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One way to understand how the stock market works is to look at how it was built throughout time. As a dividend growth investor, I focus on picking shares from strong companies that show several growth vectors. I want to make sure those companies not only paid dividend in the past, but that will also continue to pay and increase it in the future.

I started investing in 2003. This gives me 15 years of investing experience including 2 bull markets and only one crash. I’ve followed the techno crash on my computer while I was working on my bachelor’s degree in finance, but that doesn’t really count as I had no money invested back then.

I remember feeling that my first investments weren’t growing fast enough for me. A high single-digit to low teens return each year didn’t appear that impressive back then. Today, I understand that the path through dividend growth investing is a long hike through the mountains. Sometimes you go up, sometimes you go down. It’s important to take pause and admire the nature. Eventually, you will rise to the top and feel like a king. But that takes lots of time and effort.

I thought of looking at 3M Co (MMM) over the past 30 years to give younger investors a perspective of what is looks like to be a long-term focused investor.

1988 to 1998
  • Stock price on December 31st 1987: $15.52
  • Quarterly dividend: $0.133/share
  • Stock price on December 31st 1997: $41.03 (+164%, 10.19% CAGR)
  • Quarterly dividend: $0.265/share (+99%, 7.12% CAGR)

Source: Ycharts

Founded in 1902, MMM was already an old company in 1988. The 80’s were marked by a very important innovation:  the famous Post-It was created in 1980 and offered in multiple colors in 1985. MMM was getting to enter into the “new world” with its first internet website in 1995. In 1996, the company’s data storage and imaging divisions were spun off as Imation Corporation.

As you can see on the graph, MMM also benefitted from the tech bubble lift-up. Shares went up from mid $20’s in 1995 to close to $50 in 1997. In the meantime, MMM never missed an occasion to reward its shareholders with consistent dividend increase.

1998 to 2008
  • Stock price on December 31st 1997: $41.03
  • Quarterly dividend: $0.265/share
  • Stock price on December 31st 2007: $84.32 (+105%, 7.44% CAGR)
  • Quarterly dividend: $0.48/share (+81%, 6.11% CAGR)

Source: Ycharts

The stock went sideways along the rest of the market going through the tech bubble, the Enron fraud and the World Trade Center attack. In 2004, boosted by several innovations, 3M tops $20B in sales. The company introduces many upgraded products such as Post-it® Super Sticky Notes, Scotch® Transparent Duct Tape and optical films for LCD televisions.

At that time (mid-2000), the stock surges and so is the dividend. While it was a good decade, MMM performances on the market weren’t as good as they were 10 years ago. Is the company done with innovation? Is it a sign MMM will finally slow down? Let’s continue our time travel story…

2008 to 2018
  • Stock price on December 31st 2007: $84.32
  • Quarterly dividend: $0.48/share
  • Stock price on December 31st 2017: $235.37 (+179%, 10.81% CAGR)
  • Quarterly dividend: $1.175/share (+145%, 9.37% CAGR)

Source: Ycharts

2008 arrives and the stock drops back to nearly $40. All of a sudden, 10 years of stock market returns disappear. Thanks to all those dividends, 3M shareholders still have a reason to smile. Nonetheless, new investors don’t find it very funny. However, in 2013, 3M tops $30 billion in sales and the stock is back on track. A year later, 3M registers its 100,000th patent and proves itself as being the innovation company it always been.

Believe it or not, MMM posts its strongest decades in 30 years. Keep in mind the stock lost about 50% of its value in the first 12 months of the decade, and yet, finished 200%+ up if you include dividend payment!

Final thought; stay invested!

Over the last 30 years, both MMM and the rest of the stock market went through many great periods and several challenges. When you look at each graph, you will see how MMM was dead money for a few years and then offer a big boost. A similar trend could be seen with its dividend policy. But overall, MMM posted high-single digit stock return and dividend growth rate for each decade. Long-term investors have passed through all those storms and ended-up with amazing results:

Source: Ycharts

In then end, it doesn’t matter the price you pay; just pick strong companies and they will reward you decades after decades.

