The Best Consumer Products Dividend

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Many investors make the mistake of believing that large conglomerates are a dime a dozen. I've heard investors before trying to figure out whether they should buy companies like Colgate-Palmolive (NYSE: CL), Procter & Gamble (NYSE: PG), or Clorox (NYSE: CLX). In many of these discussions the general idea is that you can pretty much flip a coin and buy whatever you want. However, these three companies in particular have specific strengths and weaknesses and one in particular looks like the best bet among the three. 

Each of the above companies faces man of the same pressures. The economic malaise globally is causing customers to be more price sensitive. I'm sure everyone can relate to customers choosing to trade down to cheaper products, or even trying private label brands as a way to save money. To combat this challenge, Colgate-Palmolive has developed updated versions of its toothpaste lineup like Colgate Total and Colgate Optic White. Clorox continues to expand its cleaning options with items like Clorox Anywhere spray. Procter & Gamble is coming up with new formats for its most popular products like Tide Pods. While each of these companies is expected to post similar EPS growth in the next few years, Colgate-Palmolive seems to be making the most of its opportunities.

Colgate-Palmolive experienced a quarter where sales were down 1%, but global unit volume was actually up 2%, and pricing was up 3%. Where volume and price increases should have meant a 5% growth in sales, foreign exchange cost the company 6%, resulting in the 1% decline. The good news for investors is, the company managed costs and its share count well enough to post a 3.82% increase in diluted EPS. What is more impressive was the company's volume growth in most of its divisions. When foreign exchange cuts into results, I tend to look at volume growth and pricing. Positive volume growth and pricing power usually argue well for future results. Take a look at how each unit performed:

<table> <tbody> <tr> <td> <p><strong>Division</strong></p> </td> <td> <p><strong>Volume Growth Or Decline</strong></p> </td> <td> <p><strong>Pricing Growth or Decline</strong></p> </td> </tr> <tr> <td> <p>North America</p> </td> <td> <p>Up 2%</p> </td> <td> <p>Up 0.5%</p> </td> </tr> <tr> <td> <p>Latin America</p> </td> <td> <p>Up 2.5%</p> </td> <td> <p>Up 5.5%</p> </td> </tr> <tr> <td> <p>Europe / South Pacific</p> </td> <td> <p>Down 1.5%</p> </td> <td> <p>Down 1%</p> </td> </tr> <tr> <td> <p>Greater Asia / Africa</p> </td> <td> <p>Up 7.5%</p> </td> <td> <p>Up 4%</p> </td> </tr> <tr> <td> <p>Hill's Pet Nutrition</p> </td> <td> <p>Down 2.5%</p> </td> <td> <p>Up 4% </p> </td> </tr> </tbody> </table>

As you can see, the company saw positive volume and pricing growth in most of the world, and the only exception was Europe. Since this part of the world has been struggling economically, this really shouldn't be a surprise. The fact that Colgate-Palmolive splits its Hill's Pet Nutrition unit out separately argues that maybe this division doesn't really fit with the rest of the company. While pet food is a consistent business, it's possible Colgate-Palmolive would be better off selling or spinning this business off into a separate entity. Since Hill's represents about 13% of sales, this wouldn't be a major blow to the company, and would allow a better focus on the company's cleaning and personal care businesses. That being said, Colgate-Palmolive managed to increase its gross margin to 58.4% from 56.2% last year. Considering competitors Procter & Gamble and Clorox managed gross margins of 50.09% and 42.9% respectively, this is a very impressive showing. Colgate-Palmolive also used its cash flow to retire 2.3% of its diluted shares in the last year. While these are good results, what potentially makes Colgate-Palmolive the best dividend payer in this space is their dividend growth and financial position.

Colgate-Palmolive clearly has pricing power and good organic growth, and this is probably why analysts are calling for slightly better growth than Clorox or Procter & Gamble. These two competitors have seen inconsistent volume growth, and while each company pays a good dividend, it is dividend growth that many investors should be looking at. Procter & Gamble has been raising its dividend for 50+ years, but in the last four years dividend growth has been between 6% and 9%. The problem is, P&G's free cash flow growth hasn't been keeping up with dividend growth. In the company's recent quarter, their free cash flow payout ratio was 81.67%. This argues that dividend growth will have to lag their expected 8% EPS growth rate going forward. I've written before that investors should expect maybe 6% dividend growth in the future at best. Looking at Clorox's dividend, the company suffers from a very inconsistent dividend policy. In fact, prior to 2005, investors in Clorox were not assured a dividend increase at all. In each of the last three years, the dividend growth rate has slowed sequentially. In addition, operating cash flow has fallen at over twice the rate of net income in the last few years. While Clorox's free cash flow payout ratio is reasonable at 53.90%, this disconnect between net income and operating cash flow is a concern. This suggests dividend growth that will lag EPS growth of about 8%, and Clorox investors might expect 6% dividend growth as well. Colgate-Palmolive on the other hand, has averaged an 8% dividend increase the last few years. Analysts are calling for EPS growth of 8.44% in the next few years, and the company has the lowest free cash flow payout ratio at 52.37% of the three companies we've looked at. This suggests that Colgate-Palmolive should be able to continue to grow its dividend by 8% or so in the next several years.

Since these companies are often mentioned as core holdings by investors, they are normally held for a longer timeframe. Though Procter & Gamble and Clorox has higher current yields at over 3.3%, Colgate-Palmolive has better organic growth, a lower payout ratio, and should grow earnings faster. With these companies, better earnings growth usually means better dividend growth, and thus Colgate-Palmolive should increase its dividend at a faster rate. Though the company's current yield is lower at about 2.4%, over time this will change. If Colgate-Palmolive were to shed its Hill's Pet Nutrition business, the company's growth rate could increase even faster. Investors need to look beyond current yield, and if you do so, Colgate-Palmolive could be the best dividend in the consumer products space.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of The Clorox Company. Motley Fool newsletter services recommend The Procter & Gamble Company. 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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