Dividend Investors' Guide 2014 Review - Household Products Industry

Includes: CHD, CL, PG, TUP
by: Mark Bern, CFA


Overview and brief discussion of rules used in my stock selection process.

Overview of my expectations for the household products industry for the next five years.

Evaluation of my 2012 Procter and Gamble, Colgate-Palmolive, Church and Dwight and Tupperware recommendations and my updated projected five-year target prices.

Back to Part V - Toiletries and Cosmetics

By Mark Bern, CPA CFA

If you are new to the series and would like to start at the beginning, just follow this link to "The Dividend Investors' Guide to Successful Investing." In the initial article, I provide a description of my selection process and explanations of all the metrics I use. I am currently in the process of providing annual updates to the original industry articles.

I would like to reiterate some of the simple rules that I use as filters to find prospect companies for my master list. Companies must pay a dividend and increase it regularly. I prefer dividend yield above 2.5% but will consider slightly lower yields if yields are growing much faster than the average rate for the industry. Companies that have cut the dividend within recent years or have a history that includes multiple cuts will not make the list. I require a positive cash flow that includes the ability to pay long-term debt coming due within the next five years. This is to provide certainty of viability in case the credit markets freeze up again as happened in 2008 and 2009. Companies that post losses in earnings from ongoing operations will not be considered. I also do not like stocks of companies that tend to fall further than the broad market index, S&P 500.

The purpose of these rules, as well as the other metrics that I use, is to identify companies that are well positioned to weather recessions without worry of bankruptcy. I like to hold for the long term and collect an ever-increasing stream of dividend income. Market corrections give us opportunities to add good companies to our portfolios at bargain prices. I also do not follow companies that experience significant volatility in earnings. I do remove non-cash accounting entries and one-time gains so that I am analyzing operations. But when companies have too many one-time adjustments, especially when the adjustments result in losses, it often means that management has made bad capital allocation decisions. Those companies do not make my list either.

The results from this industry are mixed since my last review. I will get into specifics on each list company shortly, but let me first provide a little overview on what I expect from this industry as a whole over the next few years.

Currently there are countervailing issues affecting this industry. As you know, if you have read my previous articles about household products companies, the emerging economies have been creating new consumers at the rate of tens of millions per year for nearly a decade. As people climb the economic ladder out of poverty there is a strong tendency to do more to maintain health and to take advantage of labor saving products. When a woman is able to obtain a washing machine (plus electricity and ready access to water) she will free herself of many hours of weekly labor down at the rock by the stream. There may be more than a billion women still washing clothes at the stream even today. When she gets that machine to do the work she also changes one of her buying habits. She now needs detergent that works best in the machine rather than with the rock. When she learns that she and her children can retain teeth for many more years than her ancestors she buys toothbrushes and toothpaste.

That may sound crazy to many readers, but unless you have traveled through the third world as I have you have no idea how wonderful life is in developed nations compared to what much of the world population must endure. But much of the world is making strides to decrease the huge gap in living standards. The companies in this industry are among the first to benefit from this global transformation and will continue to do so for decades to come. This trend is slowing down at present but will continue to expand in leaps and lurches over time. And the population of earth is expected to grow by more than two billion inhabitants by 2050 (according to a UN report) from seven billion to over nine billion. A significant number of them will eventually need household products. Thus, continued growth is highly likely for most of the companies in this industry. Those who have anticipated this trend have been bidding some of the shares of these companies beyond realistic valuations.

The industry is also considered to be a defensive investment with more resistance to a collapse of sales and earnings during recessions because people tend to keep buying what they consider to be daily necessities that are provided by these companies. The shares of household goods producers generally either hold up well during recessions or bounce back quickly. And the companies on my list keep increasing dividends right on through the bad times every year. With the current bull market getting relatively long in the tooth compared to the average economic recovery and resulting bull market, investors are bound to add shares of some of our favorites here. This is another reason why share prices have gotten a bit ahead of schedule. If you have considered hedging your equity portfolio and have not yet done so, you may want to consider my low cost strategy.

On the flip side, there are also headwinds that are slowing down sales and earnings growth. These may be temporary, but still counter the other, more positive trends for now. One of those headwinds is the slowing of global growth and employment. Another stems from higher raw material prices. Additionally, competition from generics are negatively impacting market shares in developed economies and have made it more difficult to increase prices compared to previous, more robust economic recoveries.

Different companies are using different strategies to deal with the adverse trends; some are increasing marketing and advertising in an attempt to recapture some of the previously loyal customers who abandoned branded products during the last recession; many are investing in new product innovations; and several are expanding or extending cost cutting initiatives that were spawned during leaner times. Finally, several of these companies will likely make strategic acquisitions to improve reach and margins.

My view is that the companies on my list have excellent long-term growth prospects combined with consistently rising dividends and more stability during economic downturns. These are companies that we should buy during dips and hold forever.

On June 15, 2012, I published an article about the household products industry that included the four companies I like best from that industry: Procter & Gamble (NYSE:PG), Colgate-Palmolive (NYSE:CL), Church & Dwight (NYSE:CHD) and Tupperware (NYSE:TUP).