Obvious disclaimer… long MMM

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Summary
  • Physicians Realty Trust evolves in a growing market (healthcare).
  • This REIT pays a 6% yield and focuses on quality tenants.
  • But where is the dividend growth?

There is no doubt the Healthcare sector is a growth sector for the upcoming decade. As the population ages in the U.S., the amount spent on healthcare will skyrocket. The CMS projects a 63% increase in healthcare expenditures during the next 10 years. DOC is well positioned with its growth-by-acquisition strategy. DOC has focused on tenants’ quality and continuously improving its tenants grade. Between 2015 and 2018, DOC has also reduced the weight of its top 10 tenants from 34% to 27%.

Now that DOC shares have tumbled by almost 20% ytd (-17% as of May 15th), is this 6% yield REIT worth your attention?

Understanding the Business

As the name suggests, DOC is a self-managed healthcare real estate investment trust that acquires, owns, and manages healthcare properties that are leased to physicians, hospitals, and healthcare delivery systems and other healthcare providers. You can download the complete list of solid dividend paying REITs here.

Their properties are likely to be on campus with a hospital or located nearby with partnerships in place. DOC currently manages 280 properties worth about $4.3B. 96.6% are leased with an average contract term of 8.3 years.

Source: DOC investors presentation

DOC shows a great geographic diversification with properties in 31 states and only one (Texas) representing more than 10% of its portfolio (14%). This enables DOC to reach a maximum population potential without cannibalizing its own offer.

Source: DOC investors presentation

Growth Vectors

Source: Ycharts

DOC shows an impressive growth profile over the past 5 years. The company quickly positioned its business through various acquisitions while maintaining a healthy balance sheet. Its revenue plainly skyrocketed during that period. DOC will continue to surf on the same tailwind (aging demographic) for another decade.

Source: DOC investors presentation

It’s obvious that DOC wanted to position itself as a leader in this industry. The main advantage with Real Estate is that once DOC builds (or buys) a healthcare property and links it to a hospital, it is very hard for a competitor to build a new one right beside it. This is a first mover advantage in this business and DOC jumped on the occasion.

Dividend Growth Perspective

When you look at DOC’s dividend history, you will not be flabbergasted. We are talking about a company that paid its first dividend in 2013 and increased it only once in the past 3 years (+2.22%). We are far from talking about a Dividend Achiever here. You can download complete list of stocks with 10+ year dividend growth here.

Source: Ycharts

We have used a 2% dividend growth rate for our DDM calculation, but keep in mind this doesn’t reflect the current situation. In other words, DOC pays a yield around 6% and this is what you are going to get from this REIT. Don’t expect much else.

Potential Downsides

There are many changes around the healthcare system and it is still unclear on how those modifications will affect businesses evolving in this playground. DOC grew very fast over the past 5 years and now that interest rates are rising, this will affect future profitability. The company currently shows a dividend payout ratio (based on FFO) of about 90%. While the payout is safe due to a healthy business, this doesn’t leave much room for increases. Once debt matures and need to be renewed at a higher rate, the dividend perspectives will not improve. Keep in mind that if your dividend payout doesn’t increase, your buying power shrinks year after year. For your retirement plan, you should consider an inflation rate of 2%. Therefore, any stocks showing less growth perspective are hurting your portfolio and reducing your retirement budget.

Valuation

Now that the stock has dropped by almost 20% in 2018, maybe it’s time to take a second look at DOC fair valuation. Since using the PE ration history isn’t very useful when looking at REITs, we’ll focus on the dividend discount model.

As previously discussed, we used a 2% dividend growth rate to match the inflation. Unfortunately, this is not the case at the moment. Therefore, if DOC can’t show any upside potential now (fair value at $13.41), there is not much appeal to invest in DOC.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $0.92
Enter Expected Dividend Growth Rate Years 1-10: 2.00%
Enter Expected Terminal Dividend Growth Rate: 2.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $18.77 $16.09 $14.08
10% Premium $17.20 $14.75 $12.90
Intrinsic Value $15.64 $13.41 $11.73
10% Discount $14.08 $12.07 $10.56
20% Discount $12.51 $10.72 $9.38
Final Thought

Please read the Dividend Discount Model limitations to fully understand my calculations.

