rd 2015, the Dividend Monk was transferred to Mike, the owner of The Dividend Guy Blog. I could have faked being Matt (the original author) and let you think that you are still reading his work, but I prefer to be transparent with you and keep his dividend stock analysis methods and writing style intact.

 

Who’s Mike, Who’s The Dividend Guy?

First and foremost, I’m a passionate investor. I have a CFP title, a BAA in finance and an MBA. I’m happily married with three wonderful children and currently work in the financial industry. I started investing in 2003 using leverage techniques and bought my first house in 2006 with cash down coming from my trading successes. I have been writing blogs since 2006 and own several websites. I love my day job, but I also want to keep a very good sideline in case anything happens. In June 2010, I bought The Dividend Guy as I wanted to share my passion for investing with readers. I have authored this blog since then and have even written a book and created an investing platform. My goal throughout the years remains the same: share my passion for investing with my readers and helping them in their investment journey.

 

Why Buy the Dividend Monk?

You might think that with a dividend blog already, I could be busy enough and there would be little to no purpose of writing for a second one and you could be right. To be honest, I wouldn’t buy most dividend websites I read on a weekly basis simply because they are quite similar to mine. In business, we would call this cannibalism since I would only split the same readership amongst the two blogs.

The reason I bought Dividend Monk (DM) is because it is quite different from The Dividend Guy Blog (DGB). I’ve always appreciated the more analytical side of DM which I never developed on my own blog. This is why I will keep the structure and calculations he uses to analyze a company. While I make jokes from time to time on DGB, DM will remain serious and go deeper with its analysis.

This will also answer a good question I keep having from my own readers: when buying a stock? When is the value right? Using the dividend discount model is a great way to determine the value of a company and, therefore, the right moment to buy it. This is why I will keep using the DM Toolkit to analyze companies from a different angle than I use on my own blog. It’s just easier for me to separate the two types of analysis on two different websites. I hope you will like the work produced here.

 

Matt is Still on Board for the Newsletter

In our agreement, Matt will continue writing newsletter issues. Not all of them, but he will still be around. I’m happy to count him on my team as he will continue to add great value to the investing newsletter.

I’m excited to start this new adventure and hope you will have great success in your investing journey!

 

Cheers,

Mike

The Dividend Guy… and the Dividend Monk ;-)

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JM Smucker: Fair at $100

-Seven Year Average Revenue Growth Rate: 15.4% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 10.7%
-Seven Year Average Dividend Growth Rate: 9.5%
-Current Dividend Yield: 2.29%
-Balance Sheet Strength: Strong

For solid if not impressive risk-adjusted returns, J.M. Smucker seems well-positioned and fairly valued.

Overview

The J.M. Smucker Company (symbol: SJM) was founded in 1897, is headquartered in Ohio, and is still run by the Smuckers family.

The company produces jam, jelly, preserves, peanut butter, sandwich products, ice cream toppings, baking products, oil, juices, and coffee. The company draws its revenue mostly from North America, but has international ambitions as well. The company focuses primarily on having the #1 brand in any given category.

Coffee
For coffee brands, Smuckers has gone on a buying spree. They acquired the large Folgers brand of coffee from Procter and Gamble, and they also sell Dunkin Donuts coffee for retail markets. They now sell Millstone, Cafe Bustelo, and Pilon coffee, with the last two being popular among Hispanic demographics, statistically speaking.

K-Cups are becoming more popular, and Smuckers has offerings in this area, including from their Folgers Gourmet Selections brand. Smuckers does face strong coffee competition from several brands, with Starbucks and Green Mountain Coffee Roasters being the two most worth mentioning.

Coffee contributes 39% of SJM sales.

U.S. Retail Consumer Foods
The company’s original flagship product is their line of Smuckers fruit spreads: jams, jellies, and preserves. They were smart to acquire the Jif peanut butter brand as well, and they also control or license other brands like Crisco, Pillsbury, and Hungry Jack.

This segment contributes 38% of SJM sales.

International, Foodservice, and “Natural” Foods
Some of the company’s largest brands compete internationally, and they also have brands dedicated to certain markets, like Canada. For “natural foods” in this category, they have Santa Cruz Organic and R.W. Krudsen Family. In fiscal year 2012, the company invested in Seamild, a leading provider of oats products throughout China.

This segment contributes the remaining 23% of sales.

