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Chevron: Growth From Australian LNG

-Seven Year Average Revenue Growth Rate: <3% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 10.7%
-Seven Year Average Dividend Growth Rate: 10.5%
-Current Dividend Yield: 3.26%
-Balance Sheet Strength: Perfect

Chevron appears to represent a decent buying opportunity at this time in the mid-$120′s.

Overview

Founded in 1879, Chevron (NYSE: CVX) is currently one of the largest oil and gas companies in the world. The company is involved in almost every type of energy business available.

Exploration and Production
In 2012, Chevron produced an average of 2.61 million barrels of oil per day, and at the end of the year their proved oil-equivalent reserves were 11.35 billion barrels. The company has exploration and production operations all over the world, and tends to particularly specialize in deep sea drilling.

Gas and Midstream
Chevron has a strong vertically integrated natural gas business. They’re involved in liquefaction, pipelines, marine transport, marketing/trading, and power generation. The company has 160 billion cubic feet of natural gas resources.

Downstream and Chemicals
In 2012, Chevron processed 1.7 million barrels of oil per day on average. This results in fuels, lubricants, and petrochemicals. There are over 16,000 stations selling Chevron products.

Technology
The company operates technology centers in the United States, United Kingdom, and Australia where they develop technology for use in the other business areas.

Renewable Energy and Energy Efficiency
Chevron is one of the largest global producers of geothermal energy, and is also involved in the solar energy industry and the non-food biofuel industry. Chevron Energy Solutions installs large solar arrays for clients.

Valuation Metrics

Price to Earnings: 10
Price to Free Cash Flow: Highly Variable
Price to Book: 1.7

Revenue

Chevron Revenue
(Chart Source: DividendMonk.com)

Chevron has somewhat erratic revenue growth, with an average of under 3% per year. The growth comes from production quantity as well as the current pricing of their commodities and end-products.

Earnings and Dividends

Chevron Dividends
(Chart Source: DividendMonk.com)

Chevron has enjoyed 10.7% average EPS growth over the last seven years, although these numbers were also made erratic during the financial crisis. This is fairly strong EPS growth, considering that the company also pays a higher than average dividend yield to shareholders.

The dividend growth rate over the same period was about 10.5% per year, and so the dividend payout ratio has remained flat at around 25%. The earnings of oil companies tend to be cyclical, so they keep payout ratios on the lower end so that the dividend can be grown even during the barely profitable periods. The current dividend yield is a healthy 3.26%, and the company recently achieved 25 years of consecutive annual dividend growth.

Approximate Historical Dividend Yield at Beginning of Each Year:

Year Yield
Current 3.26%
2013 3.3%
2012 3.0%
2011 3.2%
2010 3.6%
2009 3.4%
2008 2.4%
2007 2.9%
2006 3.1%

 

How Does Chevron Spend Its Cash?

Chevron brought in over $34 billion in free cash flow cumulatively during the fiscal years of 2010, 2011, and 2012. Over the same time period, the company spent about $3 billion on acquisitions, nearly $19 billion on dividends, and about $4 billion on share repurchases.

Balance Sheet

Chevron’s balance sheet is about as strong as they come. Total debt/equity is only 14%, and the amount of goodwill on the balance sheet is negligible compared to equity. The debt/income ratio is less than 1x, and the interest coverage ratio is extremely high. Not counting other long term liabilities, there is more cash sitting on the balance sheet than there is total short term and long term debt.

Balance Sheet Expansion

Year Total Assets Total Liabilities Shareholder Equity
Current $244.0 billion $101.2 billion $142.8 billion
2012 $233.0 billion $96.5 billion $136.5 billion
2011 $209.5 billion $88.1 billion $121.4 billion
2010 $184.8 billion $79.7 billion $105.1 billion
2009 $164.6 billion $72.7 billion $91.9 billion
2008 $161.1 billion $74.5 billion $86.6 billion
2007 $148.8 billion $71.7 billion $77.1 billion
2006 $132.6 billion $63.7 billion $68.9 billion

Shareholder Equity has grown by an average of 11% annually over this seven-year period.