While the sector and tenant profile are interesting, DOC’s dividend perspectives are deceiving. It would become a buy if DOC shows the ability to grow its distribution to match inflation. At this time, there are too much uncertainties around the healthcare industry in the U.S. and DOC doesn’t pay us enough to wait. I understand the 6% yield looks appealing, but it’s nothing if the payment can’t increase in the future. With a 90% FFO payout ratio, there is little room for this scenario.

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

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Summary
  • BHP is a pure play in the basic materials sector.
  • Since 2016, BHP shares shows twice the ETF’s return.
  • Is it time to forget the dividend cut and buy some shares?

As it is the case with the rest of the basic materials sector, BHP Billiton (BHP) saw a strong rebound after 2016. The mining company didn’t only see its shares outperforming the sector, BHP shares show twice the ETF’s return.

Source: Ycharts

Bolstered by strong demand in China and supported by various projects  across the globe, BHP is growing full speed ahead. Is it too late to jump on this commodity train? Let’s take a deeper look.

Understanding the Business

BHP is a pure play in the basic materials sector. The company is one of the rare solid dividend payers in this sector due to its highly cyclical nature. You can download the complete list of dividend growing stocks in the basic material sector here.

BHP is producing commodities, including iron ore, metallurgical and energy coal, conventional and unconventional oil and gas, copper, aluminium, manganese, uranium, nickel and silver.

Source: BHP Feb 2018 presentation

The company is the world’s largest mining conglomerate. This is a key element when the company hits a resource downturn cycle. Through its size, BHP has built a solid balance sheet and a well diversified asset portfolio going across different commodities across numerous countries.

Growth Vectors

Source: Ycharts

BHP enjoys low cost iron core exploitation in Australia which leads to natural business with China. While the golden years of the world’s second largest economy is behind it, China’s economy remains strong and continues to  grow. The demand for iron and other materials will continue to be strong for many years to come. Since BHP owns several assets near this part of the world, it has an important advantage over its competitors.

Another strong advantage BHP has over many other commodities producers is its size. Being big in this industry means that you can offer different commodities coming from various countries. In other words; when it’s not going well in one part of the world (economic, politic, etc.), you can count on another part to support demand. This makes BHP less vulnerable to basic materials cyclical nature. This is also one of the reason why its stocks jumped by 80% over the past 18 months.

As it is often the case with the energy sector (you can download the energy dividend list here), the quality of a company’s assets portfolio managed is crucial for its profitability. BHP has built a large low-cost portfolio of various commodities. This enables the business to go through more challenging periods. Considering the long life of most assets, BHP will show low cost of productions for several years.

Dividend Growth Perspective

When you look at BHP’s dividend history, you realize you haven’t found the Klondike yet. As many companies in the basic material sectors, dividend cuts are often the easy options during cyclical downturns. BHP had to cut its dividend in 2016 following a difficult period in the commodities market. Therefore, we are far from considering BHP to be the next Dividend Achievers.

The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 266 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

With 2 consecutive years with a dividend increase and a yield of 4%+, is it the time to reconsider your investment? After all, the company is on its way to offer the same payout post-dividend cut.

Source: BHP Feb 2018 presentation

From BHP’s presentation, we can clearly see that the dividend cut was the consequences of several years of capital expenses hurting BHP short-term cash flow to build long-life assets. The company’s financial situation looks better now and the current payout ratio is under control:

Source: Ycharts

However, I would not hope for a strong dividend growth going forward the next decade. In fact, I think it would be safe to expect a low single-digit dividend growth rate as dividend cuts could happen later down the road.

Potential Downsides

It is difficult to predict where a company like BHP will stand in 10 years from now. Chances are that it will be well and generating money since BHP is strong enough to go through an economic recession. With its low costs assets, it can survive poor demand periods. However, it doesn’t mean its dividend can survive the same path.

What happened in China in the 2000’s will not likely never happen again. This should put additional pressure on commodity costs for decades to come. A major weakness that all basic materials companies show is their dependence to a highly cyclical demand. You may be the largest and most diversified mining company, but you are still waiting for others to ask for your product. The problem is that demand is extremely volatile from one year to another.

