Who's Next: In Search Of The Next Dividend Champions

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Includes: ECL, GD, LLTC, MGRC, UMBF, WABC, WTR
by: Passive Income Pursuit

Summary

Dividend Champions have increased dividends for 25+ years through every economic malady.

The Contenders list has the next potential Champions with 7 companies on the cusp of earning the title belt.

This article culls through the 7 would be Champions to decide if they are worth further research.

Dividend Champions are the creme de la creme. A company that reaches Champion status has to increase dividends for at least the last 25 years. That's a major accomplishment when you think back to all of the economic situations the companies have been through. There's the end of the savings and loan crisis of the late 80's/early 90's, the technology boom and subsequent bust, 9/11, the housing bubble and its bursting which led to the financial crisis and a whole host of other economic maladies that have come and gone as well. Through them all the Champions have been able to raise their dividends year in and year out.

There's currently 7 companies that are on the threshold of earning their Championship belt. These 7 companies have all increased dividends for 24 years and assuming everything goes right should gain the title of Champion at the end of this year.

Who's next to become a Champion?

I wanted to highlight these companies in order to give them their props for being on the cusp of something truly special. These companies all make for great candidates for further research based on their history alone; however, I've also included some valuation metrics as well as my thoughts on the companies and their respective outlooks.

The metrics that I will include are:

  • TTM P/E Ratio - In order to get a sense of the current valuation based on the last 12 months of earnings.
  • Forward P/E Ratio - Since we invest for the future we need to have an idea of the valuation based on future growth.
  • Current Yield - Dividend yield is a vital data point for dividend growth investors.
  • Forward Payout Ratio - The current quarterly dividend rate, annualized, divided by the one year forward earnings per share estimate.
  • 5 Year EPS Growth Estimate - The estimated growth for one year isn't a long enough time to get a feel for the potential future prospects. Therefore I like to look at the 5 year estimated earnings growth as compiled by Yahoo Finance.
  • Forward Chowder Rule - I prefer the forward "Chowder Rule" to get a quick estimate of the total dividend return potential of an investment. The 5 year estimated earnings growth is a good proxy for potential dividend growth over the medium term assuming that management maintains a constant payout ratio.

Valuation and yields are based on the closing price from March 24, 2016.

Aqua America, Inc. (WTR)

Aqua America is a regulated utility that both provides water and cleans up wastewater with operations in 8 states. Considering that we all need water to survive I'd say they have a fairly captive consumer.

TTM P/E Ratio 27.7
2016 Forward P/E Ratio 23.5
Current Yield 2.26%
Forward Payout Ratio 62.5%
5 Year EPS Growth Estimate 5.9%
Forward Chowder Rule 8.1%
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In a yield starved world the valuation here looks to be pretty stretched. The current yield is only 2.26% which doesn't bode well for a company that has a forward payout ratio over 50%. Especially when you account for the fact that earnings are only expected to grow by 5.85% annually over the next 5 years. Dividend growth has historically been in the high single digits ranging from 7.8% to 8.6%.

The upside to utilities is that they are typically local monopolies with relatively stable demand from year to year. However, the two big downsides are that they're regulated, meaning the government makes pricing/return decisions, and they are very capital intensive.

While earnings have covered the dividend the same can't be said for free cash flow. For fiscal year 2015 the free cash flow payout ratio was a rather alarming 526%.

Ecolab, Inc. (ECL)

Ecolab provides a variety of cleaning products and services for consumers as well as other industries such as oil and gas, commercial laundry, food and beverage, mining, manufacturing and many more.

TTM P/E Ratio 33.2
2016 Forward P/E Ratio 24.7
Current Yield 1.27%
Forward Payout Ratio 31.3%
5 Year EPS Growth Estimate 12.5%
Forward Chowder Rule 13.7%
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What's really encouraging is that Ecolab's 1 year dividend growth (20.0%) > 3 year dividend growth (18.2%) > 5 year dividend growth (16.3%) > 10 year dividend growth (14.2%). Some of that outsized growth has come from an expanding payout ratio; however, the forward payout ratio sits just over 30%.

If the double digit earnings growth continues I see no reason that dividend growth won't follow. Ecolab is definitely a company for further research although the valuation looks to be a bit stretched currently.

General Dynamics Corporation (GD)

General Dynamics is an aerospace and defense company that operates globally. The company is split into four operating segments: Aerospace; Combat Systems; Marine Systems; Information Systems and Technology. Around 60% of revenue is generated from the U.S. government.

TTM P/E Ratio 14.2
2016 Forward P/E Ratio 13.8
Current Yield 2.36%
Forward Payout Ratio 32.4%
5 Year EPS Growth Estimate 9.6%
Forward Chowder Rule 11.9%
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The valuation looks fairly good on the surface; however, comparing the P/E ratios to the 5 year average P/E ratio of 13.3 it's about par for the course. The current yield isn't all that exciting, but the Forward Chowder Rule approaching 12% in intriguing when combined with the modest payout ratio of just 32.4%.

Linear Technology Corporation (LLTC)

Linear Technology designs, manufactures, and markets a line of analog integrated circuits around the world. These chips are things that process real world information such as temperature, pressure, weight, sound and much more. The chips are vital for many manufacturing and engineering processes looking to solve real world problems.

