A Dividend Aristocrat for an Economic Recovery

By Chad Henage - July 3, 2012 | Tickers: DD, PPG, RPM, DOW | 0 Comments

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If you are looking for a stock that would benefit directly from a further recovery in the economy, look no further than PPG Industries (NYSE: PPG). PPG is involved in coatings and sealants for the automotive, aviation, tire, construction, and other industries. The company has been in business since 1883, and is one of the handful of companies that has raised its dividend for at least 25 straight years.

With exposure to many cyclical industries, if the economy continues to recover, PPG should benefit. We've seen in the last few years that cyclical companies are not always safe bets to continue their dividend. One of the most famous dividend blowups was Dow Chemical (NYSE: DOW) after all. So the question is, can PPG continue their aristocrat status, or are they destined to be that next blowup?

If we are trying to figure out if PPG can continue its streak of dividend increases, we should look at the relative health of the company compared to its competition. We've already mentioned Dow Chemical, which is a competitor of PPG in the construction industry. PPG also competes with E.I. Du Pont de Nemours (NYSE: DD) in the automotive industry, and RPM International (NYSE: RPM) in the construction industry. Let's compare PPG on a few metrics and see how the company matches up:

You can see that while PPG pays the lowest dividend, the company is the only one selling for just less than its growth rate. Of the four companies, PPG and Dupont are the most efficient using their assets to generate free cash flow. Speaking of free cash flow, determining PPG's ability to continue their current dividend is based primarily on this measure.

When it comes to free cash flow, PPG has been a pretty consistent performer in the last few years. The company has paid out between 38% and 44.5% of their free cash flow in dividends over the last three years. While free cash flow growth has not kept up with dividend growth, the payout percentage has only risen by 6% in this timeframe. As an over 100 year old company, PPG's capital expenditures are relatively predictable, and thus investors should be comfortable with a 44% payout ratio. So what about dividend growth?

PPG won't win an award for the most exciting dividend growth record, but the company is consistent. Look at the rate of dividend increase over the last several years:

In the first six years of the chart, the average dividend increase was 2.95%. The most recent six increases show growth of 2.4% on average. So while dividend growth has slowed, the difference is very small, and probably has a lot to do with the challenges the economy has presented in the last few years. So what should investors expect in the future?

In the last few years, PPG's operating cash flow growth has lagged net income growth. Even if this trend continues, PPG shareholders should be excited about the potential that analysts see in the next few years. With analysts calling for EPS growth of over 13%, if operating cash flow were to lag again and only grow by 8-10% this would seem to set up PPG for better dividend increases in the future. Based on the last three years, the company appears to be comfortable with a free cash flow payout ratio around 40-45%. If operating cash flow grows by even 8%, and the company increased the dividend by a lesser amount, the company's dividend growth rate could double.

I wouldn't be surprised to see PPG's dividend increases average 6-8% over the next few years. The closer cash flow growth tracks net income growth, the higher these increases are likely to be. Given that PPG is selling for close to its expected growth rate, the stock looks like a decent value. If you are looking for a stock for a continued economic recovery, give PPG some consideration.

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