5 Controversial Dividend Growth Stocks

Includes: KMB, KMP, RSG, RTN, VZ
by: Valuentum


The benefits of dividend growth investing over the long haul have been widely-documented.

Cash-flow-based dividend analysis such as the Valuentum Dividend Cushion helps investors take into consideration the strength of a firm's balance sheet, which is a key source of funding.

Let's walk through 5 controversial dividend growth stocks. Our best dividend growth ideas are included in the Dividend Growth portfolio.

History has revealed that the best performing stocks during the previous decades have been those that shelled out ever-increasing cash to shareholders in the form of dividends. In a recent study, S&P 500 stocks that initiated dividends or grew them over time registered roughly a 9.6% annualized return since 1972 (through 2010), while stocks that did not pay out dividends or cut them performed poorly over the same time period.

Such analysis is difficult to ignore, and we believe investors may be well-rewarded in future periods by finding the best dividend-growth stocks out there. Let's take a look at the recent performance of five controversial high-dividend payers that may not be as attractive as investors make them out to be. Let's also disclose their most recent Valuentum Dividend Cushion scores.

Valuentum updates each firm's cash-flow derived valuation rating and Dividend Cushion scores at least on a quarterly basis (or after material events). The Valuentum Dividend Cushion is a pure financially-derived cash-flow coverage ratio that considers a dividend payer's future free cash flow, expected future cash dividend payments and balance sheet (net cash/debt information).

Kimberly-Clark (NYSE:KMB) - Dividend Cushion: 1.3 - Dividend Yield: 3%

Kimberly-Clark is best known for its personal care and consumer tissue brands, which include Huggies, Pull-Ups, Little Swimmers, Depend, Kleenex, Scott, and Cottonelle. Its portfolio remains strong. Organic sales advanced 4% during its first quarter thanks to an impressive 12% increase in K-C International, and the company reaffirmed its earnings per share target in the range of $6-$6.20 per share. Kimberly-Clark has raised its dividend in each of the past 40+ years, and its Dividend Cushion score indicates future dividend increases are in store for investors. Shares, however, aren't necessarily cheap, and we think investors could get a better price in the next few years. The company is not a portfolio holding at this juncture.

Kinder Morgan (NYSE:KMP)* - Dividend Cushion: 1.5 - Dividend Yield: 7.2%

Kinder Morgan Energy Partners has been a controversial idea. The view that MLPs are inherently risky enterprises is not based on their business operations, but instead is grounded on the riskiness of their business structure, which is always reliant on new capital to fund growth capex. Bulls will say that this is just how MLPs operate (and they're special entities to be evaluated differently), and some will even refuse to accept this view. But the reality is that the inherent riskiness and capital-market dependence of an MLP is a fact: the entity is dependent on new, incremental money for growth spending. This has always been the case, and the SEC and accounting boards have signed off on it.

In this light, we don't like the MLP structure any more than the next person, but we accept the abnormal risks related to it in the form of a significantly larger distribution payout than otherwise could be had under a general operating structure (as in a corporation). Kinder Morgan Energy Partners had a strong first quarter and raised its cash distribution 6%, to $5.52 per unit annualized, and it has largely shrugged off the market's concerns, punctuated by a Barron's article, about how it accounts for maintenance capital spending. The midstream pipeline giant expects to pay at least $5.58 per unit in 2014, so unitholders should expect another increase in the distribution this year. Still, the unique fundamental risks of an MLP's business model cannot be ignored, and while we include it in the Dividend Growth portfolio, we don't think we've heard the last about accounting (contractual) topics impacting master limited partnerships.

* Note: The Dividend Cushion score for master limited partnerships considers future equity issuance, which supports growth maintenance capital expenditures, in the numerator of the function. Investors should take this to mean that a MLP's Dividend Cushion score is highly dependent on the healthy functioning of the capital markets.

Raytheon (NYSE:RTN) - Dividend Cushion: 2.8 - Dividend Yield: 2.5%

Raytheon caught investors by surprise with its disappointing first-quarter results following a bullish piece in Barron's shortly before the release. The defense contractor's adjusted earnings per share fell to $1.43 in the period from $1.56 per share in the first quarter of last year, as net sales dropped to $5.5 billion from $5.9 billion. Operating cash flow improved in the period, but the company credited this more to the timing of collections than any fundamental improvement. Sales dropped in all four of its business segments, and operating income in all but one. Boeing (NYSE:BA) is our favorite defense contractor, but this is more due to its exposure to the burgeoning aerospace industry than anything else. We won't be adding shares of Raytheon to the Dividend Growth portfolio, and we still expect ongoing backlog contraction across most of the defense arena.

Republic Services (NYSE:RSG) - Dividend Cushion: 0.9 - Dividend Yield: 3%

Solid waste operators generate strong and predictable cash flow. Within the collection line of a waste hauler's business, residential services provided to municipalities and individual households are on a service-based model (not-volume based) and can largely be viewed as insulated from economic pressures. Such a constant revenue stream helps to mitigate cyclical pressures in a trash taker's commercial collection and industrial roll-off lines, which also fall into the overall waste-collection category. Cell-by-cell landfill build-out provides additional flexibility with respect to capital outlays, as haulers can scale back expenditures during troubled economic times. It's probably no surprise why trash takers boast lofty payouts. Republic Services' first-quarter results were decent, but its Dividend Cushion has waned in recent years. It has been one of the few firms we have removed from the Dividend Growth portfolio, and while we like its stable collection operations and landfill position, we don't intend to add it back to the Dividend Growth portfolio anytime soon. It is a holding in the Best Ideas portfolio, however.

Verizon (NYSE:VZ) - Dividend Cushion: Under Review (expected to be below 1) - Dividend Yield: 4.3%

Verizon has complicated matters way too much as of late. Even though the firm is one of the market's great cash generators, we have material concerns about the size of Verizon's debt load following its decision to bring Verizon Wireless into the fold. Though unlikely, we've heard speculation that a deal for Dish Network (NASDAQ:DISH) has been considered as well. Simply put, investors cannot ignore the balance sheet, which is critical in assessing financial risk and the concept of value creation. We do not think Verizon's elevated debt load bodes well for dividend growth investors in the near term, nor do we think it is a prudent move to add on so much debt so late in the economic cycle. The company's first quarter results showed lower postpaid adds and a higher churn rate relative to expectations, and we're just not excited about its soon-to-be-mountain of debt on the balance sheet in an ultra-competitive environment. We're not considering the firm for addition to the Dividend Growth portfolio and expect the company's updated Valuentum Dividend Cushion score to fall below 1.

Wrapping It Up

The Valuentum Dividend Cushion continues to be the primary metric we use in deciding which companies to add to the Dividend Growth portfolio, and we've yet to have a dividend cut in the portfolio to date. Only the best of the best dividend growth giants are included in the portfolio, and with the exception of Kinder Morgan, the ones in this article didn't pass the test. Though we fully expect there to be varying opinions on these companies, we trust you found this piece helpful. Thank you for reading!

Disclosure: KMP is included in the Dividend Growth portfolio. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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