TTM P/E Ratio 21.6
2017 Forward P/E Ratio 20.5
Current Yield 2.89%
Forward Payout Ratio 59.3%
5 Year EPS Growth Estimate 11.0%
Forward Chowder Rule 13.9%
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I'm interested in learning more about Linear Technology since they provide chips that give data for engineers to both automate and optimize. Efficiency is the name of the game for companies and as more processes become optimized that will lead to increases in demand for Linear Technology's products.

The current yield is approaching 3.0% which could be a nice entry point for shares when combined with the 11.0% estimated growth rate. The current valuation is in line with the 5 year average P/E ratio of 20.0; however, that likely means there's not much of a margin of safety at the current price levels. Linear Technology makes for an interesting candidate for further research.

McGrath Rentcorp (MGRC)

McGrath Rentcorp deal in business to business rentals. Things like modular or temporary buildings, test equipment, storage tanks and boxes. The three operating segments don't appear to have too much in common; however, the basics of renting goods to businesses is rather straightforward.

TTM P/E Ratio 15.2
2016 Forward P/E Ratio 15.2
Current Yield 4.20%
2016 Forward Payout Ratio 63.8%
5 Year EPS Growth Estimate 10.0%
Forward Chowder Rule 14.2%
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McGrath Rentcorp has a solid dividend growth history and has done a solid job continuing to grow. They're the smallest company out of the list with a market cap of just $574 M which adds another layer of difficulty in analyzing the company. However, that can also be a good thing for investors because there's less people/analysts following the company potentially giving an opportunity to take advantage of pricing mishaps.

On the surface the company looks pretty solid although the payout ratio is a bit higher than I like but still at a manageable level. Earnings are expected to be stagnant for 2016, but are expected to ramp up growth to 10.0% annually over the next 5 years.

My big concern for McGrath Rentcorp and its dividend lies in cash flow. Free cash flow was negative for 2011-2014 and just barely turned positive for 2015. The cash flow situation is definitely a concern going forward.

UMB Financial Corporation (NASDAQ:UMBF)

UMB Financial is a bank holding company that operates through 4 segments: Bank; Payment Solutions; Institutional Investment Management; and Asset Servicing. UMB Financial offers a wide range of financial services to both companies and individuals.

TTM P/E Ratio 21.2
2016 Forward P/E Ratio 17.4
Current Yield 1.88%
Forward Payout Ratio 32.7%
5 Year EPS Growth Estimate 15.8%
Forward Chowder Rule 17.7%
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UMB Financials' service diversification is intriguing as an investment candidate. The wonderful thing about the financials is that when they're run properly they essentially make money on the interest rate spreads or take a cut of assets each year. The likelihood of a competitor offering a truly innovative product that crushes your business just isn't likely.

The current yield isn't that enticing at less than 2%, but the payout ratio is sufficiently low. Couple that with a high expected earning growth rate and you have the makings of potential investment. One bit of a concern is the rather low historic dividend growth rates across the 1 year, 3 year, 5 year and 10 year periods that are just 4.4%, 4.7%, 4.9% and 7.9%, respectively.

The historic dividend growth rates aren't inspiring, but future growth could very well increase if the earnings growth plays out. UMB Financial definitely looks like a candidate for further research.

Westamerica Bancorp (WABC)

Westamerica Bancorp is a traditional savings and loan banking institution with both individual and corporate customers. Operations are localized to northern and central California.

TTM P/E Ratio 21.3
2016 Forward P/E Ratio 21.2
Current Yield 3.19%
Forward Payout Ratio 67.5%
5 Year EPS Growth Estimate 5.0%
Forward Chowder Rule 8.2%
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A traditional savings and loan bank can be a great source of reliable and consistent profits. These banks make money on the interest rate spread between what they pay on deposits and receive on the loans. Conservative loan underwriting is crucial to their operations.

The valuation looks to be a bit stretched currently compared to the 5 year average P/E ratio of 17.5. The big concern just glancing at the financials is the revenue showing a consistent decrease since peaking in 2009 and declining by approximately 45% over that time. Returns on equity have subsequently declined by approximately 60% over the same time as well and were just 11.1% for 2015.

Dividend growth has been following the business decline with 1 year, 3 year, 5 year and 10 year growth rates of 0.7%, 1.1%, 1.2% and 2.3%, respectively. Westamerica Bancorp doesn't appear to warrant further analysis based on the low expected growth and declining fundamentals.

Conclusion

It's important to remember that this is just a starting point in the research process to look for potential investments.

These 7 companies are all on the cusp of reaching a huge milestone of 25 consecutive years of dividend increases and the distinguished title of Champion.

Here's how I would rank the companies based on this screen and whether the company deserves a closer look.

  1. Ecolab, Inc. - Investment Candidate
  2. General Dynamics - Investment Candidate
  3. Linear Technology Corp. - Investment Candidate
  4. UMB Financial Corp. - Investment Candidate
  5. Aqua America Inc. - Pass
  6. McGrath Rentcorp - Pass
  7. Westamerica Bancorp - Pass

A full list of my holdings can be found here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: Investing involves risk. Any mention of companies in this article is not meant as investment advice. Please consult a financial professional prior to investment and do your own due diligence. Some companies mentioned have market caps < $1 B.