Valuation Metrics

Price to Earnings: 19
Price to Free Cash Flow: 22
Price to Book: 2.1

Revenue

Smuckers Revenue
(Chart Source: DividendMonk.com)

The revenue growth rate is high at 15.4% per year averaged over the past 7 years. This is because the company issued new shares for capital to make acquisitions up until 2010.

Earnings and Dividends

Smuckers Dividends
(Chart Source: DividendMonk.com)

Over the same 7 year period, EPS growth was 10.7% per year while dividend growth was close behind at 9.5% per year. The most recent dividend increase was 11.5%.

The current dividend payout ratio from earnings is about 40%, so the dividend is well-covered and has room to grow.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.3%
2013 2.3%
2012 2.5%
2011 2.6%
2010 2.3%
2009 2.9%
2008 2.4%
2007 2.3%
2006 2.3%

As can be seen by the chart, except for certain points of volatility, Smuckers stock has maintained a fairly consistent mediocre dividend yield. The price of the stock has risen at almost exactly the same rate as the dividend growth.

How Does SJM Spend Its Cash?

Over the past three years combined, Smuckers brought in about $1,300 million in reported free cash flow. About half of that, or $630 million, was spent on dividends. Over $1 billion was spent to buy back stock, and the outstanding share count has decreased by nearly 8% cumulatively over the past three years. Approximately $730 million was spent on acquisitions.

Balance Sheet

Smuckers has a total debt/equity ratio of under 45%, although goodwill makes up about 60% of existing shareholder equity due to acquisitions. The total debt/income ratio is about 4x. The interest coverage ratio is just over 10x, indicating that Smuckers can easily pay all debt interest.

Overall, the balance sheet is in a strong position. Management has used leverage appropriately and conservatively.

Investment Thesis

Smuckers has substantially outperformed the market over the last 15 years due to a series of large successful acquisitions and good management of their capital. A diverse set of top brands gives the company a steady, defensive position while outperforming, and therefore the risk-adjusted returns have been particularly good.

Looking to the future, management aims for sales growth of 6% per year (organic growth of 3-4% and acquisition growth of 2-3%), and EPS growth of 8% driven primarily from that sales growth plus share buybacks. With the dividend, this would lead to total returns of 10-10.5% or so, which is higher than the S&P 500 historical average.

The internal strategic efforts appear to be a page out of Pepsico’s current playbook with their “Healthy for You”, “Good for You” and “Fun for You” levels of products representing the spectrum of how bad for you a given product is. Smuckers has “Good for You”, “Easy for You” and “Makes You Smile”.

Overall focus of the company includes concentrating on North America and China rather than expanding everywhere, focusing on health products such as ones with natural ingredients or special-diet options such as gluten free products, and continuing to look for bolt-on acquisitions to complement their previous transformational acquisitions.

Risks

Like any company, SJM has risks. Being a food company, they are a defensive stock, but they always face risk in two main forms: commodity costs and cheaper private label competition. In addition, in contrast to many large American companies, Smuckers has most of its sales and operations in North America, meaning it is geographically concentrated.

Packaged food is a competitive business, and Smuckers expects flat volume growth and a 1% sales reduction in 2014, but decent EPS and dividend growth.

Conclusion and Valuation

With the DJIA and S&P 500 continuing to hit new records, stocks at a decent valuation are difficult to find, and this is especially so for relatively stable blue-chips that you can buy and set aside for a while. In addition to increasing risk and reducing overall returns, this pushes dividend yields lower across the market, which reduces the amount of dividend income you can buy with any given amount of cash.

That being said, SJM neither appears to be a clear value or a clear overvaluation. While the markets soared upward throughout 2013, SJM actually fell over ten bucks from its mid-year high.

The earnings multiple approach should work well for valuating the company. If management is successful and raises EPS by 8% per year over the next 10 years, then the EPS figure will be $10.57 at that time. Putting an earnings multiple of 16 on that EPS figure in ten years (compared to an earnings multiple of 19 now) puts the stock price at about $169. If dividends continue to be paid with a payout ratio of 40%, that’ll be about $30 in cumulative dividends over those ten years, or about $42 if they are reinvested into the stock. So, $169 + $42 = $211 in value in ten years.

That’s an annualized rate of return of about 7.5% from the current price of $101, which is neither particularly appealing, nor particularly bad for a defensive company in a highly valued market, and assumes a significant drop in valuation. If instead the valuation remains constant at a P/E of about 19, the rate of return under the same conditions would be about 9% per year, which is in line with historical S&P 500 growth.

