By Serkan Unal
The industrial sector has historically been a good source of dividends, including special dividends. Last year, due to healthy free cash flows, this sector registered one of the highest numbers of companies issuing special dividends, according to S&P Capital IQ. The sector pays a competitive yield and many of the sector's leading names are offering appealing combinations of dividend yield and growth. Now that the market outlook for industrials is improving, as U.S. industrial production picks up pace and global economies rebound, some investors are likely to look for growth opportunities in the sector.
A specific group of industrial stocks comprises the Broad Dividend Achievers IndexTM, representing the companies with at least 10 years of consistent dividend growth. These index constituents also include some of the best known dividend stocks. Here is a closer look at top five industrial sector Dividend Achievers, based on their weights (as % of net assets) in the The PowerShares Dividend AchieversTM Portfolio ETF (PFM), which seeks to replicate, before fees and expenses, the Broad Dividend Achievers IndexTM. The featured industrials have an established reputation for solid balance sheets and/or free cash flow, as well as improving EPS growth outlooks.
United Technologies Corp. (UTX) is maker of helicopters, aircraft parts, building heating and air conditioning, and elevators. The company, which has raised dividends for 18 consecutive years, has a dividend yield of 2.5%, payout ratio of 44%, and five-year annualized dividend growth of 11.2%. UTX's EPS growth averaged 8.2% annually over the past five years, and is expected to accelerate to 11.5% annually for the next five years. On January 18th "Mad Money," CNBC's host Jim Cramer called the stock "terrific," saying that, along with Honeywell International (HON), it represented "the best way to play the aerospace" sector. However, the recent problems with Boeing's (BA) Dreamliner could be a setback for the company, as it produces the troubled electrical units for the plane. Still, UTX has many positive aspects. It is a good play on emerging market growth, as the lion's share of its revenues comes from abroad, including emerging markets like China. Just to illustrate its exposure, in China, UTX accounts for two thirds of the nation's elevator market. Giving the country's stock of new and old buildings, one can imagine how robust demand for elevators can be in China. According to Bespoke Investment Group, among S&P 500 constituents, UTX has one of the highest rates of beating EPS estimates-this company does it 96% of the time. The stock is trading at 15.0x trailing and 15.9x forward earnings. Last quarter, Maverick Capital's Lee Ainslie initiated a large new position in this stock.
3M Company (MMM), a diversified conglomerate and one of the S&P 500 Dividend Aristocrats, has raised dividends for 54 consecutive years. Its dividend yield is 2.4%, payout ratio is 38%, and 5-year annualized dividend growth is 3.5%. Last year, the company raised its dividend by more than twice the five-year average rate. 3M Co.'s EPS growth averaged 3.3% per year over the past five years, and is expected to accelerate to 10.6% annually for the next five years. The stock has low long-term-debt to equity of 27%, 14.6% of total assets in cash, and ROE of 27.6%. Bank of America Merrill Lynch includes 3M Co. on the list of its "10 Stocks for 2013," according to Business Insider. Citing the new CEO's inclination to boost margins for faster growth, the bank sees a 14.5% upside potential for the stock from the current price. 3M Co. has a large China exposure, so an accelerating growth in China bodes well for the company. In fact, the company expects developing markets' growth to average between 5% and 10% this year. It also aims to expand through acquisitions in the future, with up to $2 billion planned for acquisition in 2013. The stock is trading at a small premium to peers, based on a forward P/E of 14.7x. Last quarter, value investor Jean Marie Eveillard's First Eagle Investment Management held more than $522 million in 3M Co.'s stock.
Caterpillar (CAT), the world's largest construction and mining equipment maker, has raised dividends for 19 years in a row. Its dividend yield is 2.2%, payout ratio is 21%, and five-year annualized dividend growth is 7.0%. The company's annualized five-year EPS CAGR is forecasted at 14.0%, almost double the average rate over the past five years. Earlier concerns about the adverse effects on the company's performance from the weak demand and inventory glut in China are dissipating. The company's two largest markets, U.S. and China are seeing faster growth. U.S housing market is facing an inflection point while non-residential construction is picking up over the year-ago levels. The American Institute of Architects forecast non-residential construction growth at 6.2% in 2013. While the mining outlook, the reason for Caterpillar's lowering of 2015 outlook back in September 2012, will remain depressed this year, a modest rebound is forecasted for 2014. Citing expectations of a market trough in 2013 and better conditions in China, Piper Jeffrey has just upped CAT to outperform with a potential 15.8% gain from the current price. Caterpillar is trading at 9.0x trailing and 12.0x forward earnings. Last quarter, Bill and Melinda Gates Foundation Trust (check out its top picks) initiated a large new position in the stock.
Emerson Electric Co. (EMR), a diversified industrial equipment and components maker, is a Dividend Aristocrat that has raised dividends for the past 56 consecutive years. Its dividend yield is 3.0%, payout ratio is 61%, and five-year annualized dividend growth is 7.5%. The company's EPS hardly grew, on average, over the past five years; its long-term annualized EPS growth is forecasted to accelerate to 9.7%. On January 7th, Jim Cramer called the stock "a China play," saying he expected the company's CEO to undertake restructuring and deliver some good numbers, pushing the stock higher. The company has a well-diversified revenue sources across process management, industrial automation, network power, climate technologies, and appliance and tools segments. The stock has just set a new 52-week high. Still, EMR looks pricey, with its above-industry forward P/E of 15.4x and price-to-book of 3.9 (versus 2.6 for the industry on average and the company's five-year average ratio of 3.7). Last quarter, RenTech's Jim Simons established a new position in EMR worth more than $80 million.
Illinois Tool Works (ITW), a maker of industrial products and equipment, is a Dividend Aristocrat with 49 consecutive years of dividend increases. Its dividend yield is 2.4%, payout ratio is 31%, and five-year dividend growth is 9.5%. The company's EPS growth averaged 8.2% annually over the past five years, and is forecasted to accelerate to 10.7%. The company sees organic growth 200 basis points above industrial production by 2017; operating margins and return on invested capital above 20% by 2017; 100%-plus free cash flow conversion and 12%-plus EPS CAGR beyond 2017. In the near term at least, growth will be supported by expansions in the housing market and the auto industry. International sales, especially in Asia, will be propping up financial results. The stock is trading at 15.3x trailing and 14.8x forward earnings. Still, it should be noted that JPMorgan (JPM) analysts recently downgraded the stock to underperform citing expected underperformance relative to peers. The stock is popular with Relational Investors' Ralph V. Whitworth, who reported owning nearly $866 million in ITW last quarter.