Boring Business=Exciting Dividend Growth

By Chad Henage - July 5, 2012 | Tickers: GE, GWW, WCC | 0 Comments

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Honestly there is very little about W.W. Grainger's (NYSE: GWW) business that would be considered exciting. The company offers safety and security supplies, power and hand tools, lighting and electrical products, and material handling. When a company's business description could be sold as a sleeping aid, you don't have to worry about a lot of entrepreneurs fighting to take your business.

The part about W.W. Grainger that's exciting is the company's dividend growth. Not only has the company increased its dividend for over 25 years in a row, but their recent growth is as impressive as it has ever been. Can this huge dividend growth continue?

Before we get to the company's dividend, we need to understand the company's competitive position in its markets. In the industrial segment, a company like WESCO International (NYSE: WCC) is a direct competitor. When it comes to electrical and lighting, one name synonymous with this industry is the 120-year-old General Electric (NYSE: GE). Let's see how W.W. Grainger stacks up against this competition to see if the stock is fairly valued. Even if the dividend is growing fast, if the stock is overvalued, the dividend growth might be overshadowed by poor stock performance.

While W.W. Grainger has the largest forward P/E ratio, the company also has the highest expected future growth rate. While in this comparison, General Electric looks to have the best combination of traits, it seems that W.W. Grainger could be fairly valued. Knowing the stock is fairly valued gives us the chance to examine the dividend without worrying too much that we are overpaying for the stock.

While yield and dividend growth are important, nothing is more important than if a company's dividend is sustainable. Without sustainability, no other measure really matters. The best way to determine if a company can afford its current payout is to look at its free cash flow situation. This is an area of strength for W.W. Grainger, as the company's free cash flow payout ratio has varied between 22% and 32% over the last few years. With a low payout ratio, you would expect that the company should have good dividend growth.

W.W. Grainger in fact, does have an impressive track record where dividend growth is concerned.The company has increased its dividend no less than 14% in the last eight years. Even more impressive is five different times the company has increased its dividend by 20% or more. The company's 2012 dividend increase was actually the second largest in recent history. With such heady increases, what should investors expect going forward?

Analysts are calling for EPS growth of over 14% in the next few years. However, in the last few years, cash flow growth has trailed net income growth. If this trend continues, I would expect dividend growth in the 12-15% range. While it's possible dividend growth could be faster, a higher rate of increase would cause the company's free cash flow payout ratio to jump more than management would feel comfortable with. If free cash flow grows by 12-13% and the dividend were increased by 15%, this would only lead to a minimal increase in the payout ratio. With the most recent ratio at just 32%, the company can afford minimal increases.

While the current yield of 1.65% isn't much to write home about, this has a lot to do with the fact that the stock price has more than doubled in the last two years. While the stock isn't the bargain it was two years ago, a 15% dividend growth rate, 14% expected EPS growth, and a fairly valued stock represents a decent opportunity for investors in today's uncertain market.

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