Excluding any major company missteps, it seems unlikely that investors would be disappointed having invested in Smuckers stock at the current price over the long-term, and so I view the company as a reasonable, if not appealing, buy. There is of course a large risk of near or mid-term stock price declines during a market correction.

Full Disclosure: As of this writing, I am long SJM.
You can see my dividend portfolio here.

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Johnson and Johnson: Let it Dip to a 3% Yield

-Seven Year Average Revenue Growth Rate: 4.2% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 1.6%
-Seven Year Average Dividend Growth Rate: 9.4%
-Current Dividend Yield: 2.83%
-Balance Sheet Strength: Perfect

The company has a good foundation for growth after a difficult few years, but the current price in the low $90’s leaves little or no margin of safety.

Overview

Johnson and Johnson (NYSE: JNJ) was founded in 1886 and today is the largest and among the most diverse of health care companies in the world. The company consists of three segments: Medical Devices, Pharmaceuticals, and Consumer.

Medical Devices and Diagnostics Segment
This segment was responsible for $27.4 billion in sales in 2012, which is up 6.4% from the previous year. Orthopaedics is the largest unit, accounting for over a quarter of the sales from this segment. Surgical care is the next largest unit, accounting for nearly a quarter of segment sales. The remaining units are vision care, diabetes care, specialty surgery, cardiovascular care, diagnostics, and infection.

Pharmaceuticals Segment
Johnson and Johnson brought in $25.4 billion in sales for 2012 with pharmaceuticals, and this figure was up 4% from the previous year. Immunology is the largest pharmaceutical unit (nearly a third of segment sales), followed by neuroscience (about a quarter of segment sales), infectious diseases, oncology, and other.

Consumer Segment
Consumer sales were $14.4 billion in 2012, and this figure was down 2.9% from the previous year. OTC is the largest unit accounting for nearly a third of segment sales. Skin care is another big unit, accounting for a quarter of segment sales. Other units are baby care, oral care, women’s health, and wound care.

Valuation Metrics

Price to Earnings: 20.7
Price to Free Cash Flow: 21.2
Price to Book: 3.8

Revenue

Johnson and Johnson Revenue
(Chart Source: DividendMonk.com)

The revenue growth rate over the latest seven year period was about 4.2% per year on average. Over the trailing twelve month period, the company has sustained strong revenue growth, going from $67.2 billion in 2012 to about $70 billion over the last four quarters.

Earnings and Dividends

Johnson and Johnson Dividends
(Chart Source: DividendMonk.com)

The EPS growth rate over this period was only 1.6%. But, EPS for the trailing twelve month period is much higher than it was in 2012, and using that adjusted time period, the EPS growth rate is 2.7%. Overall, JNJ has had weak earnings growth.

The dividend growth rate over this period has been a solid 9.4% per year, which when combined with a yield of 3% or so represents very solid long-term returns. The dividend payout ratio from earnings however, has increased over the last decade from comfortably under 40% to nearly 60%.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.9%
2013 3.5%
2012 3.5%
2011 3.5%
2010 3.0%
2009 3.0%
2008 2.5%
2007 2.2%
2006 2.1%
2005 1.8%

The yield for Johnson and Johnson is currently at a low point. Although JNJ boosted its dividend for 2013, the fact that the stock price roared from the low $70’s to the low $90’s during the year to date, has increased the valuation and decreased the current dividend yield.

How Does JNJ Spend Its Cash?

During the fiscal years of 2010, 2011, and 2012, the company brought in nearly $38 billion in free cash flow. Over the same period, the company paid about $18.5 billion in dividends, another $18.2 billion on share repurchases, and about $8.5 billion on net acquisitions.

Balance Sheet

Johnson and Johnson is one of only a very few non-financial companies that maintains a perfect AAA credit rating.

The total debt/equity ratio is about 21%, and less than a third of existing shareholder equity consists of goodwill. The existing amount of total debt is less than 1.2x the annual net income figure, and the interest coverage ratio is 35x, which is extremely well-covered.

The company generates positive free cash flow each year from a highly diverse sales base, and often it’s a higher figure than net income.

Investment Thesis

The company has started fresh with a relatively new CEO (of which there have only been 7 in over 120 years of operating history) with substantial industry experience, and with several difficult years behind the company, the next few years look brighter.

