Lancaster Colony: Shares Are Beyond Ripe

| About: Lancaster Colony (LANC)

Summary

Lancaster Colony Corporation is a dividend king that attracts many dividend investors because it has paid a dividend each year since 1963.

Lancaster has had a particularly strong 2016, with shares rising more than 15%.

With Lancaster seeing a relatively tepid fiscal 2017 for itself, we had to ask, is now the time to buy?

Analysis

A Food Company for Healthier Times. As 2016 enters in homestretch, dividend-focused investors are probably thinking about their portfolio composition for 2017. One company that might pique their curiosity is Lancaster Colony Corporation (NASDAQ:LANC), the specialty food products maker known to consumers for its Marzetti salad dressings and dips, New York Bakery packaged bread and croutons and Flatout wraps and rolls.

Lancaster's product mix is interesting in today's environment because it hews closely to consumer trends favoring healthier, non-fried fare. In fact, for Lancaster's fiscal 2016 (which ended in June), sales were driven higher by sales of various salad dressing brands and its packaged croutons -- that is, the sort of products that calorie-conscious buyers favor.

As a dividend stock, Lancaster is considered a "Dividend King," having paid a dividend each year since 1963. However, at 1.51%, its dividend yield is somewhat lower than that of its peer group, which has an average yield of 2.37%. It is also a bit lower than that of the S&P500, which has a yield of around 2%.

Thus, investors who buy $10,000 worth of Lancaster shares are looking at annual passive income of just $151. That being said, Lancaster is the only major diversified food-maker that has been paying a consistent dividend for over 50 years so investors looking for a long-term dividend stock should consider the important question of whether a steady, practically guaranteed dividend is worth more (in the long run) than a moderately higher, but less certain dividend payout.

Investors should also note that Lancaster has paid special dividends from time to time. It paid a $5.50 per share special dividend in December 2015 and, prior to that, paid a $5.38 dividend in December 2012. Its latest special dividend was equivalent to over 2 years' worth of dividends and was equivalent to a 4.1% dividend yield by itself.

In any case, Lancaster's low dividend yield means that investors should, be looking at other reasons to own the stock. Let's take a look:

Dividend and Outlook. Fiscal 2016 was a good one for Lancaster, with the company recording record net revenues of $1.19 Billion on nearly 8% sales growth while its diluted earnings-per-share increased by nearly 20% from $3.72 to $4.44. It also managed to beat Wall Street's estimates in three of the last four quarters and its cumulative earnings for the year were 8% ahead of the consensus forecast for the year.

As mentioned, the growth in Lancaster's Fiscal 2016 revenues were driven by healthier fare, which helped to offset the negative drag from its customer rationalization process meant to improve efficiency in key product areas such as salad dressings and sauces, where it has a 50% market share.

That being said, Lancaster sees continued rationalization as impacting sales growth in fiscal 2017 and Lancaster sees a reduction in its retail prices following a decrease in the cost of inputs such as eggs, historically high prices of which (due to an egg supply shortage cause by an Avian Influenza scare) had led to pass-through price increases previously. It also sees some price deflation from its food service segment.

However, Lancaster does expect some sales pickup from new products that it is planning to introduce during the fiscal year -- and it also anticipates further gains from its 2015 acquisition of Flatout breads, which enabled Lancaster to broaden its footprint to the branded specialty bakeries and delis.

Consequently, we see Lancaster's sales growth dipping to the low single-digits -- around 3% to 4%, which is consistent with the 4.5% sales growth expected by Wall Street.

Investors who marvel at Lancaster's ability to pay dividends for 50-plus years should take note of its prudent management as evidenced by its solid financials. To wit, it has $1.62 of cash for every $1.00 of its short-term liabilities -- and nearly $3.70 of overall working capital for every dollar of its current liabilities. It also has no financial debt. All these compare quite favorably to its peer group, which is normally quite short on liquidity and moderately leveraged.

In practical terms, what this means is that investors who buy Lancaster's share can probably book their next few dividend payments -- there are no interest payments and the company is likely to improve on the $125 million in free cash flow it generated in 2016.

In fact, Lancaster's regular dividends -- at $53 million -- have been its largest use of cash three years running and even then, we would argue that it could raise its current quarterly dividend from $0.50 per share to $0.55 per share (a 10% increase) without straining its balance sheet at all since it would only add another $7 million or so to its current payout. While highly unlikely, given its history, it's also possible for Lancaster to pay another $5.50 special dividend without much trouble -- provided it's able to generate another $125 million or so in free cash flow in fiscal 2017.

Lancaster's shares have risen by 16.4% this year, which is three times the average return of the major indices. Consequently, its trailing earnings ratio is at nearly 30-times, which is higher than the S&P500's. Since its revenues are only expected to rise by 4% this year, we only expect a similar increase in its earnings for fiscal 2017 (i.e. to $4.62 per share) -- so its forward ratio will remain elevated at nearly 29 times earnings.

Lancaster's stable revenues and strong and unlevered balance sheet (unlike the rest of corporate America, which is now highly leveraged) make us more bullish on the stock in the long term than the rest of the market - but its slower sales make us we believe that its multiple needs to dip closer to the 22 to 25-times range in the short term. Thus our price target for Lancaster is $115.5, which is 13% lower than its current market price - and around 6.5% lower than the consensus price target.

Conclusion

As a long-term play, we'd like to have Lancaster as part of our investment portfolio. Its prudent management, strong brands, leading market position in the markets it serves, appropriate product positioning and long dividend history tick the right boxes for us.

That being said, we believe that Lancaster's current price has been driven by a market seeking strong defensive plays such as consumer staples, which has made its shares somewhat overvalued - and its low dividend yield doesn't provide much of a buffer against market volatility. Given this, we believe that investors should wait for a pullback before getting into Lancaster.

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: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.