Beautiful Dividend Growth, or is it?

By Chad Henage - August 4, 2012 | Tickers: AVP, EL, TUP | 0 Comments

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There recently were several new dividend aristocrats named. Normally this would be an excellent starting point for investors to find stable companies that have continually increased their dividends for many years. One such company is Avon Products (NYSE: AVP), which not only has increased its dividend for the last 25+ years, but also sports an impressive yield of about 6%. With a great brand name, good yield, and dividend growth, you would expect this to be an ideal investment opportunity. However, investors should be cautious of assuming that this company will stay a dividend aristocrat much longer.

Avon operates in the highly competitive beauty and cosmetics industry. Some of their competition have well established brand names as well, such as Estée Lauder (NYSE: EL). Other competitors come from companies most people don't associate with cosmetics such as Tupperware Brands (NYSE: TUP). While Estée Lauder is generally sold through department stores, both Avon and Tupperware depend primarily on individual representatives. Since all three companies compete directly in the beauty and personal products category, it makes sense to compare the companies across several different metrics.

As you can clearly see, there is a large difference between each of the companies just based on their growth rate, valuation, and dividend yield. Avon's primarily attractive based on its dividend yield. With analysts calling for negative growth over the next few years, investors should be careful that they don't expect too much. Avon has consistently missed earnings expectations, and while the idea of the Avon Lady is nice, it also comes with higher distribution costs than selling products directly to retailers for distribution. Estée Lauder has the highest expected growth rate, but also sells at a premium multiple. Analysts expect the company to benefit as the economy recovers and more customers trade up to the traditionally higher-priced Estée Lauder product line. Tupperware seems like it could be the most attractive, as the company is growing at a respectable rate, sells for a multiple below its growth rate, and pays an attractive dividend. Tupperware is less of a pure play on the beauty and cosmetics industry, as its storage business plays a huge role in the company's fortunes. Investors looking for income would likely be attracted to Avon's high-yield, but can the company afford its current dividend?

To figure out if the company can afford its current dividend, we have to look at how much free cash flow Avon is producing. Over the long-term, free cash flow is what should pay for dividends and any share repurchases. In the last four years, the company's free cash flow payout ratio has steadily risen from over 94% in 2008, to over 106% last year. In the last two years, the company has paid out more in dividends than they have brought in free cash flow. This is a red flag that should signal investors to be cautious. A high payout ratio should cause investors to ask if the company can continue to increase its dividend. Looking at the company's history of dividend increases, you can see the challenges of this high payout ratio.

In the last five years, Avon's dividend growth has slowed down in nearly sequential order.

You can see that the company's dividend growth has slowed down in particular over the last four years. Knowing what we do about their free cash flow situation, this really isn't a surprise. There is one additional red flag that investors need to pay special attention to. The company has historically increased its dividend around the first quarter of the year. So far this year, the company has yet to announce a dividend increase. While technically the company remains a dividend aristocrat as long as they increase during the calendar year, Avon is running out of time. Unless the company announces an increase in the next two quarters, we may see the fastest movement of a company becoming a dividend aristocrat, and then losing that status within the same year. With analysts calling for negative earnings growth and a payout ratio over 100%, expecting dividend increases from this point seems very unlikely. While there's no question Avon has an impressive brand name and network of distributors, the company's current yield appears unsustainable and I would recommend investors avoid the shares.

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