Investment Thesis

Chevron is constantly developing new upstream resources, but the key growth over the next several years will be from Australia. The company’s LNG production is going to more than double in the next four years, primarily due to the Gorgon (operational in 2015) and Wheatstone (operational in 2016) projects in Australia. Gorgon had budget overruns but these challenges have been worked through, and the project is now two-thirds complete. The other two main sources of growth will be from deepwater drilling and from shale production.

Risks

Large oil companies have among the largest and broadest set of risks for any investment.

There is an ever-present risk of an environmental catastrophe, which can lead to up to ten-figure lawsuits. Chevron is still dealing with the nearly $20 billion litigation risk related to operations in Ecuador, which were part of the Texaco acquisition in the 90′s. Recent court decisions have generally favored Chevron on these matters.

More regularly, the company has to deal with more commonplace instances of litigation, changing oil and other commodity prices, and managing its oil and gas reserves in a competitive environment driven by scarcity. The company has reported 112% reserve replacement rates on average over the last five years, meaning that reserves are being maintained and grown at the current time.

Conclusion and Valuation

Chevron consistently adapts to changing energy needs, with a currently strong presence in deepwater drilling, moves towards shale production, and huge investments in LNG, along with smaller operations like Chevron’s Energy Solutions (solar) business. The company has a 25 year history of paying growing dividends, and currently offers a reasonable dividend yield of over 3% with a low and safe payout ratio.

Based on a two-stage Dividend Discount Model, assuming a 10% discount rate, if the company grows its dividend by 9% per year for the next decade and 7% per year thereafter, then the calculated fair price for the stock today is over $147. The current price of under $123 gives a more than 15% margin of safety for these estimated figures, leading to what appears to be a reasonable buying opportunity in a diversified and financially stable dividend-paying company.

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

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Medtronic Dividend Stock Analysis 2013

-Seven Year Revenue Growth Rate: 5.6% Dividend Stock Report
-Seven Year EPS Growth Rate: 7%
-Seven Year Dividend Growth Rate: 15%
-Current Dividend Yield: 2.08%
-Balance Sheet Strength: Very Strong

Medtronic looks solid in the mid-$50′s, but not with a margin of safety. Looking for dips or writing puts would be a more conservative approach.

Overview

Founded in 1949, Medtronic, Inc. (NYSE: MDT) is a medical technology company focusing on alleviating pain, restoring health, and extending life for people all over the world. With over 46,000 employees and a market capitalization of over $50 billion, Medtronic is the world’s largest independent medical device company.

Approximately 45% percent of company revenue comes from outside of the United States. The company markets its products in over 120 countries.

The company is divided into two primary groups.

Cardiac and Vascular Group

Medtronic’s core area of expertise has long been the heart and related systems, and slightly more than half of total company sales come from this group. The group contains four segments:

Cardiac Rhythm Disease Management
This segment accounts for 30% of total company sales. Products in this segment include pacemakers, implantable defibrillators, leads and delivery systems, ablation products, electrophysiology catheters, and other products.

Coronary, Structural Heart, and Endovascular
These other three heart segments account for 11%, 7%, and 5% of total company sales.

Restorative Therapies Group

Medtronic has been growing their products for ailments unrelated to the heart since the 1990′s, and now they collectively represent nearly half of company sales.

Spinal
This segment accounts for 19% of total company sales. Products in this segment include thoracolumbar, cervical, neuromonitoring, surgical access, and more.

Neuromodulation
This segment accounts for 11% of total company sales. Products include implantable systems for treatment of chronic pain, movement disorders, bladder problems, and other conditions.

Diabetes
This segment accounts for 9% of total sales. Products include insulin pumps and disposable products.

Surgical Technologies
This segment accounts for 9% of total sales. Products of this segment are used to treat ear, nose, and throat conditions.

