4 Dividend Growth Stocks That Are The Pillars Of My Portfolio

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 |  Includes: KMI, KMP, MCD, XOM
by: Larry Smith

In my previous article, I mentioned that I currently own four stocks that I call "pillar stocks," stocks that can be the foundation for a successful portfolio. I believe these four companies can be owned forever, or until their fundamental story changes. I also believe all four stocks will continue to grow their business and earnings, as well as steadily raise their dividends.

I also mentioned in the article that I look for four things before investing in a company. These four things are: a sustainable product, meaning no fad investments (I want a company to have a product that will still be here in 20 years); a wide moat (the company must dominate its business in such a way that competition is minimal and the barriers to entry into the business are huge); a rising dividend of at least 2%; and the price must be reasonable. I believe the following four companies meet all of above criteria and will reward investors with steady gains for years to come.

Exxon Mobil (NYSE:XOM)

Description: Exxon Mobil is a direct descendent of John D. Rockefeller's Standard Oil and is the world's largest publicly traded integrated oil and gas company. Exxon has operations around the world including oil and gas exploration, chemical plants, pipelines, refining, and product distribution.

Sustainable Product: Oil and gas have been with us for over 100 years and I believe will be around for another 100 years. The International Energy Agency forecasts rising demand for oil and natural gas through 2030. As the world's population grows and other areas of the world become more developed, the demand for energy will continue to rise. Renewables simply cannot scale up to meet the demands that will be placed on the world's energy providers. Exxon's oil, natural gas and petrochemical products will be needed at an increasing rate for decades to come.

Wide Moat: Exxon Mobil is the largest non-government owned producer of oil and gas in the world. Exxon has 24.9 billion oil equivalent barrels of resource and has replaced all of its production for 18 straight years. Just to maintain this production Exxon will invest $37 billion dollars in the various components of its business in 2012. Although I do not believe in peak oil, I do believe in peak "cheap" oil. Exploring for oil is a very expensive business; only a handful of international oil companies have the financial resources to explore for oil in the difficult environments oil and gas is now found. A start-up company is not going to compete with Exxon. In the world today, it takes advanced technology, financial strength and a skilled work force to find and develop oil and gas, Exxon has all three.

Dividend: Exxon Mobil is a Dividend Champion, having raised its dividend for 29 straight years. I fully expect Exxon to make it 30 years next month, when Exxon announces its second quarter dividend. It yields 2.3% paying $1.88 a share. The payout ratio for Exxon is a miniscule 22%, leaving plenty of room for increases far into the future. If ever a dividend could be considered safe, it is Exxon. Exxon has been raising its dividend at an annual rate of approximately 6%, but I look for a larger increase this year. I make this prediction based off comments CEO Rex Tillerson made at the recent analyst conference held in New York. When asked about the dividend during the Q&A portion of the event, Tillerson said management is aware the dividend is a little low compared to competitors. Exxon had been concentrating on buying back the shares issued to purchase XTO, Exxon expected to complete buying back the shares issued in the just-completed first quarter, and would then look at the dividend. I believe they will increase the dividend by at least 9%.

What I Think: Exxon is a cash flow generating machine. Since 2007, it has generated $146 billion in free cash flow, which is more than Royal Dutch Shell, BP, and Chevron combined. This cash flow allows Exxon to pay the dividend, buyback stock, and fund investment opportunities. I know some investors do not like stock buybacks, but I do. To me, stock buybacks allow me, the shareholder, to own more of the company. In 2011, Exxon returned $29 billion dollars to shareholders through $9 billion in dividends and $20 billion in buybacks. I believe Exxon will continue to generate cash long into the future and will funnel much of its cash back to investors. The world will need energy, especially fossil fuel energy, for decades to come and Exxon will be the leader in that field for decades to come. I intend to go along for the ride, enjoying the increasing dividends and the declining share count.

All of the above Information, as well as additional detail on Exxon, can be found here.

Coca-Cola (NYSE:KO)

Description: Coca-Cola, as everyone knows, is the world's largest beverage company, but I think it is more. I believe Coca-Cola is one of the great companies of all time. Coca-Cola was invented by Doc Pemberton and originally sold at drug store soda fountains. From that beginning in 1886, it has grown to a company that operates in over 200 countries and provides 1.7 billion beverage servings a day.