I own PG and will likely leave shares to my children unless the company changes course dramatically. The stock did not perform as well in 2013 as the S&P 500. PG shares ended 2012 at $67.89 and ended 2013 at $80.54, resulting in a 19 percent appreciation and about 3.5 percent more of dividends. That was nice but not like the 30 percent from the broader index. This is where buying the dips helps as you will see when I explain the performance of PG from the recommendation date. I like stability and dependability and I get both from PG. I like the adage often applied to buying bonds: we buy the cow for the milk not the beef; if you want the beef buy a steer. In other words, we buy bonds for the dividends not the appreciation. PG stock is not a bond but I hold it for much the same reason, except that the income rises every year (which I prefer over bonds) and the principal appreciates over time (also better than bonds, in my opinion). If these shares were to end the next two years at the current price level I would not be upset. Eventually, I know the stock will rise and I get to collect the dividends that increase every year while I wait. The three percent current yield is a bargain compared to a 30-year treasury bond. The yield is slightly less now but should be far more before the end of that 30-year term and the shares will, in all likelihood, be worth several times more than what I paid. The bonds will mature at par value and cannot keep up with the future returns offered by a quality investment like PG.

Since I recommended PG shares on June 15, 2012, the shares have appreciated from $63.18 to $80.60 (as of the market close on Monday, March 31, 2014) for an unrealized gain of 27.6 percent. Add the $1.81 of dividends collected during that span and we can add another 2.9 percent, resulting in a total return of 30.5 percent. I do not expect more of the same going forward. What I do expect is for PG shares to consolidate around the current level, probably becoming range bound for much of the first half of 2014, at least. Right now I like PG shares more for the dividend and defensive quality afforded.

I do believe that there will be opportunities to add shares of PG on dips of five percent or more in the coming months. The current share price is a little above fair value, in my opinion. I would prefer to pay no more than $74 per share and expect that price to become available for the patient investor. My projected five-year target price is $102 per share. Including dividends, this price would provide an annual compounded rate of return of 8.3 percent.

Next on my list is another stock that I own, Colgate-Palmolive. I am happy to see that CL has improved its debt-to-capital ratio by ten percent. This is as I expected and should continue this year as well. The payout ratio is similar to that of PG but the yield is significantly lower at 2.2 percent. However, over the next five years I expect CL to outgrow PG in terms of EPS and dividend growth. My reasoning is that CL continues to grow nicely in its emerging markets, management plans further geographic expansion into additional high growth markets, and CL is also a leader in premium toothpaste sales in its markets which provide higher profit margins. The company is also in the midst of a multi-year effort to become more cost efficient which is already adding to the bottom line and should continue to help more each year through at least 2016.

The one difficulty facing CL at present is currency devaluations. Of course, CL is not alone in this area, but the company derives about four percent of operating profits from Venezuela and will need to take a one-time charge to write down assets located there in addition to the translation losses for the full-year results. The company has a strong presence in Latin America where personal care products use is expanding.

The shares were recommended in the same article with PG last year and have appreciated by 29.7 percent since to a current $64.87. We have also collected $1.02 in dividends adding another two percent to our unrealized gain on CL. Again, I do not expect a repeat of these results in 2014, but do expect to do well holding these shares over the long term. But the current share price is too rich for my liking so I will wait for a better entry point. I may have to wait for a major correction as I believe fair value for this issue is closer to $55 than the current level. But even at the current price my expected compounded annual total return over the next five years is 9.8 percent. My five-year price target for CL shares is $90.

CHD shares have also gone up nicely since recommended last year at $53.51 and currently stand at $68.88, or up 28.7 percent. Add in the $0.87 of dividends we have collected for an additional 1.6 percent and we have an unrealized gain of 30.3 percent thus far. The dividends have been growing at 40 percent annually over the last five years. That level of increases is not sustainable without increasing the payout ratio above the industry average. I suspect that the best days of dividend expansion from CHD are behind us and expect a more moderate pace going forward.

CHD is smaller than PG, CL and some other competitors. The bigger competitors are beginning to muscle into CHD's markets. The company will weather the onslaught, but growth will likely be diminished as a result. The company is not defenseless and is fully capable of competing for market share. But, I believe that most of the easy growth at the expense of larger rivals is in the rear view mirror now. Competitors have taken notice and are fighting back so growth should moderate.

This stock is likely to provide below average total return potential over the next five years, in my opinion. I do not own the stock and would not add shares unless the price drops below $60. I like management and the company's product line, but the stock is too pricey for me at current levels. My five-year target price for CHD is $81 which would result in annual compounded total returns averaging only 5.3 percent from the current price.

My final company on the list from this industry is Tupperware. TUP shares took a hit earlier this year as did shares of several other companies with direct selling business models. Nu Skin (NYSE:NUS) shares fell as a result of an announced investigation into its business practices by the Chinese government in January. Over the next week or so shares of TUP and others with similar business models and exposure to China fell in sympathy. The investigation was concluded in March with a relatively small fine paid by NUS for minor, correctable infractions. The industry has not fully recovered.

Additionally, TUP's fourth quarter results were below expectations which also pressured the stock. All this adds up to a nice buying opportunity in my opinion. TUP derives 91 percent of its revenues from outside of the U.S. It is truly a geographically diversified company with an expanding footprint in emerging nations around the globe. The company has tremendous potential growth in Latin America, Asia and Eastern Europe. Currency devaluations are probably the biggest headwind in the near future for TUP. But I believe that negative will be offset by strong growth.

The dividend paid in 2013 amounted to $1.86 while the indicated 2014 dividend is up to $2.72 per share to yield 3.3 percent. I expect future dividend growth to moderate to an annual compound rate of about 8.6 percent, still nicely outpacing inflation. Shares are up 56.6 percent since my recommendation last June at $53.49 to a current $83.76. Including dividends collected of $1.86 per share, the total return to date has been 60.1 percent.

Of the four companies highlighted in this article, I believe TUP has the most potential for total return over the coming five years. My five-year price target is $136 and, if hit, would produce an average compounded annual total return of almost 16 percent.

That concludes my update review of the household products industry. I hope this article was helpful in some way to readers. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.

Disclosure: I am long PG, CL, TUP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.