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In this article we will analyze the ability of "Dogs of the Dow" to continue paying dividends. We have analyzed their business models, free cash flow yields, dividend history and the balance sheet strength in order to determine the sustainability of future dividend payments.

Johnson & Johnson (JNJ)

Johnson & Johnson engages in the research, development, manufacture, and sale of various products in healthcare worldwide. Johnson & Johnson sells its products to the general public, retailers, distributors, wholesalers, healthcare professionals and hospitals.

JNJ's dividend yield is attractive at 3.70%, which is higher than most of its peers. It has also been consistently increasing its dividends for the last few decades, as is visible from the following graph, which shows the year-over-year increase in dividends per share. Over a period of the last five fiscal years, dividends have grown at the rate of almost 6%, and in April 2012, the company announced a four cents per share increase in dividend payments to $0.61.

The company's gross margins have remained high and flat at around 70%, with a modest two-year CAGR in revenue of almost 3%. The company has consistently beaten earnings estimates, providing positive earnings surprises YoY with an average EPS beat rate of almost 3%. Its ROE has remained in the range of 16% to 29%, currently declining and at the lower end of the range. JNJ has a current payout ratio of 62%, paying annualized dividends of almost $6 billion in FY2011, which was well supported by its operating cash flows of $15 billion and free cash flows of $8.5 billion. The company's trailing free cash flow yield is 5%, which covers the 3.70% dividend yield well. JNJ's P/E, at a discount to its 5-year average as well as the industry average, indicates that the stock is currently cheap. Other price multiples for the company are also at a discount to the industry averages. JNJ's balance sheet is reflective of its financial strength, with reasonable debt levels (debt-to-equity of 32%). The company meets its liquidity and capital requirements mainly through its operating cash flows.

In summary, the stock offers attractive returns of 3.70% in the form of dividends, which are well supported by its operating cash flows and earnings. The company has generated healthy cash flows over the past five years, and with no indication of cash flow disruption, we are confident that JNJ will be able to maintain and even raise its dividends going forward.

Pfizer Inc. (PFE)

Pfizer Inc., a biopharmaceutical company, engages in the discovery, development, manufacture, and sale of medicines for humans and animals worldwide. It primarily offers Celebrex, Chantix/Champix, Lipitor, Lyrica, Premarin, Pristiq, and Viagra pharmaceutical products in the therapeutic and disease areas of Alzheimer's disease and cardiovascular.

PFE has a dividend yield of 3.90% and its dividends per share have grown by an impressive 10% in FY2012, compared with the previous year. The company cut its dividends back in FY2009, but has since increased its payout to a quarterly $0.22 per share.

The company posted gross margins of 78%, 76% and 80% in FY 2012, 2011, and 2010 respectively, and also posted an impressive two-year CAGR in revenue of almost 20%. However, the company's revenue might decline going forward, as its drug, Lipitor, which accounted for a major chunk of its revenue, has lost its patents. PFE's earnings have grown at the rate of 8% over a period of two years, and it has consistently beaten the consensus analysts' estimates, giving a positive earnings surprise of almost 11% in the quarter ended September, 2011. PFE's ROE has stayed in the range of 7% and 25%, whereas it was 10% in FY2011. The company currently has a payout ratio of 66%, and in 2011 it paid an annual dividend of $6 billion, which was well backed by its operating cash flows of $18 billion and levered free cash flows of almost $20 billion. The company has a trailing free cash flow yield of 12%, which is sufficient to cover the company's dividend yield of 3.90%. PFE's P/E is at a discount to its industry average, indicating that the company's stock is currently undervalued.

In summary, the stock offers attractive returns of 3.9% in dividends, and has shown an upward trend in its earnings and revenue. We believe that it has enough financial muscle to afford its dividend payouts in the future, based on its strong cash flow generation ability and operations. We are of the opinion that PFE is well poised to sustain and even raise its payout going forward.

Kraft Foods Inc. (KFT)

Kraft Foods Inc. manufactures and markets packaged food products worldwide. The company offers biscuits, including cookies, crackers, and salted snacks; confectionery products, such as chocolates, gums, and candies; beverages comprising coffee and packaged juice drinks.

KFT is a high dividend stock, currently yielding 3.10%. KFT's gross margins are impressive at 35% and have more or less remained at these levels over the last five years. Since the spin-off from the Altria Group, the company has not been able to increase its earnings since FY2008. Moreover the acquisition of Cadbury in 2010 has also had an adverse impact on its bottom line due to the costs involved. The company currently has a dividend payout ratio of 58%, which is normal for its industry. It is currently paying a quarterly dividend per share of $0.29 for the current fiscal year, with no growth seen since 2008, evident in the graph below.

In 2011, KFT paid a cash dividend of $2 billion, which was well backed by its operating cash flows of almost $5 billion, showing a growth of 20% in FY2011 from the previous year. The company's operating cash flows have recently been on an upward trend. Furthermore, the company has free cash flows of $2.6 billion (yield of 4%), which are sufficient to cover its 58% payout ratio. The company also has a dividend yield of 3.10%.

Currently, KFT is trading at 19 times its earnings, yields 3.10%, and appears to have a sustainable dividend payout based on its cash flows. Therefore, we believe it to be a good dividend stock.

We are also bullish on six other Dogs namely: Procter & Gamble (PG), Merck & Co. (MRK), Intel (INTC), Du Pont (DD), General Electric (GE). Read our analysis on these stocks here. We are recommending investors avoid two Dogs, Verizon Communications. (VZ) and AT&T (T), because of their high payout ratios.

Source: 3 Dogs Of The Dow To Buy