Strong First Quarter
Mondelez International (NASDAQ:MDLZ) surprised investors with its very robust first-quarter earnings. The Deerfield-based snacks and chocolates colossus reported a profit of 48 cents per share, handily beating analysts' consensus estimate of 39 cents per share net income.
The blitz in Mondelez's first-quarter performance occurred even as the company reported a 17% slide in its net revenues compared to the same period a year earlier. Instead, a wider gross margin of close to 40% and a 16% reduction in its operating expenses were responsible for Mondelez's solid performance, and provided further evidence that its $3.5 billion restructuring plan has gained traction.
Dividend Impact and Outlook
Following the release of its first-quarter results, Mondelez announced a quarterly dividend of 17 cents per share. This is the same dividend that the company has been paying investors since the third quarter of 2015, and represents a 1.5% dividend yield in relation to its current stock price. Thus, an investor who purchases $10,000 worth of Mondelez shares can expect to earn around $150 in passive income each year by holding the stock.
Despite its bumper first quarter, Mondelez shares have traded flat in 2016. Consequently, investors are getting nearly the same dividend yield in June that they could have gotten in December 2015. In fact, the company's dividend yield has stayed in a fairly narrow range over the past twelve months.
Given this, investors are probably wondering whether it makes sense to get into the stock. After all, the company's prospects look good, and its dividend yield is already the lowest in the peer group - better to get in now before it gets worse.
In our view, it probably doesn't make sense. Here's why.
First of all, while Mondelez certainly has the ability to continue paying dividends, it doesn't have much leeway to boost dividends by much. To wit, its working capital ratio is at 0.68-to-1.00 - that's less than half the average for its industry, and suggests that Mondelez has to carefully plan its cash disbursements.
While it's certainly hard to believe that the owner of seven "billion-dollar brands" is tight on liquidity, the truth of the matter is that Mondelez's working capital ratio has been trickling down continuously since 2012, when it was spun off from Kraft Foods. Even back then, its working capital ratio was a meager 1.05-to-1.00.
Second, Mondelez has a substantial debt burden with nearly $17.4 billion in both long- and short-term debt. Based on its latest quarterly report, the company's weighted average interest rate on its total debt is 3.1%. This means that, all else being equal, its annual interest expense works out to around $539 million - or roughly half the amount that it paid out in dividends in 2015. This is in addition to the hundreds of millions of dollars - even billions - that it pays each year to cover its debt amortization.
To be fair, the company's leverage ratio of 1.3-to-1.0 is actually below the average for the sector, so it's not as though its debt burden is unusual or unsustainable. Rather, investors can't expect Mondelez to pay the 29 cents per share dividend that it paid regularly prior to its spin-off, because it needs to service its debts first.
Third, the outlook for Mondelez's revenue growth is tepid - analysts expect approximately 10.6% annual growth over the next 5 years. While encouraging, that's less than the 13.4% rate anticipated for its sector, and will probably be subject to further revisions in light of the poor year-on-year revenue growth it disclosed for the first quarter.
Mondelez has shown that it can grow its profits even without growing its top line, but this is an unsustainable tactic. For one thing, its gross margin of nearly 40% is already double that of its industry peers. For another, the company can't keep reducing its operating leverage indefinitely. At some point, it will have to boost its top line in order to bring about the kind of sustained earnings gains that will allow it to pay higher dividends.
Fans of Mondelez stock will argue that the shares have further room to climb considering the effectiveness of its restructuring efforts and success at extracting better margins from the company's operations. They'll also argue that the stock is cheap, trading at only 9.6x earnings.
Investors should pay them no mind: Mondelez only looks cheap on a trailing Price-to-Earnings basis. On a forward basis, the stock is trading at 21.3x earnings, which is actually higher than the forward ratio for the S&P 500, and in line with the current valuation for its peer group. That's hardly cheap at all.
Moreover, as we've asserted, there is a limit to how much cost savings the company can derive from its operations, and its balance sheet doesn't provide it with much wiggle room. Indeed, Mondelez's relatively tight liquidity position and considerable debt burden will probably prevent the company from bringing its dividend back up to its former lofty levels, at least in the medium term.
Finally, the stock price is actually closer to its 52-week high than its 52-week low, so a sharp increase in market volatility during the summer months could push it lower, wiping out the thin margin provided by its dividend. Our suggestion is for Dividend Investors to avoid Mondelez for now.
Disclosure: I/we 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.
Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.