Kellogg Dividend – Slowing Or Growing?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Whenever the market hits a rough patch, many investors run for safety in large-cap names that are consumer staples. One such company that seems to always be a safety net for investors is Kellogg (NYSE: K). One of my favorite investors of all time Peter Lynch said, that investors liked Kellogg because people might cut back on lobster dinners, but they don't stop buying Cornflakes. With the volatility of the market in the last few years Kellogg has also become a decent dividend play. With a current yield of 3.41%, Kellogg's dividend is better than most fixed income options, and you get a chance at a capital gain. Let's check on both Kellogg's current dividend affordability, and see what we can expect in dividend growth in the future.
Kellogg has raised its dividend for the last 7 years in a row, not the greatest record, but nothing to be ashamed of either. With about 8.5% EPS growth expected and a 3.4% dividend, investors should be able to expect a combined return of 11.90% which is pretty good no matter the market environment. Kellogg sells for about 15 times forward earnings, not a bargain price for a company growing at 8.5%, but not terribly overpriced either. The company's recent acquisition of the Pringles brand from Procter & Gamble gives the company some additional future growth, as well as some short term integration challenges. Kellogg's main competitor is General Mills (NYSE: GIS). General Mills is expected to grow earnings by about 7%, and pays a dividend of just over 3% for a combined return of 10%. Given that General Mills sells for about 15 times earnings and has a lower combined expected return, it seems that Kellogg could be slightly undervalued.
Since part of the attraction to Kellogg stock is the dividend, it makes sense to examine if the current dividend is sustainable. After all it doesn't make sense to look at dividend growth, if the company can't afford the current payout. In the last three years, the company's free cash flow payout has varied between 40% and 70%, with last year's ratio at about 60%. (The ratio for 2010 has been adjusted for the one time change in liabilities that hurt operating cash flow of about $292 million.) As long as the company's payout ratio stays below 70-75% I'm usually comfortable that the company isn't in danger. The one troubling issue is, Kellogg has been growing capital expenditures by an average of 19% per annum in the last three years. With operating cash flow staying basically flat, the company is going to either need to figure out how to grow operating cash flow, or the rate of capital expenditure growth is going to be a problem. For now this is something to keep an eye on.
Assuming the current dividend is safe, which it looks like it is, we can turn our attention to dividend growth. Look at Kellogg's dividend growth rate over the last ten years:
In the last 7 years of increases, the average has been nearly 8% per year. The company is nothing if not consistent as two years ago they increased the dividend by 10%, last year was an 8% increase, and 2012 was about 6%. The average of these three years, you guessed it 8%.
So what should investors expect in the future? Kellogg's operating cash flow seems to mirror earnings, but at higher dollar amounts due to the company's depreciation allowance. If that continues, I would feel comfortable expecting dividend increases in the 6-8% range. With the most recent payout ratio of 60%, I don't think that Kellogg wants this payout to creep too much higher. That being said, Kellogg looks like a decent value at these levels. Buying a company with 8.5% growth, a 3.4% dividend, and a high likelihood of 6-8% dividend growth sounds like a safe investment to me.
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