Time To Buy These 3 Dividend Growth Bargains

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Includes: DIS, LOW, SBUX
by: The Dividend Guy
Summary

These 3 companies show great upside potential, AND you are getting paid to wait.

Their dividend growth is assured for years to come and will complement your existing portfolio.

I have selected 3 companies with strong business models that will weather any economic storm.

Investment Thesis:

Last year, I wrote a similar article with 3 picks that were undervalued according to my analysis and 2 out of 3 beat the S&P 500 within a year of its publication:

Source: Ycharts

Since the market continues to rise a little every day, finding undervalued companies has been quite a task. I’m back this year with my 3 picks for the next 12 months.

Disney (DIS)

Disney is the king of content. In 2006, Disney bought Marvel for $4 billion. Six years later, Disney sealed another $4 billion deal through the purchase of Lucasfilm. What do both deals have in common? They prove Disney's incredible ability to generate billions of dollars with purchased content. Over the past 5 years, their blockbuster movies and theme parks have shown strong potential and drove both revenues and earnings up:

Source: Ycharts

Why is the company undervalued?

One word: ESPN. Or should I write “three words”: declining cable clients. While the DIS media network (driven by ESPN) is definitely a strong cash cow (revenue of $23,689M and profit of $7,755M in 2016), the steady decline of cable subscribers is worrying the market. For this reason, each piece of news confirming this issue brings the stock price down.

How will dividend payments increase?

Disney has increased its dividend payment for 7 consecutive years and you can count on 2017 to be the 8th. Over the past 5 years, DIS has increased its dividend payment from $0.75 to $1.56 annually. This is a 15.77% annualized growth rate. With a payout ratio of 26.50%, you can expect DIS to keep raising its distribution in the high single digits to double digits for several years.

What will change in the upcoming years?

Through the acquisition of Marvel and Lucas Film, Disney has built a never-ending universe of blockbuster movies. For example, since its acquisition, Lucas Film has brought 2 movies - Star Wars: The Force Awaken & Rogue One: A Star Wars Story - and generated over $3 billion in revenue. I expect the next Star Wars (Episode VIII to be launched on Dec 15th, 2017) to generate over $1.5 billion in revenue. Disney has already planned 1 production per year for its Star Wars franchise through 2020:

Star Wars Anthology: Han Solo: May 25, 2018.

Star Wars: Episode IX: 2019.

Star Wars Anthology: Boba Fett: 2020.

Recent improvements to their theme parks (an Avatar section this year + Star Wars section next year) along with growth coming from their newest one in Shanghai (opened in mid-2016) will also push revenues higher.

What is the real valuation?

For each calculation presented in this article, I’ve used a double-stage dividend discount model:

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.56

Enter Expected Dividend Growth Rate Years 1-10:

10.00%

Enter Expected Terminal Dividend Growth Rate:

8.50%

Enter Discount Rate:

10.00%

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$464.76

$154.13

$92.03

10% Premium

$426.03

$141.28

$84.36

Intrinsic Value

$387.30

$128.44

$76.69

10% Discount

$348.57

$115.60

$69.02

20% Discount

$309.84

$102.75

$61.35

As of August 7th, DIS has upside potential of 20%. Since the company has a very low payout ratio, I’ve decided to use a strong dividend growth rate. On the other side, I also use a 10% discount rate.

Starbucks (SBUX)

Starbucks is one of the recent success stories in the consumer space. Founded in 1971 by the opening of the first coffee shop at the iconic Seattle Pike Market, it now operates 22,519 stores in 75 countries. Starbucks is known for its stellar customer experience and its variety of beverages. They have built a reputation of listening to their customers and using technology (Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), mobile payment) to continuously improve its in-store experience.

Why is the company undervalued?

Over the past 3 months, the stock price dropped by almost 9% (as of August 7th). The bulk of this drop happened on July 28th when the company announced its latest earnings. SBUX announced weaker than expected margins as a result of closing all its Teavana stores. The company had bought Teavana for $612M in 2012. Assets impairment dragged margins down by 110 points and EPS by 8%. This was definitely not the quarter the market was looking for.

How dividend payments will increase?