Johnson and Johnson is often viewed as the quintessential blue chip stock. The combination of a particularly strong balance sheet, five consecutive decades of annual dividend growth without a miss, strong free cash flow generation, and a highly diverse sales base, is hard to compare to any other company.

Most segments have various durable economic advantages which help to protect their cash flows. For example, the pharmaceutical segment, like other pharmaceutical companies, uses a series of patents to maintain a consistent pipeline and portfolio of patented drugs, and because of their size, they can fund the largest of R&D projects or they can acquire drugs for their pipeline. This makes their pipeline rather consistent from year to year. The medical devices segment is similar, with advanced patented devices created from one of the largest medical device segments in the world. The consumers segment is a bit different in that it relies on brand strength. Each of the three segments is supported by the others, so a weak pharmaceutical period can be balanced by strong medical device sales during that time, or as we saw in previous years, a weak consumer segment can be balanced by the pharmaceuticals and medical devices. Most of JNJ’s products are protected from recessions due to their rather necessary nature, with the exception of some of their over-the-counter products which are vulnerable to market share losses to private label products during those times.

Risks

Although the company is large and well-diversified, the complex nature of the company results in numerous risks. 2010 was a particularly difficult year for the company, as they recalled 43 over-the-counter medications due to systemic quality control issues in their subsidiary that is responsible for this lineup of products, recalled hip replacements due to a revision ratio that was far above acceptable levels, and faced a shareholder lawsuit regarding these quality issues and other aspects of company governance.

The pharmaceuticals segment, like any company in the industry, has pipeline risk. It can take billions of dollars to develop or acquire a blockbuster drug, and a weak pipeline of upcoming drugs can mean that sales will be lackluster in upcoming years. Unexpected events of drugs failing approval or showing to be ineffective can be a major blow to the segment. Currently the pipeline is strong, and unlike pure pharmaceutical companies, Johnson and Johnson buffers this risk with their other business segments.

Litigation is a constant risk for any large health care company, because so many lives are affected so dramatically. Products can mean the difference between life and death for patients, and something like a hip replacement that has a revision rate of over 10% compared to the typical and acceptable 1% can mean major financial losses, recalls, and/or litigation.

Conclusion and Valuation

There’s little doubt that overall, JNJ is a particularly strong company. Just about every metric is spectacular from the balance sheet to the cash flow generation to the diversification to the dividend safety. Still, the company does have downsides.

Growth has been poor in the recent several years due to the recalls which were acting as anchors on profitability, as well as the financial crisis and recession to a limited extent. On one hand, the fact that the company weathered a cluster of problems with flat sales base and earnings base shows the strength of the company. On the other hand, several years of poor growth does have a major negative impact on shareholder returns.

With a strong pipeline and with better quality oversight in place, the company is in a good state for growth going forward. The one problem, of course, is valuation. Johnson and Johnson outperformed the S&P 500 by nearly 10% year to date, and the S&P 500 itself outperformed its average growth rate during 2013 to reach record highs. Last year in the JNJ stock analysis report, I stated similar views about JNJ- that it was in a good position for growth (which based on revenue growth has been true), but at that time the stock was in the high $60’s and I was cautiously optimistic about it being a buying opportunity at that price.

Now at $93/share, we’re looking at a similar situation with a much higher valuation. Using the earnings multiple valuation approach, if the company grows EPS by 8% per year over the next 7 years on average, and we place an earnings multiple of 18x on the stock at the end of that seventh year, then the price will be around $138. The investor will have received about $26 in dividends per share, and if reinvested, can expect another $8 or so in value. The seventh year value therefore would be $184, which is roughly double the current value. This translates into a rate of return of about 9%, which is not bad on a conservative dividend payer.

But that doesn’t leave any margin of safety. If EPS growth averages only 7%, the rate of return under the same circumstances would be down to a bit over 8%, and if the earnings multiple at that time is 16 instead of 18, the annual rate of return is down to about 7%.

In conclusion, I believe that few investors would be disappointed several years from now with a purchase of JNJ stock today, but I don’t think it’s in a good position to outperform unless estimates use very optimistic growth estimates. So, the price is fair but not ideal, in my view. The yield is historically low for the company at 2.83%, and I believe a wiser play would be to wait for the growth to catch up with the valuation and see if the stock becomes available at a lower earnings multiple of under 20, and with a yield of over 3%.

Full Disclosure: As of this writing, I am long JNJ.
You can see my dividend portfolio here.

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