Yield, Value, Safety Series: 2 Out Of 3 With Consumer Staples

by: John D. Thomason

This is a continuation of the series of searching for stocks with the above listed attributes suitable for an income portfolio, this time focusing on another "staple" of income investors (pun intended), consumer staples. In this article I will present how I approached the task of narrowing down the choices available in this grouping, and what I believe to be the best selections available at the moment. While unfortunately there are no outright bargains to be had, there are several that are not too far out of line, and if not buys at the moment, would be appropriate additions to a high priority watch list.

Consumer staples should be represented in a diversified income portfolio. Sales of consumable products, such as packaged foods, personal hygiene items, and so on continue in good times and bad, making these firms recession-resistant. With sales often extending internationally in many cases, these companies are often diversified beyond the economics of a single nation or region. Growth, while hopefully steady, is limited. These are all typical characteristics of income stocks, and indeed many of these firms are known as dividend stalwarts. Similar to utilities, the steady revenues allow for high levels of debt to be carried, and many of these firms are significantly leveraged beyond what one would expect, or at least in my case, what one would prefer. All is not roses for these companies as competition is brutal, input costs are hard to control, and brand loyalty is probably lower than it has ever been since national brands came onto the scene 100 or more years ago.

Before I get into details, I want to note that most of the data presented was taken from the MSN Money website, which I refer to repeatedly as the "primary source website". In addition, I have used the TD Ameritrade website available to me as an account holder for dividend data - specifically, the Chart with Events feature. Another website referenced was the Financial Industry Regulatory Authority (FINRA), for corporate bond ratings. I used the E*Trade scan feature, available to me as an account holder, to perform my initial scan. The ratings data came from resources available to me as an account holder with E*Trade, TD Ameritrade, Schwab, and Fidelity.

To begin the search, I first scanned for consumer non-durables, with the only qualifier being yield, which had to be at least 2.00%. I elected to do all eliminations manually, other than the yield qualification, to ensure no significant companies would be overlooked. From the initial list, I excluded tobacco-related firms, brewers, distillers, fast-food / snack food companies, and soda / beverage firms. I'm going to classify all these as "sin" stocks, or less judgmentally, consumer discretionary stocks, and evaluate them as a separate group later on. I also eliminated direct sellers. I did not exclude foreign firms, since these companies compete in world markets, just as do the U.S. based multinationals, and they have no special handicaps from being based outside the U.S. After these eliminations, I ended up with 22 companies, four of which were foreign firms. Of the 22 companies, nine offered a yield under 3%, but I decided to keep them in the mix initially.

I then evaluated all 22 companies against the first three of the six criteria sets, which are the dividend criteria, the earnings criteria, and the debt criteria. My rationale is, if a company exhibits a major shortfall in any of these areas, it should be eliminated, regardless of how it ranks when considered against the latter three criteria sets. These latter three criteria categories are investment returns, valuation, and ratings. At this point, eight more firms were eliminated: One had a payout ratio over 100%, one had no equity, as total liabilities exceeded total capitalization, one had no dividend increases since 2008, exhibiting a lack of management commitment to dividends, and five had excessive debt. This first group of firms eliminated is presented as Table 1, which identifies the firms, and gives specifics on the data which resulted in them being dropped. There are some surprises, as most are household names.

Now my list was down to a more manageable 14 companies. I then elected to hold off on further eliminations until after all of the remaining criteria had been applied. After this was done, I came to the conclusion that none of the firms yielding less than 3% were so compelling that I could justify picking any of them over any of the firms yielding more. Yet, many if not all had been found to be very solid, plus I felt that the SA readership would be interested in the data for all of the 14 firms. I resolved this controversy by dividing the survivors into two groups, eight of which were yielding over 3%, and six that were yielding between 2% and 3%. I then ranked the companies in each group, best to worst, for each of the six evaluation criteria sets. These results are shown in six sets of tables following, with each set consisting of two tables, one for the higher-yielding group, and one for the lower-yielding group. A brief recap describing each evaluation criteria set is presented, followed by the two tables showing the results of applying that criteria to the two groups of companies. After all tables have been presented, conclusions and recommendations are presented.

DIVIDENDS (Tables 2A and 2B)

The first criterion set is all of the key metrics relating to dividends. In addition to the current yield, I reviewed the last five years of dividend history and calculated the dividend growth experienced over the period. I also show, for informational purposes, the payout ratio, the ex-dividend date of the last increase, and the announced or estimated next ex-dividend date. The rankings are based on yield, highest to lowest.

EARNINGS & REVENUE (Tables 3A and 3B)

The next criterion set is earnings and revenue, which is the foundation upon which dividends are based. If earnings and revenue are lacking, dividends cannot be sustained for long. I reviewed the operating cash flow vs. net income for the last five years and the last five quarters, to see if cash flow consistently exceeded net income, which would indicate high-quality earnings. The table indicates the number of periods, out of five possible, that cash flow exceeded net income. Thus, 5/5 is an ideal reading. I also reviewed the ten year histories of revenue and net income, to get an idea as to the stability of revenue and earnings, and also debt. The ideal case would be steadily increasing revenues and net income, and flat or declining debt. While revenue and earnings were mostly stable, there were occasional hiccups. Another data item shown is the consensus five-year earnings growth forecast estimates from analysts. Finally, when available, the S&P earnings quality rating is shown. S&P reports are available for most of the household names reviewed in this article.