Sustainable Product: Coca-Cola sells beverages, including sodas, juices, teas, sports drinks, energy drinks and water. Beverage products have been consumed by the world's population for decades and will continue to be consumed for decades. In 2009, the company unveiled its 2020 Vision; this long-range plan calls for doubling sales to over 3 billion by 2020 (here). Imagine that, a company as big as Coca-Cola doubling sales in 10 years, I would certainly call that a sustainable product.

Wide Moat: No matter where in the world you go to purchase a beverage, you probably are going to see multiple Coke products. Coca-Cola's beverage distribution system is unequaled and continues to expand. Coca-Cola sells over 500 different beverage products and has four of the world's top five selling sodas. Coke has 14 brands that have sales of over one billion dollars. Coke is the number one beverage company in almost every country they operate. Coca-Cola CEO Muhtar Kent has been pushing the company to expand rapidly in China, Russia and the African continent. Coca-Cola's main competitor Pepsi is far behind Coke in worldwide sales and no other company is even on the radar. In the beverage business, Coke is king.

Dividend: Coca-Cola is another Dividend Champion, having increased its dividend for 50 straight years, just recently increasing its annual dividend by 8% to $2.04 for a yield of $2.75. Coca-Cola's dividend payout is approximately 50%, leaving room for more dividend increases into the future. Coke generated over $10 billion dollars in cash from operation in 2011, from this ever-growing cash, Coke funds the dividend. The cash has grown steadily and will continue to grow as Coke sells more and more products to more and more people.

What I Think: As I said earlier, I think Coca-Cola is one of the all-time great companies and I see it maintaining its preeminent position as the world's largest and most recognized beverage brand. When I think of Coca-Cola in the future, two thoughts jump out at me. One, Coke sells 1.7 billion servings a day; imagine if it increased the cost of those servings by one penny. If you do the math, you would see that the one-penny increase would generate $17 million additional dollars a day, or over $6 billion dollars a year -- that is pricing power I love. Two, the per capita consumption of Coke products in Mexico is 728, in the United States 403, in Russia 73, in China 38 and India 12. As the emerging markets of the world continue to develop and incomes grow, Coke products will become more readily available to their populations. Many investors see Coca-Cola as a mature company without any growth left, I disagree completely. Coke has many years of mid to high single digit growth left along with an ever-increasing cash flow. As a dividend growth stock, Coca-Cola is at the top.

All of the above Information, as well as additional detail on Coca-Cola, can be found here.

McDonald's (NYSE:MCD)

Description: In 1955, Ray Kroc founded McDonald's with a vision of having McDonald's restaurants all over the United States. Ray Kroc demanded four things, quality, service, cleanliness and value. That vision of a vast restaurant chain and a strict adherence to quality, service, cleanliness and value has lead to a worldwide dominant restaurant chain.

Sustainable Product: Every day, McDonald's serves fast food to 68 million people in over 119 countries and in over 33,000 locations. The basic menu of burgers, fries, and beverages are available in all restaurants, but many local menu items are also available in various countries. As the world has become more urbanized and people's time for food preparation has shortened, fast service food has become more popular. Last year sales in every area of the world grew, with overall sales up 5.6%, which was the ninth consecutive year of growing sales. As the world's population grows and as incomes grow, McDonald's will have more customers to serve.

Wide Moat: Although there are many restaurant chains, there are not any with the global reach of McDonald's. McDonald's has tremendous advantages in scale. Last year, McDonald's had roughly $67 billion of system wide sales, which is about 3 times the combined sales of rivals Burger King and Wendy's (NASDAQ:WEN). This provides McDonald's with a lot of power over its suppliers, many of whom rely on McDonald's for their existence. McDonald's size also provides incredible advertising muscle, with McDonald's far outspending both Burger King and Wendy's. In addition, McDonald's has secured some prime and valuable real estate. Locking up this prime real estate is an advantage that is difficult for any new restaurant to overcome.