Ratios

Price to Earnings: 15.4
Price to Free Cash Flow: 13.4
Price to Book: 2.9

Revenue

Medtronic Revenue
(Chart Source: DividendMonk.com)

Revenue growth was a solid average of 5.6% per year over this period. It’s consistent as well- looking back over a decade there have not been any years where revenue fell compared to the previous year.

Earnings and Dividends

Medtronic Dividends
(Chart Source: DividendMonk.com)

Growth of EPS per share was fairly mediocre, at 7% per year on average. The growth was rather erratic as shown on the chart, but this was due to reasons other than core profitability from sales. Multiple variables of litigation costs, acquisition-related items, and restructuring charges, were involved each year. For example, the low figure of 2009 was due to a combination of substantial litigation and acquisition-related items.

Those costs are part of doing business, but factoring them out to get a different look at profitability shows that, if those types of costs are factored out, EPS grew each year over this period compared to the previous year.

The dividend growth rate over the same period averaged 15% per year, because the company wisely decided to increase its payout ratio from under 20% to currently just over 30%. The current yield is still fairly low at 2.08%, and the company has three and a half decades of consecutive annual dividend growth without a miss.

Approximate historical dividend yield at beginning of each year:

Year Yield
Current 2.1%
2013 2.4%
2012 2.5%
2011 2.4%
2010 1.8%
2009 2.3%
2008 1.0%
2007 0.8%
2006 0.7%

 

How Does Medtronic Spend Its Cash?
Over the fiscal years of 2011, 2012, and 2013, Medtronic brought in $11.6 billion in cumulative free cash flow. Over the same period, $3 billion was spent on dividends, $3.8 billion was spent on share repurchases, and $2.3 billion was spent on net acquisitions.

Balance Sheet

The total debt/equity ratio of the company is about 60%. Of the nearly $19 billion in existing shareholder equity, over $10 billion of that is goodwill.

Total debt/income is a bit over 3x, and the interest coverage ratio is nearly 30, which is extremely healthy.

Investment Thesis

A considerable portion of the total Medtronic offer of shareholder returns comes from dividends and buybacks. The second major portion comes from expanding the business with small and medium acquisitions and research and development of more advanced products in developed markets. The third key portion is to expand their platform to less developed areas that may be considered roughly developed, but aren’t nearly at the same level of health care spending as some of the most developed areas.

Dividends and Buybacks
The shareholder yield of Medtronic tends to be about 4-5% per year, which represents a fairly reliable portion of returns over the long term; dividends are immediate and buybacks increase EPS. Add onto that perhaps 2% top line pricing growth each year to keep up with inflation which boosts revenue and income, and the result is that 6-7% of total returns come before actual company growth. Growth adds onto that foundation of returns to get us up to where we want to be at around 10% annual returns or better, so before core growth is even factored in we’re already two-thirds of the way there (a reminder of the virtue of a good dividend stock, even if Medtronic’s yield is at least 1% lower than I’d like).

Research, Development, and Acquisitions
Medtronic spends about $1.5 billion, or roughly 3% of market cap, on R&D each year. This includes new and improved medical devices, such as new products to treat conditions, updates on existing products for increased effectiveness or increased longevity, or updates on existing products to make them resistant to the effects of MRI scans. Major pipeline projects for fiscal year 2014 include the RestoreSensor SureScan MRI spinal cord system, the MiniMed 530g/640g diabetes systems, and the Endurant II AAA stent graft.

Acquisitions by their nature tend to be more erratic, but it’s not uncommon for Medtronic to spend 2% or more of its market cap on acquisitions in a given year. The Aquamantys system, acquired in 2011, uses a combination of RF technology and a saline to reduce blood loss during surgery. The PEAK PlasmaBlade is a scalpel that uses pulsed plasma technology. A typical scalpel cuts but causes significant blood loss, so an alternative is to do electrosurgery which uses electrical current to produce heat and cut tissue, which reduces blood loss but can cause thermal damage. Pulsed plasma technology is reported to do less thermal damage than electrosurgery while maintaining satisfactory blood loss control.

Market Expansion
Medtronic continues to invest and expand into markets with the idea that they should pay well in the future. In particular, Medtronic makes acquisitions and expands treatment options into China each year, so that they can establish a strong platform in the country as it grows per-capita GDP and health care costs.

