The Search For Rising Dividends: MeadWestvaco

Mar. 2.12 | About: WestRock Company (WRK)

By Mark Bern, CPA CFA

MeadWestvaco (MWV) provides packaging solutions for the beauty, beverage, food, healthcare industries as well as specialty chemicals for adhesives, inks, and oilfield services industries. It derives 32% of sales from outside the U.S. The company pays a handsome dividend yield of 3.3%.

The reason that the packaging industry has caught my eye is that the global growth of consumers in emerging markets should create excellent growth potential for industry leaders with good exposure to foreign markets. The industry has done better over the last five years, by and large, than it had been doing, partly because of global growth but also because of some consolidation and improving efficiencies.

Zacks has rated MWV a strong sell recently based primarily on a miss in the fourth quarter and reduced guidance by the company. Over the next year I believe that Zacks probably has it right. But I'm not a short-term investor so I try to look at companies for their long-term potential (5 or more years out). From that perspective, I think MWV paints a different picture. This, of course assumes that the global economic expansion continues, that the EZ recession is mild, and that there is no significant collateral damage from the sovereign debt crisis.

And with the ECB having pumped a second round of cheap capital into the EZ banks and those companies with financial units (1% interest is great if a company can get it because it lowers the overall cost of capital), there is a much stronger possibility that Armageddon can once again be put off at least until the next group of political leaders takes over.

So, why do I say that the miss and lowered guidance does not concern me for the longer term? MWV and other in the packaging industry have been hit rather hard by rising energy prices and input cost inflation. MWV had decided to step up its capital improvement plans and update facilities more aggressively to become more efficient sooner rather than later. This will lower earnings in the short term but should add significantly to earnings in the longer term. At least, that is my opinion.

Let's look at how MWV scores on the report card relative to the industry averages. I prefer comparing companies to industry peers rather than the broader market because each industry has unique requirements in areas such as debt, labor intensity, marketing, and the like. Thus, comparing to industry averages provides me with what I believe is a better gauge of how well a company is managed.

Ratio / Measure

MWV

Industry Ave.

Pass / Fail

Ave. Annual 5-Yr Earnings Growth

10.2%

3.5%

Pass

Ave. Annual 5-Yr Div. Growth

1.7%

8.0%

Fail

Net Profit Margin

5.9%

5.5%

Pass

Debt to Total Capital

38%

42%

Pass

Return on Total Capital

8.0%

10%

Neutral

Dividend Yield

3.4%

1.8%

Pass

Payout Ratio

48%

25%

Fail

Price-to-Earnings

20.8

25

Pass

Click to enlarge

The company has two areas of failure: dividend growth and payout ratio. Obviously, these two ratios are related as the dividend growth is unable to be improved when the payout ratio is too high relative to the industry average. The payout ratio has come down from 116% in 2008 when the company's earnings were down 39% and then began to rebound in 2009. Current earnings per share are the highest in the company's history dating back to 2002 when it was formed as a result of the merger between Mead and Westvaco.

MWV is on a course that could lead to shares reaching $60 within the next five years. Add in the dividend at 3.3% that is likely to grow, in my opinion, by an average of around 5% a year and an investor has a stock that should keep them ahead of inflation while also providing some decent appreciation. But before buying MWV, you might want to take a closer look at a few other companies in the packaging business, like Rock-Tenn (RKT) (which I wrote about), Greif (NYSE:GEF), or Packaging Corp (NYSE:PKG). I'll be writing about the last two within the next 48 hours.

My goal is not to try to time the market or pick the top or bottom for any individual stock. Rather, I hope to separate the wheat from the chaff, so to speak. I try to bring the best two or three companies in each industry to investor attention. None of us knows with certainty when the market will correct or head higher or by how much. I also hope that all investors will complete additional due diligence on each stock considered before adding purchases to their portfolio to ensure that each holding is appropriate and suitable to each individual's needs.

If I were trying to buy shares of WMV now I'd want a little better price. Thus, I would consider selling a put options(s) to either get the shares at a discount from the current price or collect the premium and a decent return on my cash while I wait for the price to come down to my level. I like the September 2012 put option contract with a strike price of $27.50 and paying a premium of $1.80 per share (the price of the last transaction; the spread between the closing bid/ask was $1.20/$2.50).

If I were to sell a put option contract at that price I would receive $180 (less commission) and have an annualized return of about 10.3% if the option expired worthless. If the option gets exercised I would be obligated to purchase 100 shares of the stock (for each contract sold) at $27.50 or a cost basis of $25.70 ($27.50 - $1.80) for tax purposes. That would improve my initial dividend yield to about 3.9%. I must caution readers to never sell a put option on a stock unless you really, really want to own the stock. It could happen.

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