Finally, with such a ride on the stock market, investors wonder if there is still room for growth on the market for BHP…

Valuation

This leads us to the final part of this report: valuation. BHP’s PE ratio history is quite hectic (what a surprise!):

Source: Ycharts

This doesn’t help us much to determine its fair value. Digging deeper, I’ve used the dividend discount model. I’ve used a 4% growth rate for the first 10 years and reduced it to 3% afterwards. I rather be conservative than overly hyped with this kind of company.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $2.20
Enter Expected Dividend Growth Rate Years 1-10: 4.00%
Enter Expected Terminal Dividend Growth Rate: 3.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $48.91 $41.81 $36.49
10% Premium $44.84 $38.33 $33.45
Intrinsic Value $40.76 $34.85 $30.41
10% Discount $36.69 $31.36 $27.37
20% Discount $32.61 $27.88 $24.33

Please read the Dividend Discount Model limitations to fully understand my calculations.

I had to use a 10% discount rate due to the volatility of BHP sector and the fact the board already cut its dividend not too long ago. It’s not really a surprise to see a dividend based valuation model finding poor value in BHP…

Final Thought

In the light of this analysis, I don’t think BHP is a bad company or a bad investment. However, as a dividend growth investor, I find little interest in investing my money in such hectic dividend payer. The yield is interesting at 4% and the payments are sustainable. I understand why an income seeking investor would want to look at BHP. But for my own portfolio, I will pass.

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

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Summary
  • Scana struggled with their nuclear plants and Dominion saw an opportunity.
  • This is risky play as Dominion could burn lots of cash on Scana’s business.
  • The stock is down, the yield is up, should you buy this dividend growth utility?
Understanding the Business

Dominion Resources changed its name in 2017 (was previously named Dominion Energy). It is one of US largest producers and transporters of energy, with a portfolio of approximately 25,700 megawatts of electric generation, 15,000 miles of natural gas transmission, gathering, storage and distribution pipeline and 6,600 miles of electric transmission and distribution lines.

Most importantly, the company has made a business shift from energy production to distribution over the past decade. It is still an important energy producer, but its distribution business is gradually increasing. D has built a predictable business model with 90% of its revenues coming from regulated operations.

Growth Vectors

Source: Ycharts

Management expects a 6-8% EPS growth through 2020. This is some great perspectives coming from a stable and predictable business. D can count on various projects to sustain its growth in the upcoming years like Greensville Power Station (combined cycle plant, 73% completed), Cove Point Liquefaction (LNG production, 100%  completed) and Atlantic Coast Pipeline.

As it is the case with many utilities, D counts mainly on new projects to generate additional growth. The recent Tax Reform will also give a hand to the EPS boost.

Finally, D has announced an all-stock merger with Scana energy (SCG) at the beginning of 2018. As Scana struggled with new nuclear plants construction and shares plummeted, Dominion saw an opportunity to grow its business. All stock merger will provide 0.669 shares of Dominion Energy for each share of SCANA Corp… in other words; there is a deal if you buy SCG now… unless the deal goes south! I’ll detail why it’s not so simple in the “potential downside” section of this article. Yes, it is THAT bad…

Dividend Growth Perspective

Dominion Resources shows 14 consecutive years with a dividend increase. This make it part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

With the recent stock price drop, D’s yield is getting closer to 5%. This make it a very attractive play for income seeking investors. Management confirmed its intention to grow its dividend by 10% annually through 2020.  Shareholders can expect a mid-single digit growth rate afterwards as management plans a 5% EPS growth rate post 2020. You will rarely find a stable company paying such growing payouts with an interesting yield. However, you will on have a chance to invest in such company if the deal with Scana doesn’t go sideways…

Potential Downsides

The deal with Scana is not that simple. Dominion tries to acquire a client base but wants off any liabilities Scana may have towards its customers. D is looking at buying a company at a cheap price, but this company has several lawsuits against it. It’s definitely not a slam dunk. Through this deal, Dominion also adds another $7 billion ($6.7) in debts. With rising interest rate, growing debts Telsa Style may not be the smartest moves.

