Capital Preserve's  Instablog

AstraZeneca (AZN) like many foreign stocks gets little attention from investors who focus on, and write about dividend stocks.  This aversion seems to stem from a couple of primary sources.  First, foreign dividend payers do not typically pay dividends on a quarterly basis and the dividend is often linked directly to profit levels so that consistent growth is less likely due to short-term earnings fluctuations.  Another factor seems to be that many reporting services and stock screening tools simply do not handle foreign dividends correctly.  Many such information sources will take the last dividend paid and multiply it by four to come up with an annual dividend figure that is inaccurate when evaluating stocks that pay dividends on an annual or semi-annual basis. Add to this the associated exchange rate risk inherent in investing in foreign securities and you have a level of income uncertainty that often causes dividend investors to shun foreign stocks.

Perhaps because I lived and worked in Europe for a number of years and have more than a passing familiarity with foreign companies, I am comfortable with investing in these securities and do not automatically exclude them from my research.  For the past several months, I have been looking at AstraZeneca as a possible investment.  With the release of their Interim Financial Statements today I have performed my initial analysis of this company, and have the following observations.

At the end of Q2-2009 AZN had:

• $7.2 billion in cash (equivalent to more than 9 quarters of dividend payments at its current rate annual rate.  Cash increased during the first six months of 2009 by more than $2.9 billion from the end of 2008.

• A current ratio (Current Assets/Current Liabilities) of 1.26, which is somewhat lower that its' ten-year average of 1.50.

• A Debt to Total Capital ratio of 36%, which is down from 40% at the end of 2008.

• A Sustainable Growth Rate (SGR), which is the theoretical maximum rate of growth the company can achieve long-term without accessing additional capital, of 20%.

AZNs’ dividend payout ratios are comfortable.  The Trailing Twelve Month Payout ratios were 45% of earnings, 32% of operating cash flow, and 28% of Free Cash Flow, all of which were equivalent with 2008 rates, slightly better than 2007 and broadly in-line with the company’s ten-year averages. 

While Morningstar calculates a Fair Value for AZN of $49.00, my analysis indicates a FV closer to $80.00.  Even after applying an adjustment for the confidence level I have in my valuation metrics, I still come up with a FV for AZN in excess of $60.00

Revenues for the most recent six months were essentially flat with the same period last year, which seems to be consistent with what most other drug companies are reporting.  Over the past ten years, AZN has been able to increase revenues at a rate of 5.5% annually.

Over the past ten years AZN has increased its’ earnings at an 20% compound annual growth rate, and has increased operating cash flow and free cash flow at 17% and 10% respectively.  The growth in all three of the metrics has been somewhat inconsistent. Over the past ten years, dividends have increased at a 10% CAGR and have increased every year since 2002.

AZN, like many drug companies faces headwinds related to slow growth, patent expirations, generic competition, pipeline strength and other issues inherent in the field.  In spite of these concerns, AZN with an indicated yield in the neighborhood of 4.5% is worthy of deeper investigation.

Disclosure: No current position in AZN

Dividend Growth Investing is by nature a long-term, value based, investment strategy.  Once a target list of safe, cheap companies has been determined one must then, determine which to purchase.  When choosing between two potential investments, one must, at some point, confront the issue of current yield versus dividend growth.  The simple rule of thumb that says a stocks long-term return is equivalent to the yield on cost plus the dividend growth rate would seem to tell you that, all else being equal, all you need do is add these measures together to determine the better investment.  Is this in fact the case? 

The answer depends largely on the anticipated holding period for the stock.  When evaluating two similar potential investments, I typically look at five and ten year holding periods and discount the income streams by 3% per year which is my long-term inflation assumption. 

Let us look at a real world example: 

Coke (KO) versus Pepsi (PEP) 

On May 7, 2009, KO was trading in a range around $43.00 per share and has a dividend of $1.64 (Yield of 3.81%).  PEP was trading in a range around $50.00 with a ecently increased dividend of $1.80 (Yield of 3.60%)  KO has a long-term record of increasing its dividend at a CAGR (compound annual growth rate) of 9.7%, while PEP over the same 10-year period has increased its dividend at a 12.4% CAGR.

While the difference in initial yield between KOs’ 3.81% and PEPs’ 3.60% may seem small in relation to the difference between their long-term dividend growth rates, the higher initial yield provided by KO outweighs the growth advantage that PEP offers for five years.  After five years, the advantage goes to PEP.

Admittedly, the differences in the above table are small and other considerations would likely outweigh them, but my purpose here is not to say that KO is a better income stock than PEP.  Rather it is to provide one specific tool to use when evaluating a choice between two competing choices for an investors dollar.

Disclosure: Long KO