4 Consumer Cyclicals With Income & Growth

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The consumer discretionary sector is a pro-cyclical sector that gets a lift when the market outlook brightens due to improved prospects for economic growth. Exactly for this reason, this sector has been particularly robust this year, outperforming the overall market. However, according to FactSet, the consumer cyclical sector, with the average forward P/E of 16.9x, is also the sector with the highest forward earnings multiple in the S&P 500. Still, the sector will lead all S&P 500 sectors with forecast revenue growth of 6.7% in 2014 and with the third-highest rate of EPS growth, at 17.6%.

Below is a closer look at four dividend-paying stocks in the consumer discretionary/cyclical sector with yields above 2% and positive long-term forecast EPS growth. This list should provide growth-oriented investors a good starting point for further research; take a look at one particular market-beating strategy here.

Johnson Controls

Johnson Controls (NYSE: JCI), the largest U.S. auto supplier and a major play on emerging markets, has a diversified exposure to a few growth industries, including automotive and housing given that, in addition to auto parts, it also produces heating and air-conditioning products and lithium-ion batteries. The company has seen poor revenue and earnings performance recently, mainly due to the weak European auto market. However, the second fiscal quarter is generally viewed as an inflection point, as automotive segment restructuring initiatives, cost and pricing initiatives in the building efficiency division, and the positive outlook for the power solutions segment support a stronger second-half performance.

The company’s automotive operations should rebound with improvements in Europe and the continued strength in the Unites States. Its seating production should receive a boost from backlog growth and Asian strength. The outlook for its HVAC operations is bullish, as the company expects annual sales growth between 8% and 10%, driven by market share gains and emerging market expansion. Its battery division is expected to deliver sales growth of between 10% and 15% annually, mainly on China and emerging market growth, as well as on improved North American and European aftermarket battery demand. In general, the company stands to benefit from energy efficiency trends. It also sees margin expansion in all its segments in the medium term.

Johnson Controls has paid consecutive dividends to investors since 1887, and currently offers a yield of 2.1% on a payout ratio of 29% of the analysts’ current-year EPS estimate. The company’s capital expenditures are moderating, which should help the company reach the $1.2 billion target in free cash flow before dividends by year-end. Johnson Controls’ liquidity and cash position may also improve in the coming months if it decides to divest its automotive electronics business, for which it has already received expressions of interest. Shoring up its balance sheet, the company plans to reduce its net debt by $1 billion by the end of this year.


Williams-Sonoma (NYSE: WSM), a specialty home furnishings retailer, has seen tremendous growth in recent years. Its prospects are supported by the housing recovery and the company’s innovation in the form of new brands and products. In addition, the popularity of healthy living choices, including cooking-at-home trends, plays out well for this “Tomorrow’s Retailer,” as the company brands itself. As a result, Williams-Sonoma’s financial performance has been robust. Its first-quarter financial results were its best first-quarter results in history.

Williams-Sonoma bucked the general trend of robust EPS expansion without meaningful revenue growth by producing strong top-line growth of 9% year-over-year in the first quarter—with comparable brand revenue growth projected between 4% and 6% this year. Over the next three years, its revenues should increase in the mid to high single-digits, which should help drive low double-digits to mid-teens growth in adjusted EPS. An added support to the bottom line will come from share repurchases, given its three-year $750 million repurchase program announced back in March 2013.

Williams-Sonoma has a solid balance sheet, with almost no long-term debt and about 20% of assets in cash and equivalents. Its capital deployment policies are shareholder-friendly, as evidenced by its generous share repurchase program and a 40.9% increase in its quarterly dividend earlier this year. Williams-Sonoma currently yields 2.3% on a payout ratio of 44% of the current-year EPS estimate. The company’s direct-to-customer segment, accounting for 46% of revenues, is one of its strongest points. Its international expansion, with strong branding power, will support Williams-Sonoma’s continued financial expansion. Still, when considering this stock, it is necessary to pay attention to its valuation, which is slightly above the sector’s average, and to weigh in the prospect of a possible adverse effect on U.S. housing from rising mortgage rates.

Packaging Corporation of America

Packaging Corporation of America (NYSE: PKG), the fourth largest producer of containerboard and corrugated packaging in the United States, has also seen revenue and earnings momentum amid pricing power and recovering volume growth. In fact, this company and its industry peers have benefited from the industry consolidation that has created conditions for price increases amid capacity reductions. The companies in the industry have implemented a few containerboard price hikes, including the one in April.

According to the company, the April price increase is expected to have a major earnings effect in the third quarter of this year when the higher prices are passed through to corrugated products. Market analysts hold that the imposed price increases will likely stick, producing higher earnings and cash flow. Packaging Corp is already on a roll, as its first-quarter EPS excluding special items surged 47.6% year-over-year on a 12% increase in revenues, due to higher containerboard and corrugated products prices and higher sales volumes. In fact, the first quarter results featured all-time records for sales, corrugated products shipments, and EPS.

The company’s improving free cash flow is already resulting in higher returns to shareholders. In May, the company announced a 28% dividend hike, its second increase this year, which has bolstered its yield to 3.3% on a payout ratio of 54% of the current-year EPS estimate. Next year, Packaging Corp is forecast to deliver a 16.3% increase in EPS, which will likely support additional dividend boosts. While the forest products industry researcher RISI sees modest growth in U.S. containerboard apparent consumption this year and next, any acceleration in overall economic growth, including consumer spending, could provide an impetus to stronger volume growth that would complement higher pricing. Still, the downside risks exist, if lackluster volume growth and increased supply due to higher prices undermine the currently solid fundamentals.


McDonald's (NYSE: MCD), the world’s largest chain of fast-food restaurants, is ready to see better comparable store performance as restaurant conditions improve in the United States amid an improving economy and the European recovery takes hold in the second half of this year. Even though the company’s business model makes this stock a defensive play that performs well in downturns, the stock also benefits from pro-cyclical forces.

The strengthening economy in the United States, including a stronger employment growth, is supporting a modest rebound in restaurant industry indicators. In addition, the company’s popular breakfast and everyday value options support stronger sales performance. In Europe, the outlook has also started to improve on the back of summertime promotions in some countries. The European market environment is generally expected to improve later this year.

McDonald’s market conditions have already started to improve in these two regions, as suggested by May same-store sales growth of 2.4% year-over-year in the United States and 2.0% year-over-year in Europe. These two markets combined account for as much as 73% of the company’s total revenues. However, McDonald's great potential lies in emerging markets, where the rising ranks of the middle class will be able to afford McDonald’s products in the future.

Therefore, the company is slowly shifting its focus to new markets, such as China, where it plans new store additions. McDonald’s sales should rise between 3% and 5% and its operating income will be up by between 6% and 7% in 2013. Should the global economy accelerate growth, McDonald’s outlook could improve further. This S&P Dividend Aristocrat is offering a decades-long track record of dividend growth, with a forward yield of 3.1% on a payout ratio of 54% of the analysts’ current-year EPS consensus estimate.

Final thoughts

While elevated valuations warrant caution, there are still several dividend plays in the sector that can benefit from the positive trends in the overall economy and in their respective industries. Some still boast valuations below the average for the consumer cyclical sector, and McDonald’s, Packaging Corp, Williams-Sonoma and Johnson Controls are all worth keeping a close eye on. To continue reading about all things finance, check out this market-beating strategy.

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This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends McDonald's and Williams-Sonoma. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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