Risks

Like all large health care companies, Medtronic faces considerable litigation and regulatory risk. As mentioned in the EPS section, EPS can be materially affected by litigation costs alone. There’s also regulatory risk, which can delay or disrupt large product introductions.

A major industry risk is that health care costs, especially in the United States, are considered by many to be out of control. The United States is the third most populated country in the world and has by far the highest per capita health care costs, but this is breaking both the federal budget and the budgets of middle class workers and their employers attempting to provide health care benefits to them. Any reductions in health care spending to try to reign in health care costs may impact medical devices, with Medtronic being the largest industry player.

Conclusion and Valuation

With consistent revenue growth, a very strong balance sheet, a long history of dividend growth, and a mediocre current dividend yield, Medtronic can be a decent health care selection for a portfolio.

Based on the Gordon Growth Model using a 10% discount rate (target rate of return), if Medtronic grows its dividend by an average of 8% per year for the foreseeable future, then the calculated fair value is a bit over $57. The current price is about $54. However, the most recent dividend increase was a bit under 8%, and if the average projected dividend growth rate drops to even 7.5%, then we’re looking at a fair value of more like $45. The model is sensitive for lower yield stocks, and there isn’t really a margin of safety here.

Another path is to hold off for dips, or write put options on the stock at a strike price about where the price is now. The February 2014 contracts at a strike price of $52.50 aren’t bad (results in a cost basis of about $50 if exercised), and for a longer term idea, the January 2015 contracts at a strike price of $55 potentially offer a decent annualized rate of return with a current cost basis of a bit below $49.

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

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Clorox Company (CLX) Dividend Stock Analysis 2013

-Seven Year Average Revenue Growth Rate: 2.8% Dividend Stock Report
-Seven Year Average EPS Growth Rate: 5.7%
-Seven Year Average Dividend Growth Rate: 12.2%
-Current Dividend Yield: 3.43%
-Balance Sheet Strength: Leveraged, Stable

The company appears to be a reasonable buy in the low $80′s for an estimated 9-10% rate of return going forward.

Overview

Clorox (NYSE: CLX) is a leading consumer products company and a solid dividend payer. It was founded almost 100 years ago in 1913, and currently has a market capitalization of over $9 billion. At one point during the 20th century, Clorox was purchased by Procter and Gamble, but due to concerns over a lack of competition, Procter and Gamble sold Clorox and it is again a stand-alone company.

The company is divided into four business segments: Cleaning, Household, Lifestyle, and International.

Cleaning
The cleaning segment provides 32% of company revenue, and includes brands such as Clorox, Liquid Plumber, 409, Tilex, and Pine-Sol.

Household
The household segment provides 30% of revenue and includes brands such as Glad, Kingsford, Match Light, Fresh Step, and Scoop Away.

Lifestyle
The lifestyle segment provides only 16% of revenue and includes Burt’s Bees, Hidden Valley, Brita, and Masterpiece.

International
The international segment provides the remaining 22% of revenue, and includes some international brands as well as some of the domestic brands like Clorox.

Valuation Metrics

Price to Earnings: 19
Price to Free Cash Flow: 19
Price to Book: 74

Revenue

Clorox Revenue
(Chart Source: DividendMonk.com)

Revenue grew at a low average rate of only 2.8% per year over this period. The company did, however, sell its auto care business for three quarters of a billion dollars, which impacted revenue.

Earnings and Dividends

Clorox Dividends
(Chart Source: DividendMonk.com)

EPS growth was modest at 5.7% per year on average. The dividend growth rate was high at over 12.2%. To maintain a steady payout ratio, Clorox will have to have some combination of EPS growth rate acceleration and dividend growth rate reduction. The current dividend yield is 3.43% and Clorox has increased its dividend every year since the 1970′s.

