Why I Recommend These 2 Quality Dividend Plays

 |  Includes: COH, WBA
by: Stock Gamer

Shares of Coach, Inc. (NYSE:COH) and Walgreen Co. (WAG) have dropped 7.07% and 3.94%, respectively, over the past 30 days, and I have taken this opportunity to continue adding positions during the period. These two stocks are now my core dividend holdings, and my thesis is simple - focus on attractive valuations and sustainable dividends.

Coach, Inc.

Coach trades at very compelling valuations relative to its global peers. I use four different forward valuation multiples - EV/sales, EV/EBITDA, P/S, and P/E to value the stock with each method assigned a 25% weight (see table below). The model shows that at the current stock price of $56.41, Coach trades at only 1.5% premium over the four peer-average multiples.

However, there appears to be a disconnection between the small premium and Coach's robust fundamentals. Coach significantly outperforms the group in all of the growth, profitability, and liquidity metrics I have listed. The company also has a well-established brand equity and solid emerging market (especially China) reach. As such, the stock should reasonably trade at a sizable premium.

Click to enlargeClick to enlarge

The continuously improved FCF has helped Coach initiate dividend payments in 2010 (see chart below). At the current 2.1% yield, the annual dividend paid only represent a fraction of the robust FCF, implying the company has a sufficient capacity to raise dividends down the road.

Click to enlarge

Walgreen Co.

Walgreen also provides a solid margin of safety given its cheap valuations. For Walgreen's value analysis, I added LTM EV/FCF to the four multiples I used for Coach to gauge the fairness of stock price and each method is assigned a 20% weight (see table below).

Based on the model, the current stock price of $30.69 implies a substantial 28% valuation discount to the five peer-average multiples, and considering Walgreen's solid fundamentals, the large valuation gap seems overblown. Comparing with peers' growth, profitability, and liquidity measures, Walgreen only underperforms in terms of growth potential, and the company's better profitability and somewhat comparable liquidity position should deserve an in-line valuation level.

Click to enlarge

Walgreen has a dividend yield of 3.6%. Walgreen's FCF has been improved significantly since 2009 (see chart below), and thus the increased dividend payments only represent a small portion of the total FCF - very similar to Coach's situation, suggesting the current dividend level is sustainable and very likely to be raised in the future.

Click to enlarge

In the light of sound business operations, cheap valuations, and sustainable dividends, I can't afford losing the buying opportunity now, and I strongly recommend the same for investors.

All tables and charts are created by author and all financial data is sourced from Morningstar and Capital IQ.

Disclosure: I am long COH, WAG.