Starbucks has increased its dividend payment for the past 6 years. Over the past 5 years, SBUX increased its dividend payment from $0.085 to $0.25 quarterly. This is an increase of 24.08% annualized growth rate. With a payout ratio of 44%, management has lots of room to fuel both its growth strategy in China and its dividend payments.

What will change in the upcoming years?

While the latest earnings cooled down many investors, one must look at the forest behind the tree. I consider Teavana acquisition a marginal mistake. If you exclude assets impairments, margin expanded 100 points and EPS were up by 12% according to Starbucks. Moving forward, SBUX continues its growth operation in China where sales were up by 7%, driven by 5% increase in average order price. This is another sign their menu improvements work well. Another good news was that SBUX announced the acquisition of the remaining 50% of ownership of the Mainland China Market.

What is the real valuation?

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.00

Enter Expected Dividend Growth Rate Years 1-10:

10.00%

Enter Expected Terminal Dividend Growth Rate:

8.00%

Enter Discount Rate:

10.00%

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$154.62

$76.80

$50.88

10% Premium

$141.73

$70.40

$46.64

Intrinsic Value

$128.85

$64.00

$42.40

10% Discount

$115.96

$57.60

$38.16

20% Discount

$103.08

$51.20

$33.92

Thanks to the recent stock price drop, SBUX now has upside potential of 16% as of August 7th. The shares are trading at a PE near 29. Nobody will say it’s a cheap price. However, keep in mind the company is rapidly growing and opening new stores at a very fast pace. Last quarter only, 575 net new stores were opened.

Lowe’s (LOW)

Lowe's is the second-largest home-improvement retailer in the world with over $59 billion in annual revenues. Strong from its position in the U.S., Lowe's benefits from the recent rebound of the world's largest economy. I think that after acquiring Rona in 2016, more acquisitions will come in the upcoming years.

Why is the company undervalued?

LOW stock price plummeted by almost 9% over the past 3 months (as of August 7th). While the company continues to do well, the recent cooperation between Sears (SHLD) and Amazon (AMZN) has hurt all home renovation stocks. It seems that each time Amazon is mentioned near a new sector, the whole world collapse. I don’t think AMZN will ever going to sell two-by-fours and renovation advice. Therefore, the market is overreacting to more trendy news.

How dividend payments will increase?

Lowe is not only part of the Dividend Kings, it also has an annualized dividend growth rate of 26.68% over the past 5 years. Even better, the LOW payout ratio is at 41.62%. The company has a stellar dividend history as it went from $0.08 quarterly to $0.41 quarterly in 10 years. This is enough ot make you forget its low dividend yield.

What will change in the upcoming years?

Lowe’s completed a major acquisition in Canada with Rona last year. I expect it will learn from this experience, generate synergy and eventually go for more acquisitions in the future. LOW has a solid business model in the U.S. and can export it to other countries.

What is the real valuation?

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.64

Enter Expected Dividend Growth Rate Years 1-10:

10.00%

Enter Expected Terminal Dividend Growth Rate:

7.00%

Enter Discount Rate:

9.00%

Discount Rate (Horizontal)

Margin of Safety

8.00%

9.00%

10.00%

20% Premium

$274.79

$136.06

$89.87

10% Premium

$251.89

$124.72

$82.38

Intrinsic Value

$228.99

$113.38

$74.89

10% Discount

$206.09

$102.04

$67.40

20% Discount

$183.19

$90.70

$59.91

For this final calculation, I’ve used a lower discount rate (9%). The reason is quite simple. While both DIS and SBUX are not even part of the Achievers list, LOW is a Dividend King. Such stability and long history deserve a lower discount rate as risk is lower.

Disney, Starbucks or Lowe’s?

While I already have positions in all three companies, if I had to pick one today, it would be Disney. I think the market doesn’t realize Disney’s shift toward content creation and keeping its interest in ESPN. The real strength in DIS is in its ability to generate multiple sources of revenues coming from the same product (content). Management is clearly focusing on this strategy to grow the company to another level.

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Disclaimer: I hold DIS, SBUX, and LOW 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. Pleas e remember to do your own research and know your risk tolerance.

Disclosure: I am/we are long DIS, SBUX, LOW. 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.