This is the second in a series of articles highlighting dividend companies that have large and durable economic advantages, or “moats”, that protect their business operations and allow years or decades of strong profitability. When looking for long-term investments, one typically wants to find a business that is performing well not simply because management is on top of their game right now, but rather because the business itself has fundamental and difficult-to-replicate advantages over its competitors. In the last article, examples of unrivaled economies of scale were provided.
Some companies, over the years, have chosen to throw enormous sums of money at particularly effective advertising campaigns. If done correctly, this can allow a company to charge higher prices for its products, or can bring in more customers per restaurant, or provide other benefits along those lines.
This article provides 6 examples of dividend-paying companies that have powerful or even iconic brands that keep customers coming back.
The Coca Cola Company (KO) has among the most powerful, if not the single most powerful, of brands in the world. Total 2010 advertising costs were $2.9 billion, and that doesn’t include bottler advertising.
I calculate that the company is currently moderately overvalued based on a discounted cash flow analysis with conservative growth estimates. The current rather low P/E is somewhat misleading; the price to FCF ratio is over 24. The company currently provides a 2.75% dividend yield as it pays out approximately half of its free cash flow to shareholders, and last year the company raised its dividend from $0.44 to $0.47 per quarter to continue its multi-decade streak of increases. I’m looking for a soon-to-be-expected raise to push the quarterly dividend to at least $0.50. Still, I’d look for a substantial dip before initiating or adding to a position, based on my targeted rate of return.
I’d suggest, however, that on a risk-adjusted basis, it’s likely not a bad place to park moderate-risk capital that one would desire to grow over the next ten years, even at this price. Expecting mid-to-high single digital total returns from EPS growth and dividends would not be unreasonable. Writing long-term puts for the company could potentially allow an investor to initiate a position or add to a position at a lower cost basis.
The current annual per-capita worldwide consumption of products within Coca Cola’s portfolio is under 100 (compared to approximately 400 for the United States). The high population countries of China, India, Pakistan, Nigeria, and Indonesia, each consume less than 40 annual per-capita servings, which is less than a tenth of the market penetration in America. The company, therefore, has considerable room to grow, even if soft drinks face headwinds in the United States. Coca Cola distributes its products to over 200 countries and constantly invests in increasing its distribution network.
Dividend Yield: 2.75%
Total Debt/Equity: 0.75
Price to FCF Ratio: 24
FCF Dividend Payout Ratio: 50%
Most Recent Dividend Increase: 6.8%
Full Coca Cola Analysis
PepsiCo (PEP) spent $1.9 billion in advertising for 2010, which is considerably below Coca Cola, but still huge.
At the current time, I consider PepsiCo to be a better value than Coca Cola. My DCF analysis estimates the current price to roughly match the intrinsic value. The price to FCF ratio is a reasonable 20, which is still a bit on the high end, but in my opinion fair for a premium-quality, defensive, established company. PepsiCo is more diversified than Coca Cola, as they not only have some of the top-branded drinks, but also the top-branded chips and snacks.
Overall, I don’t consider PepsiCo’s moat to be quite as substantial as Coca Cola’s, but it’s still significant. And any comparative lack in the robustness of the economic advantage is arguably offset by PepsiCo’s increased level of product diversification. Based on the the lower stock valuation of PEP and comparable company metrics, I’d expect slightly higher annualized returns over the next decade for PEP, at the cost of what I consider to be a slightly higher amount of risk.
Dividend Yield: 3.09%
Total Debt/Equity: 1.20
Price to FCF Ratio: 20
FCF Dividend Payout Ratio: 50%
Most Recent Dividend Increase: 8.3%
Full PepsiCo Analysis
In 2010, McDonald’s Corporation (MCD) contributed $687 million to advertising cooperatives and another $94 million for production costs. Franchisees also contribute significantly towards advertising costs, so the whole amount spent on advertising for the company is rather immense. It’s perhaps no surprise, then, that McDonald’s gets more customers per restaurant than their competitors, and double the net profit margin of their competitors.
I calculate that the company is trading slightly above intrinsic value based on my targeted rate of return, but if there were to occur any significant market corrections, I’d be willing to increase my position if the price dips enough to produce a dividend yield of comfortably over 3%. Like Coca Cola, I expect McDonald’s to be able to produce comparatively low risk mid-to-high single digit annualized returns over the next decade.
Dividend Yield: 2.82%
Total Debt/Equity: 0.79
Price to FCF Ratio: 22
FCF Dividend Payout Ratio: 57%
Most Recent Dividend Increase: 15%
Full McDonald’s Analysis
Diageo (DEO), the world’s largest producer of spirits, holds the number one spirit brands in most of its categories. Smirnoff is number one in worldwide vodka sales, Johnnie Walker is number one in worldwide scotch sales, Guinness is number one in worldwide stout sales, Baileys is number one in worldwide liqueur sales, and Captain Morgan is number two in worldwide rum sales, and the company has many more brands than those. The company has solid emerging market exposure.
Diageo spent a whopping £1.538 billion marketing its brands in 2011, and the focus was on their top 14 brands. Diageo stock has gone up almost continuously over the last three years, and I calculate it now to be somewhat overvalued, especially when taking into account the leverage on the balance sheet. With any significant market correction, DEO could be a fine purchase.
Dividend Yield: 2.92%
Total Debt/Equity: 1.60
Price to FCF Ratio: 20
FCF Dividend Payout Ratio: 58%
Most Recent Dividend Increase: 6.0%
Full Diageo Analysis
Philip Morris International
Philip Morris International (PM) is one of the largest producers of cigarettes in the world, and markets tobacco products in over 160 countries outside of the United States. The company has rights to the internationally recognized brand, Marlboro. Compared to Altria which operates only in the US, and so has consolidated regulatory risk, the widespread operating area of PM spreads regulatory and other risks out.
The company’s free cash flow is especially impressive, as FCF exceeds net income and grows at a very robust rate. This is partially offset by the company’s weak balance sheet. The company has the largest dividend yield, the largest recent dividend increase, and the one of the lowest price to FCF ratios, on this list. Due to low capital expenditures, PM converts nearly all of its operating cash flows into free cash flows, and the company uses practically all of its free cash flow for dividends and share repurchases.
Dividend Yield: 4.01%
Total Debt/Equity: 4.70
Price to FCF Ratio: 13
FCF Dividend Payout Ratio: 47%
Most Recent Dividend Increase: 20%
General Electric (GE) fell from grace during the financial crisis, as this once pinnacle blue-chip with an ex-perfect credit rating had to cut its dividend. It has since started its recovery, and the dividend is now 70% higher than it was during the market bottom in 2009, but still considerably below the peak. Consistency means a lot to dividend investors, and GE broke that trust.
Unlike the other brands on the list, which sell primarily to consumers, GE sells primarily to other businesses. GE, however, is indeed a household brand name, and it’s the only company currently on the Dow Jones Industrial Average that was listed there from the beginning over 100 years ago. The conglomerate, originally founded by Thomas Edison and others, currently has a strong presence in numerous businesses, including wind and gas turbines, jet engines, healthcare, and capital.
The company has a solid current dividend yield. I’m bullish on GE at the current price.
Dividend Yield: 3.55%
Total Debt/Equity: 3.60
Price to FCF Ratio: 10
FCF Dividend Payout Ratio: 32%
Most Recent Dividend Increase: 13% (or 21% compared to the same quarter last year)
Full Disclosure: At the time of this writing, I am long KO and MCD.
You can see my dividend portfolio here.
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