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Back to Part VII

By Mark Bern, CPA CFA

I had intended to do an article on the auto parts industry because I like the prospects for the next several years. However, after a closer review of Johnson Controls (NYSE:JCI) I have found that the free cash flow has flipped from positive to negative by enough for me to put the company on probation and remove it from my master list. I also like Eaton Corporation (NYSE:ETN) for its prospects going forward because the average age of vehicles on the road in the U.S. today is over 10 years, and thus we are building significant pent-up demand for future new vehicle sales as the economy improves. But because I value consistency, the auto parts industry does not leave me with a viable candidate at this time. Thus I have decided to move on to an industry that is less cyclical in nature. If you are just finding this series of articles for the first time, you may find the original article that I used to begin the series helpful to understand the process I use in selecting companies for my master list.

My top rating in this industry goes to the heavyweight, Procter & Gamble (NYSE:PG). There are still hundreds of millions of people on earth who don't brush their teeth daily, shampoo their hair more than once a week, or have washing machines. As per capita incomes rise in emerging markets for millions of people every year, many will begin to brush their teeth and wash their hair more regularly. Some will be able to afford a washing machine (a great story behind the improvements to society brought about by the washing machine) and use more detergent made specifically for the new machines. PG will get their share of this growing market. Europe will create some problems in the short term for most companies in this industry, but the longer term will look brighter, in my opinion. Let's take a look at how PG grades out.

Metric

PG

Industry Average

Grade

Dividend Yield

3.6%

2.9%

Pass

Debt-to-Capital Ratio

23.0%

33.0%

Pass

Payout Ratio

49.0%

47.0%

Neutral

5-Yr Average Annual Dividend Increase

11.4%

N/A

Pass

Free Cash Flow

-$0.08

N/A

Neutral

Net Profit Margin

14.3%

11.7%

Pass

5-Yr Average Annual Growth in EPS

8.3%

.03%

Pass

Return on Total Capital

13.5%

15.1%

Fail

5-Yr Average Annual Growth in Revenue

6.8%

-.08%

Pass

S&P Credit Rating

AA-

N/A

Pass

The only fail is a close call in the return-on-total-capital ratio. PG didn't miss by that much, but just wasn't close enough to garner a neutral. Otherwise, there were two neutral ratings and seven passes. The report card isn't perfect, but there are few perfect scores in any industry.

Colgate-Palmolive (NYSE:CL) ran a close second, but as you will see there is a potential problem with the current debt levels. I do like several aspects about this stock, however, not the least of which is how well the price has held up the past few weeks while the rest of the market tumbled. If you would like to know more about why I like CL please consider an earlier article about the company, which provides more detailed information.

Metric

CL

Industry Average

Grade

Dividend Yield

2.5%

2.9%

Neutral

Debt-to-Capital Ratio

65.0%

33.0%

Fail

Payout Ratio

49.0%

47.0%

Neutral

5-Yr Average Annual Dividend Increase

12.7%

N/A

Pass

Free Cash Flow

$1.17

N/A

Pass

Net Profit Margin

14.5%

11.7%

Pass

5-Yr Average Annual Growth in EPS

11.2%

.03%

Pass

Return on Total Capital

36.1%

15.1%

Pass

5-Yr Average Annual Growth in Revenue

7.9%

-.08%

Pass

S&P Credit Rating

AA-

N/A

Pass

One fail, two neutral grades and seven passes -- that would be a stellar report card if it weren't for the big miss in the debt-to-capital ratio category. I believe the company will be able to manage it debt level, but this is something to watch. If management pays the debt down systematically, we keep the company on the list. If management increases debt for additional acquisitions, we may have to reconsider its merits.

Church and Dwight (NYSE:CHD) is a smaller version of the two previous companies that offers consumer and personal products as well as specialty products used in the industrial, husbandry and pharmaceutical industries. The company's most prominent brand is Arm & Hammer. This is a company that didn't appear to skip a beat during the great recession, growing sales, earnings and dividends in each of that last five years. And the stock hardly dipped during what may have been the worst economy since the Great Depression. So, here is CHD's report card.