Due to the complexity of this deal and uncertainties around it, I would wait until the situation is settled before making any investments.

Valuation

After the recent price drop, D seems like a bargain when you look at its PE ratio. The company hasn’t been trading at such good price for a while:

Source: Ycharts

When I used the DDM to determine D’s fair value, I realized that it was fairly priced before the merger announcement. The stock should trade around $88 and there is definitely a deal now.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $3.34
Enter Expected Dividend Growth Rate Years 1-10: 8.00%
Enter Expected Terminal Dividend Growth Rate: 5.00%
Enter Discount Rate: 10.00%
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $134.06 $106.34 $87.91
10% Premium $122.89 $97.48 $80.58
Intrinsic Value $111.72 $88.62 $73.26
10% Discount $100.54 $79.76 $65.93
20% Discount $89.37 $70.89 $58.61

Please read the Dividend Discount Model limitations to fully understand my calculations.

An interesting combination of a sector slump and uncertainties around the Scana merger has created an opportunity to investors. However, the price didn’t drop for nothing; the deal could turn sour and it could get worst for Dominion as well. There is no reward when there is no risk!

Final Thought

Dominion resources show a strong and predictable business model. With a steady investment of $3 billion per year in projects, management make sure to put enough growth on the table. Over the long run, Dominion seems a good investment, but expect additional volatility until the merger deal is closed or abandoned.

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

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Summary
  • GM has greatly improved its financial health and is back on “growth mode”.
  • GM has eyes on the future to fuel its growth (electric & autonomous car).
  • There are several clouds looming (competition, high debts, underfunded pension plans).

Are you ready to give it a second chance? This is often a question investors must ask themselves when they look at a company that already cut their dividend. Did management really understand what put them there in the first place? While General Motors (GM) has done a marvelous job at getting back from the dead, I’m not sure it can be qualified as a “safe dividend payer” yet. GM was once admired by many as the world’s #1 automotive constructor. After its fall in 2008-2009, the company worked very hard to bring its iconic brand to the top. It did a great job, but is it enough?

Understanding the Business

General Motors doesn’t need a presentation. Even my 6-year-old can tell the difference between a GM and a Ford since there are so many of their cars on the market. GM is not only a leader in the automotive industry, it is also a leader in the high-margin pickup truck sub-segment.

GM’s presentation

GM is obviously tied to the car industry and its cycles. After becoming a low leaner, it is now showing a breakeven point when production reaches around 10-11 million units. The company counts on less brands and more productive processes. GM has switched from an old model where it used to overproduce some models and shove them through consumers’ throats to a business model where it produces what clients want and meets the demand instead of exceeding it.

Growth Vectors

Source: Ycharts

GM counts on its leadership in the pickup truck segment to boost its cash flow in the upcoming year. The demand for such vehicles remains robust and offers growth possibilities for the years to come. It seems that everybody wants to drive a pickup these days! China and other emerging markets are obviously stable a growth vector for the automotive constructor.

Now that the company is back on track with stronger financial results, it has an eye on the future. This is a future with electric and autonomous cars. Two very intriguing, yet promising segments.

Source: GM’s investors presentation

As the population grows and move toward urban areas, the desire of driving their Corvette with their hair in the wind, is being replaced by low gas consumption transportation. Even better, if people can start working early in their car and don’t have to mind traffic while commuting to work, they’ll go for an autonomous electric car. This was pure Sci-fi a few years ago, but now we have a feeling that GM could possibly be among the pioneer in this sector.

Source: Ycharts

GM has made gigantic steps in improving their cash flow generation abilities. As a dividend investor, I’m also pleased to see that management used $25B for its shares repurchase program (GM bought back 25% of outstanding shares) along with its dividend payments. Speaking of which…

Dividend Growth Perspective

GM reinstated its dividend payment in 2014 and has increased it twice since then. We are not talking about a super-powered dividend grower. To be honest, there are tons of Dividend Achievers I prefer before picking GM. You can get the full list here.

Source: Ycharts

At a 3.5%-4% dividend yield, GM could please income seeking investors such as retirees. GM dividend brings back good old memories spent of summer vacation in an Oldsmobile. However, we are far from driving on that highway right now.

