Strong Brands and an Even Stronger Dividend
Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
One of the best attributes that a company can have is a stable of strong, recognizable, durable brands. The best kind of brand is one where the brand name becomes interchangeable with the product name itself. An example of this is Clorox, the namesake product from The Clorox Company (NYSE: CLX). This kind of brand association gives the company a competitive advantage, leading to above average returns on invested capital in the long-run. These types of products also create reliable cash flows which are often used to pay out healthy dividends to investors. Clorox has all the makings of an excellent dividend stock - but is the price right?
A stable of brands
The Clorox Company owns a variety of well-known brands other than its namesake product. Liquid-Plumr, Tilex, and Formula 409 headline the cleaning brands. The most well known household brand Clorox offers is Glad, known for trash bags and food storage products. Brita is the number one water filtration brand, while Hidden Valley and KC Masterpiece round out the food offerings.
What makes Clorox especially strong is that, according to Morningstar, nearly 90% of its brands hold the number one or the number two spot in terms of market share. This focus on the strongest of brands has allowed Clorox to prosper.
Clorox currently pays a dividend yielding 3.33%, well above the average yield of the S&P 500. This compares well to yields offered by companies which sell similar consumer products, namely Procter & Gamble (NYSE: PG) and Colgate-Palmolive (NYSE: CL).
Along with this yield advantage Clorox has been increasing its dividend consistently over the past decade.
The annual dividend payment has risen from $0.86 in 2002 to $2.48 in 2012, an annualized increase of 11.17%. Over the past five years the dividend has grown slightly faster at 11.8% annually.
For comparison, Procter & Gamble's 10-year annualized dividend growth rate is 10.7% while the 5-year rate is 10.2%. For Colgate, the values are 12.98% and 11.75%, respectively.
Dividend growth has been similar for all three of these companies. Although Colgate boasts the fastest growth rate its extremely deficient yield compared to Clorox and PG make the stock much less desirable. Clorox not only bests Procter & Gamble on yield, but also on growth, making it the best dividend stock of the three.
Is the dividend sustainable
Since the dividend is paid out of the free cash flow, a useful measure is the percentage of FCF which the dividend eats up. This is the payout ratio. In the TTM period the total dividend paid was $319 million compared to $480 million in free cash flow. This puts the TTM payout ratio at 66.5%.
Although this is fairly high, FCF has decreased from $616 million in fiscal 2010. I don't think this is anything to worry about, though, because the first quarter of Clorox's current fiscal year saw a marked improvement year-on-year, with $154 million in FCF compared to $94 in the same period last year. This leads me to believe that the dip in FCF was not part of a larger trend and that the payout ratio will decrease to more historical levels.
Is the price right?
Given the current market price of $76.84 per share of Clorox, I want to determine how fast the dividend must grow in order to justify this price. To do this I'll use the dividend discount model with a discount rate of 8%, roughly the long-term growth rate of the market as a whole. I'll assume that the dividend will grow at a higher rate for 10 years and then by 3% annually in perpetuity. My calculation of this higher rate is below.
In order to justify the current stock price Clorox must grow its dividend at a rate of at least 8.158% annually over the next 10 years. Given that this is well below the 10-year and 5-year historical dividend growth rates, Clorox looks like a good value.
The bottom line
With a set of strong brand-name products and a history of reliable dividend growth, Clorox is an ideal candidate for a dividend-focused portfolio. A higher yield than its peers puts Clorox on top, and I expect strong dividend growth to continue for many years to come.
TheBargainBin has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble. The Motley Fool owns shares of The Clorox 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!