Metric

CHD

Industry Average

Grade

Dividend Yield

1.8%

2.9%

Fail

Debt-to-Capital Ratio

11.0%

33.0%

Pass

Payout Ratio

30.0%

47.0%

Pass

5-Yr Average Annual Dividend Increase

39.2%

N/A

Pass

Free Cash Flow

$0.71

N/A

Pass

Net Profit Margin

11.8%

11.7%

Pass

5-Yr Average Annual Growth in EPS

16.4%

.03%

Pass

Return on Total Capital

14.3%

15.1%

Neutral

5-Yr Average Annual Growth in Revenue

5.4%

-.08%

Pass

S&P Credit Rating

BBB

N/A

Pass

CHD would have graded better overall than any other company in the industry if its dividend yield were not sub par, the only category fail. But, make sure you note the growth in the dividends over the last five years! I don't know if management will continue that pace, but the low payout ratio provides room for future dividend growth if the company is so inclined. Eight passes is the best in this group, but I do prefer a better dividend yield.

The next company, Tupperware (NYSE:TUP), didn't quite make the list, but I included a report card on the company to give readers a sense of how close it did come. TUP holds a certain appeal because of the potential it has for expanding in and into new markets where income is low and there are many people willing to work hard and who want to start a small business of their own. TUP can fill that niche demand for several million people in Latin America and the Asia-Pacific region. If management can execute well, the potential is huge. This is one to keep your eye on for the future.

Metric

TUP

Industry Average

Grade

Dividend Yield

2.7%

2.9%

Neutral

Debt-to-Capital Ratio

45.0%

33.0%

Fail

Payout Ratio

34.0%

47.0%

Pass

5-Yr Average Annual Dividend Increase

6.4%

N/A

Neutral

Free Cash Flow

$0.87

N/A

Pass

Net Profit Margin

8.4%

11.7%

Fail

5-Yr Average Annual Growth in EPS

18.2%

.03%

Pass

Return on Total Capital

26.3%

15.1%

Pass

5-Yr Average Annual Growth in Revenue

9.7%

-.08%

Pass

S&P Credit Rating

BBB-

N/A

Pass

TUP only had two relatively small misses (fails), but the debt level is one of the more critical metrics. Management has been paying down debt over the years, since about 2006, and if it can continue apace the company could be ready for prime time within the next couple of years. All I would require is for the ratio to drop by about 5% to warrant a neutral rating and lift my concern. It is important to note that I do not consider investing to be a sprint, but rather a distance race of endurance, patience and strategy. It is best to hold back until the right moment while saving our energy for the best opportunities.

Now let's take a look at some other companies that did not make the grade and why. Clorox (NYSE:CLX) has achieved excellent growth and stock price stability, but the company has a worrisome debt level of 106 percent of total capital and a negative cash flow. These are two of the metrics to which I pay a lot of attention. The company appears to have plans to pay down debt over the next five years. If it does enough in this area it will improve scores in both areas and be a contender worth considering.

Energizer (NYSE:ENR) and Martha Stewart (NYSE:MSO) pay no dividends, which is a requirement for consideration. A number of companies have had significant volatility in earnings, including Blythe (NYSE:BTH), Kimberley Clark (NYSE:KMB), Newell Rubbermaid (NYSE:NWL) and Scott's Miracle-Gro (NYSE:SMG). I like predictable earnings that grow consistently. Companies that post losses in earnings do not make the grade. NWL made one of the cardinal mistakes by cutting its dividend. It may have been the right thing to do for the company's survival, but it also eliminates companies from my consideration. Cash flow problems also helped eliminate KMB from consideration.

So that concludes my assessment and master list entrants from the household products industry. Thanks for reading and, as always, I enjoy your comments, so keep them coming.

Source: The Dividend Investors' Guide - Part VIII: How Much Growth Is Left For Household Products?