Source: Ycharts

As previously mentioned, GM has seriously improved its cashflow generation abilities and that shows through its cash payout ratio. Before the tax bill changes short term EPS, GM’s payout ratio was also well under control. While GM tries to seduce investors with shares buyback programs and juicy dividend, I expect low-single digit growth for the future. As you are going to see in a moment, GM has other cash flow priorities.

Potential Downsides

GM obviously counts on its strong reputation and brand awareness to sell more cars. However, I doubt this will be enough going forward. The competition is fierce, and consumers are already loaded with car debts. There is a limit in refinancing their old car with a new one.

Developing, manufacturing and marketing cars is a capital-intensive business. It becomes even more expensive when you are going outside the box and go with new technology (electric/autonomous). While GM’s cash flow from operation is skyrocketing, its debts are also raising fast.

Source: Ycharts

Such high debt will need to be paid at one point in time. As long as the global demand for cars remains stable, this is not a problem. However, an economic downturn could quickly get GM back on its heels. Don’t be too quick to forget about 2008 disaster. GM is not out of the woods yet.

Finally, GM is still dragging substantial pension funds expenses. In their Q4 2017, the company estimated its pension funds underfunded debt to be around $14 billion. This is not pocket change.

GM Q4 2017

Valuation

Assessing the value of a company that went through so much over the past decade is quite a challenge. In fact, the problem is that there are absolutely no trends here:

Source: Ycharts

The PE valuation is completely useless as GM went up and down and completely transformed its business over the past 10 years. Now, using the Dividend Discount Model is also a big guess as we have limited dividend history and lots of assumptions to take into consideration.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.52
Enter Expected Dividend Growth Rate Years 1-10: 3.00%
Enter Expected Terminal Dividend Growth Rate: 3.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $31.31 $26.84 $23.48
10% Premium $28.70 $24.60 $21.53
Intrinsic Value $26.09 $22.37 $19.57
10% Discount $23.48 $20.13 $17.61
20% Discount $20.87 $17.89 $15.66

Please read the Dividend Discount Model limitations to fully understand my calculations.

Since GM hasn’t increase its payouts since 2016, I can’t go crazy with the dividend growth rates. I decided to stick to 3% going forward. I also used a 10% discount model mainly because GM could fact many headwinds going forward.

Final Thought

I don’t think GM shares will fall by 40% this year. However, the DDM calculations show me there is no deal in buying GM today. That’s too bad because I like that the company is going toward electric cars. I really hope they succeed as a consumer, but I’ll pass as an investor.

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

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Summary
  • PC sales are sluggish? Microsoft just moved towards the cloud at fast pace.
  • MSFT strong relationships with Corporate America will help the company integrate many other services.
  • The tech giant successfully switch from a one time software sale to a subscription based product with Office 365.

Microsoft (MSFT) has polarized investors for a while now. On one side, bears are telling the world that PC sales are going nowhere. Bears even come up with this theory that the PC era is dead and it will bring MSFT in its hole. I can’t argue with PC sluggish sales, bears are right on this point:

Source: Statista

Nonetheless, I disagree with their investment thesis. Microsoft is a resourceful company and saw PC sales headwinds coming at them a while ago. Over the past few years, it has moved its one time software sales approached towards subscriptions based with the creation of Office 365 (sales were up +41% during the latest quarter). It built a strong cloud environment climbing to #2 in the public business and integrating multiple solutions for businesses. I think Microsoft shares will easily hit the $100 mark, here’s why.

Understanding the Business

First, repeat after me: Microsoft isn’t just Windows and Office anymore. While the company has been tied to PC sales decades, this business model is dead already. Microsoft is the worldwide leader in software, services, devices and solutions helping consumers and businesses to become more productive. The company operates under 3 segments.

Source: author’s table based on Q2 2018 results

More Personal Computing (+2% Q2 2018) is still MSFT’s largest business segment with 42% of its revenue. This is probably why investors still think this tech giant is all about PC sales. This segment shows modest growth, but gaming revenue is showing a steady uptrend (+8%) with its Xbox live platform.