DEBT (Tables 4A and 4B)

Generally, in most cases these companies carry more debt than I would prefer. I would not have thought purveyors of soup and soap would have required such heavy debt loads. I will admit that the firms seem to use debt well, to improve returns, and debt loads don't seem to affect ratings much. I still dropped firms in the initial round of elimination with leverage ratios over 5.0 and / or with stockholder's equity percentage of total capitalization under 20%, as noted in Table 1. While a couple of the 14 survivors are not much better, I have not eliminated any more firms based on debt. The data is presented for consideration by readers for each of the final 14 firms. Also, long-term bond ratings from S&P, Moody's, and Fitch were reviewed. None of the 14 "finalists" had any bonds rated less than investment quality. Debt ratios of leverage, debt to equity, and interest coverage were taken as shown from the primary source website. Long-term debt percentage of total capitalization and stockholder's equity percentage of total capitalization were calculated from the most recent balance sheets available.

RETURNS (Tables 5A and 5B)

Return on equity, return on assets, and return on capital, as taken from the primary source website, are shown.

VALUE (Tables 6A and 6B)

Valuation ratios of price to earnings, price to book value, price to sales, and price to cash flow are shown. Unfortunately, as per the article title, this is the missing ingredient in most cases. While prices are not at extreme levels, only a couple of these stocks are near the levels whereby they could be proclaimed "value stocks". Valuation, of course, depends upon price, and the results shown are based on the prices prevailing early in the week of March 19,2012.

RATINGS (Tables 7A1, 7A2 and 7B1, 7B2 - This table set increased from 2 to 4 because of table size limitations, and I was reluctant to omit any data.)

Partly because of the lack of clear differentiation among these firms, in addition to my favored resources of S&P and Morningstar, I expanded the ratings to include several other opinions available through brokerages where I have accounts. Additional ratings are shown from Schwab (which offers its own ratings, in addition to presenting others), Credit Suisse, Argus, Ford Equity Research, Columbine Capital, Thomas White International, Ativo Research, Zacks, The Street, and GMI. GMI is interesting, in that it only focuses on accounting and governance risks. Also shown is the analysts' composite rating, presented as a numerical average, which came from the primary data source website. The number of analysts included in the rating average is also shown.

Conclusions and recommendations:

There are no clear winners or losers among the 14 firms. Since yield is very important to me, I am biased against the six firms with yields under 3%, but I will concede that there are some well-run companies in that group. The two foreign firms that are based in France and Switzerland, Danone (OTCQX:DANOY) and Nestle (OTCPK:NSRGY), respectively, will have taxes withheld on dividends paid to U.S. holders. The French rate is 25%, while the Swiss rate can be as high as 35%. I had thought that a tax treaty between Switzerland and the U.S. exists, which would lower this to 15% for U.S. citizens, but I could not confirm it. Note that if the stocks are held in an IRA, any tax withheld is not recoverable as a foreign tax credit, so the actual yield received needs to factor this in. On the topic of NSRGY, there is not much data available, other than from the company's website.

I will list the firms in each group, ranked from best to not-as-good (I won't say worst, as these are all pretty good companies), and I will offer a brief comment in an attempt to justify the placement.

Higher-Yielding Group

ConAgra Foods (NYSE:CAG) - Offers all three attributes of yield, value, safety. Buy under $26.

Unilever (NYSE:UL) - High on yield, returns, not at the bottom on the other criteria. Buy under $32.

Procter & Gamble (NYSE:PG) - Best on earnings, debt, but extended in price just now. Buy under $65.

General Mills (NYSE:GIS) - I probably wouldn't have made it to adulthood if not for Cheerios. High on value, ratings. Buy under $38.

Tate & Lyle (OTCQX:TATYY) - Based in the U.K., this stock came out well on valuation, returns, and debt. Buy under $43.

Heinz H J (HNZ) - Highly rated, it has more debt than is ideal, but returns are excellent. Not a great buy, but reasonable below $50.

Kimberly Clark (NYSE:KMB) - Highest yield, debt a little high, price is extended a bit just now. Buy under $70.

Nestle S A (OTCPK:NSRGY) - Data is lacking on this household name. One could try to calculate all of the ratios from the financial statements for comparison. Debt seems very low, which is good. If buying, acquire before April 23, or you will be waiting another year for the next dividend. Consider under $60.

Lower-Yielding Group

As noted, I would probably not buy a stock yielding less than 3%. But if I did, I would hold out for the buy-under prices indicated, to get at least a little better yield.

Hormel Foods (NYSE:HRL) - Outstanding metrics across the board, except for yield. Payout ratio of 31% proves HRL could do more for the dividend investor. Buy under $26.

McCormick (NYSE:MCK) - Similar to HRL in all respects. Buy under $48.

Archer Daniels Midland (NYSE:ADM) - Best on valuation, high on ratings, lower everywhere else, 28% payout shows ADM is not overly generous to shareholders. Buy under $30.

Smucker J M (NYSE:SJM) - Terrific products, I am addicted to apricot "Simply Fruit" jelly on toast. Not a great value now, but highly rated, low debt, a well-run company. Buy under $75.

Flowers Foods (NYSE:FLO) - If the price would drop a little, yield could break 3%. Other than that, FLO ranks poorly on most other criteria. I wouldn't pay more than $19, to get the yield up over 3%.

Danone (OTCQX:DANOY) - Offering a low yield to begin with, plus foreign tax withholding to consider, DANOY is none too attractive. Still, it could be considered upon a price drop to less than $12.

In summary, I can't get too excited about any of these stocks, especially those in the lower yielding group, but I would suggest that an income portfolio should hold three to five of these names for diversification, stability, and income. If a significant market decline should occur, some of these stocks could become much more enticing, as they present improved valuations.

Disclosure: I am long CAG, UL, PG.