Approximate Historical Dividend Yield at Beginning of Each Year:

Year Yield
Current 3.43%
2013 3.45%
2012 3.60%
2011 3.47%
2010 3.26%
2009 3.26%
2008 2.52%
2007 1.81%
2006 1.90%

 

Clorox has expanded its payout ratio from 40% to 60% over this period, which along with changes in valuation has resulted in a higher dividend yield over time.

How Does Clorox Spend Its Cash?

Clorox enjoys strong free cash flow generation, and brought in nearly $1,500 million in free cash flow during the combined fiscal years of 2011, 2012, and 2013. During that time period, the company brought in another $650 million in cash from its net acquisition activity (with the cash coming from the divestiture of their auto care segment). Over this same period, the company spent $950 million on dividends and $1,000 million on share buybacks.

Balance Sheet

The debt/equity ratio is very high, because Clorox has practically no equity. Assets minus liabilities leaves essentially zero. The company has about $1.1 billion in goodwill, so the tangible book value is negative.

The debt/income ratio, on the other hand, is fair at 4x. Most importantly, the interest coverage ratio is 8x, so the company’s operating income can pay the debt interest 8 times over.

Overall, it’s a leveraged but stable balance sheet. The company has stated in investor presentations its intention to maintain the current leverage.

Investment Thesis

The company manages a medium-sized portfolio of top brands that for the most part are the #1 or #2 brands in their categories. Some brands such as the Clorox and Kingsford brands dominate their industries with market shares that are multiple times the size of the next largest competitor.

The company aims for 3-5% organic sales growth per year going forward, with the U.S. retail segment having 2-3% growth (representing most of the company), the international segment having 5-7% annual growth (representing less than a quarter of the company), and the U.S. professional segment having 10-15% annual growth (representing only a small portion of the company).

Much of the sales growth, or about 3% per year, comes from product innovation. The product innovation varies, but generally targets one of the 4 “megatrends” that Clorox describes: Health and Wellness, Sustainability, Affordability, and Multicultural (primarily the U.S. Hispanic market). For the professional segment, Clorox is looking to expand into health care applications, to develop and sell new products for that industry.

Risks

Many products such as bleach and charcoal are commodities with no significant differentiation between brands, and yet Clorox enjoys a price premium and leading market share. The lead is maintained by years of marketing and brand recognition rather than clear product superiority. This can have difficult-to-predict consequences on pricing power over the long-term, especially since the company reports a goal of slowly increasing profit margins as part of its overall growth strategy.

A full quarter of revenue is derived from a single retailer: Wal-Mart. This gives Wal-Mart leverage in price negotiations.

Conclusion and Valuation

The company has strong brands, decent diversification, and a long history of consecutive annual dividend growth stretching back to the 1970′s. My 2012 analysis on the company was lukewarm, but after a solid fiscal year and rising stock prices overall, I believe the attractiveness of Clorox as a stock has improved compared to the overall market.

If the company can achieve 3-5% organic sales growth, and continues to buy back 1-3% of its shares each year, then that’s about 4-8% EPS growth assuming constant net margins, which specifically excludes their goal of gradual margin improvement.

Based on the Dividend Discount Model (DDM) with a 10% discount rate (the target rate of return), if the company grows the dividend by an average of 7% per year for the long term, then the fair price is over $90, compared to the current stock price of only about $83. Alternatively, if the dividend growth rate ends up only being 6.5%, that makes the current price in the low $80′s about fair.

In a fairly poor scenario, even if only a 5.7% long-term EPS/dividend growth rate is achieved (chosen to match the previous 7-year average EPS growth), then the current price in the low $80′s can still offer a 9% long-term rate of return, based on the DDM again.

Overall, the company appears to be a fairly stable bet. Most of the returns should come from maintaining pricing against inflation, moderate product innovation, dividends, and buying back shares. The valuation is neither entirely unreasonable nor unusually appealing, but compared to the fairly high valuation of the market currently, it may make a good choice for a stock with a decent dividend yield (3.43%) and consistent dividend growth history.

Full Disclosure: As of this writing, I have no position in CLX, though it is on my watch list for possible purchase.
You can see my dividend portfolio here.

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