ABM Industries: A Dividend Machine Becoming The Next Dividend King

Summary

• ABM is the next in line to become a Dividend King with 49 consecutive years with a dividend raise.
• Its 2020 Vision program will enable to expand margins in the future.
• According to two valuation methods, ABM is currently overpriced.

Investment Thesis

An investment in ABM is like buying a money making machine. Strong from its leader position in the end-to-end facility solutions, ABM is receiving recurring payments from their contracts across the U.S. and 20 other countries. While margins are very thin, management is implementing a solid process (2020 Vision) to improve efficiency and optimize costs. The company shows a very strong dividend growth history, but is it enough to convince investors to enter in a new position at this price? Let’s dig deeper.

Understanding the Business

Founded in 1909, ABM Industries Inc is engaged in providing end-to-end integrated facility solutions to commercial, industrial, institutional, retail, residential, and governmental facilities located throughout the United States. Their services include electrical and lighting, energy solutions, facilities engineering, HVAC and mechanical, janitorial, landscape and turf, mission critical solutions and parking.

In 2016, they put their Government division for sale, which was part of the Business & Industry division. Lately in June 2017, they announced the acquisition of this segment by Valiant Integrated Services. The reason why ABM sold its activities is to pursue their 2020 Vision program. This is another multi-year business revision process leading to cost optimization, margin improvement and organizational realignment.

We can appreciate the effort as ABM is evolving in a low operating margin business. Their 2017 margin project per sector goes from low 4% to 8% range. This doesn’t leave much room for bad luck.

Revenues

Source: Ycharts

ABM grows its business from various acquisitions over the years. They benefit from a fragmented environment leading to many mergers possibilities. Since 2014, they have made the following acquisitions: GBM (leading provider of facilities in the U.K.), Airco, Alpha Mechanical and Westway (U.K.-based as well).

While they grow by adding smaller businesses, management is currently refocusing the company activities and sell divisions that don’t fit with the new vision anymore. Apart from the recently sold government business, ABM also sold their security business activities to Universal Protection Services for $131 million in 2015.

Earnings

Source: Ycharts

While revenues keep increasing, I notice that earnings aren’t able to follow the same trend. Small margins and additional cost for insurance seem to be the biggest reasons why ABM struggles to grow their earnings as fast as their revenues. The earnings dip is also attributed to higher than expected cost related to insurance.

Here's what you can find the 2016 annual report in regards to earnings:

Operating profit in 2016 was negatively impacted by insurance expense of $49.6 million, consisting of a $32.9 million unfavorable adjustment to our self-insurance reserves related to prior year claims and $16.7 million of higher insurance expense due to an increase in the rate used to record our insurance reserves during 2016. Operating profit was also unfavorably impacted by $29.0 million of 2020 Vision restructuring and related charges and a $22.5 million impairment charge for our Government Services business, consisting of both goodwill and long-lived asset charges. See Note 4, “Held for Sale,” in the Notes to Consolidated Financial Statements for further information. Operating profit in 2016 was favorably impacted by approximately $22 million in savings from our 2020 Vision initiatives.

The need for better efficiency and cost control is imminent and their 2020 Vision program is more than welcome at this time.

Dividend Growth Perspective

ABM is the next in line to become a Dividend King – a company showing over 50 years of consecutive dividend increase. There are currently 19 Dividend Kings, you can see the full list here. With 49 consecutive years with a dividend raise, ABM is certainly to be considered as a dividend growth company. Let’s take a look at how the company can continue raising its payouts in the upcoming years.

Source: Ycharts

ABM raises its dividend in a similar manner year after year. However, as the stock price exploded by 112% over the past 5 years (as at July 6, 2017), the dividend yield went from over 3% to 1.67%. The current yield may not be attractive for income seeking investors, but the company showed an interesting capital appreciation capacity.

Source Ycharts

If you look at the current payout and cash payout ratios, you will notice they are through the roof. However, don’t forget considering the exceptional insurance expenses in 2016. Prior to this charge, the payout ratio was at 47.18% and cash payout ratio at 30.02%. The company has still plenty of room for future dividend increase.

Overall, ABM shows a strong dividend profile and meets my 7 dividend growth investing principles.

Potential Downsides

ABM uses a combination of insured and self-insurance programs to cover workers’ compensation, general liability, automobile liability, property damage, and other insurable risks. This seems to be its most volatile part of their business as insurance cost are highly variable. Here’s a note from their 2016 annual report:

Our risk management and safety programs may not have the intended effect of allowing us to reduce our insurance costs for casualty programs.

We attempt to mitigate the aforementioned risk that our insurance coverage may be inadequate or unavailable through the implementation of company-wide safety and loss control efforts designed to decrease the incidence of accidents or events that might increase our liability. Our claims data in 2016 is showing improvement, however this trend data is not yet fully mature and claims and severity data are subject to significant volatility and may not mitigate these risks.

The company is also subject to high deductible for specific insurable risks. Then again, there is a real need to improve their processes in order to reduce the number of claims.

Valuation

In my final step of this analysis, I will determine a fair value for ABM shares. As the stock rose significantly over the past 5 years, I have a doubt it could be overvalued at the moment. The first method I use is to take a look at the past 10 years PE ratio to have an idea of how the market value this company:

Source: Ycharts

Due to the recent event in their financial statement, this graph is also skewed. Here’s the same graph before June 2016:

Source: Ycharts

The stock price rose since 2012, but the PE followed a similar trend. At this moment, I don’t see the reason to pay a premium for ABM.

The second step of my valuation method is using a double stage dividend discount model. For the first ten years, I will use a dividend growth rate of 3.5% which is in line with the recent past increase. Then, I expect the 2020 Vision program to provide additional margin room and increase the dividend growth rate at 5%.

Source: Dividend Toolkit Excel calculator spreadsheet

Still, I’m falling short with the DDM calculation. The stock currently trades around $40 but there is absolutely no reason from a dividend growth perspective to pay this price.

Final Thought

I like the recurring sales that come with ABM business model. I also like the fact the company is working with several long term contracts. ABM also shows a stellar dividend payment history. However, from a dividend growth perspective, ABM value is clearly overvalued right now. There is no incentive to enter in a position.

Disclaimer: I do not hold ABM in my DividendStocksRock portfolios.

The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Additional disclosure: If you like my analysis, click on FOLLOW at the top of the article near my name. That will allow my articles to display on your homepage as they are published.

Analyst’s 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.