Dividend: McDonald's is also a Dividend Champion having increased its dividend for 35 straight years. McDonald's pays a yearly dividend of $2.80, which is a yield of 2.9%. The payout ratio is approximately 48% leaving plenty of room for future dividend increase. McDonald's last dividend increase, in October 2011 was 15%, in the two years prior to that, McDonald's raised its dividend 11% and 10%. McDonald's consistent double-digit dividend increases in recent years should continue as sales in 2012 and cash flow have continued to grow. With a relatively low payout ratio and with sales and cash flow growing, I expect McDonald's will continue to grow the dividend at about a 10% annual rate.

What I Think: McDonald's was the top performing Dow stock last year with a total return of 34.7%. After a year like that, I fully expect McDonald's to consolidate at this level for a while before moving higher again. I expect the stock to move higher because McDonald's sales are rising every month, margins are expanding and restaurants continue to be built around the world. In China alone, McDonald's opens a restaurant every other day and in a few years will open a new restaurant everyday (here). With a P/E of 18 and annual sales growth of five to seven percent, McDonald's pause at the $100.00 price will only be temporary.

All of the above information, as well as additional detail on McDonald's, can be found here.

Kinder Morgan (NYSE:KMI)

Description: Kinder Morgan is the general partner and owns the incentive rights to Kinder Morgan Energy Partners (NYSE:KMP), one of the largest energy service companies in the United States. In October 2011, KMI announced they were purchasing El Paso Corporation, that deal is expected to close in May 2012. Kinder Morgan has few capital expenditures; it owns 11% of Kinder Morgan energy partners and collects a distribution just like any other owner. As the KMP distribution increases, so does the cash paid to KMI.

Sustainable Product: Energy services is a rapidly growing business due to the recent boom in oil and natural gas drilling. BP (NYSE:BP) in their most recent energy outlook (here) stated they see the United States being energy independent by 2025, thanks to fracking and the production of previously unattainable oil and gas reserves. Pipelines, as well as storage capability, will be needed to move and store all the production that is coming on-line.

Moat: Kinder Morgan has unrivaled assets, when the El Paso merger is completed, Kinder will be the largest natural gas pipeline operator in the country with approximately 67,000 miles of pipe. In addition, Kinder will be the largest CO2 pipeline operator in the country, it will be the largest terminal operator in the country and just for good measure will be the second largest oil producer in Texas. Its natural gas pipeline network will stretch from one end of the country to the other. Any other company trying to duplicate what Kinder Morgan has assembled would face huge cost and regulatory hurdles; I just do not think it can be done.

Dividend Growth: Kinder Morgan has communicated they intend to raise its dividend 12.5% a year through 2015 and 10% long term. Assuming they are true to their word their future dividend payout would look like such.

Year

Increase

Dividend

2012

$1.35

2013

12.5%

$1.52

2014

12.5%

$1.71

2015

12.5%

$1.92

2016

10%

$2.11

2017

10%

$2.32

2018

10%

$2.55

2019

10%

$2.80

Click to enlarge

As you can see, by 2019 -- in just seven years -- the dividend will have doubled. Now I know this assumes a perfect world and one cannot predict the future, but I am comfortable with the idea that the country's pipeline needs will continue to grow, that natural gas use will continue to grow and that Kinder Morgan will be a leader in the field.

What I Think: Richard Kinder has his money, a lot of money, in Kinder Morgan. So Richard Kinder is going to do whatever he can to boost the dividend and the stock price. As the dividend increases, it is fair to assume the stock price itself will increase. Kinder Morgan currently yields 3.20%, and if management does double the dividend in seven years, the yield with no stock price appreciation would be 6.40%. However, I believe as the dividend increases, the share price will rise as well, providing a nice total return for investors.

All of the above Information, as well as additional detail on Kinder Morgan, can be found here

Summary: All four of the companies I have outlined have a long- term vision for the future. They plan for 10 to 20 years out, not for the next six months. All four are the leading companies in their field with assets that cannot be easily matched. All four have growing earnings and growing dividends. All four are stocks I am comfortable owning for a long time.

Disclosure: I am long XOM, KO, MCD, KMI.