Productivity and Business Processes (+25% Q2 2018) is Microsoft’s second largest division. It includes its Office 365 service that is now based on a subscription model. LinkedIn results are also included within this segment.

Intelligent Cloud (+15%  Q2 2018) may be the smaller units in MSFT, but it shows a strong potential. Public and corporate cloud services are growing at a fast pace. Azure shows 10 consecutive quarters with 90%+ growth.

Growth Vector

Source: Ycharts

Microsoft counts several growth vectors to ensure its future growth. First, the cloud business growth will last for a decade. MSFT currently shows over 800 case studies of cloud services provided to corporate clients on its website. Its strong bond with its clients is the reason why Microsoft came as a natural choice for businesses and governments when it’s time to move toward cloud based solutions for their operations. In the public space, Amazon (AMZN) remains the leader in this business and proved this business as highly profitable. Microsoft is a solid #2 with Azure showing nearly 3 years of impressive growth.

Second, MSFT is pushing its relationship with Corporate America to a whole new level. MSFT has never been afraid to deploy money to find additional growth vectors. It acquired several companies like Skype and LinkedIn. MSFT also developed its own applications including Teams (MSFT response to Slack, a cloud based workspace for businesses). Now, MSFT shows the most complete offer to businesses who want to improve their productivity. This “all-in-one” offer positions MSFT as a natural choice if you want to reach the next step with your business.

Third, subscription based solutions will drive increasing cash flow in the upcoming years. There was once a time where Windows & Office versions were the only way MSFT could push its revenue up. It was constantly working on a software cycle trying to convince clients to upgrade their system on a constant basis. Now that MSFT has shifted toward Office 365, clients will just keep paying their subscription and benefit from future upgrades. This makes cash flow more predictable and should boost margins along the way.

Dividend Growth Perspective

Microsoft shows 14 years of consecutive dividend increases. This makes it part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

I’ll agree with you, MSFT yield has lost its appeal now that it is lower than the 2% mark. But take a second to look at the blue line on the graph to see how fast MSFT price grew since 2016. Even if its dividend jumped by 82.61% over the past 5 years, it wasn’t enough to keep the yield at its 2.50%-3% levels. This means one thing; Microsoft is back on strong growth mode.

Source: Ycharts

MSFT payout ratio seems through the roof after its latest quarter but that was just related to a $13.8 billion net charge related to the Tax Cuts and Jobs Act. If you look at the cash payout ratio, you will notice that it is not only low (37%), but that it has been decreasing for the past 12 months. The effect of subscription based solutions is starting to show.

MSFT shareholders can expect a high single-digit dividend growth rate for several years to come. I wouldn’t be surprised to see MSFT showing a 9% dividend CAGR for the next decade.

Potential Downsides

The fact that PC sales are going down in the upcoming decade will not help MSFT. But instead of dragging MSFT results in negative territories, I think it will have a modest impact as the company grows in other sectors.

While MSFT is currently spending its money well, management made several bad acquisitions throughout its history. I guess that having so much money in hands could be dangerous sometimes. Let’s hope MSFT will continue to use its money wisely instead of buying another Nokia…

Valuation

When I bought shares of MSFT at $75 before its Q1 2018, many were saying that it was overpriced. Since then, the stock surged to $90+. Maybe it is overpriced now?

Source: Ycharts

MSFT 12 months forward PE ratio is at 25.61. While this number alone seems relatively high, I think it’s the right price to pay for such a leader with many growth avenues.

Going deeper, I used the dividend discount model to see how much MSFT should be trading at. I was pleasantly surprised to find significant value in MSFT.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.68
Enter Expected Dividend Growth Rate Years 1-10: 9.00%
Enter Expected Terminal Dividend Growth Rate: 7.00%
Enter Discount Rate: 9.00%
Margin of Safety 8.00% 9.00% 10.00%  
20% Premium $257.75 $128.02 $84.81  
10% Premium $236.27 $117.35 $77.74  
Intrinsic Value $214.80 $106.68 $70.67  
10% Discount $193.32 $96.01 $63.61  
20% Discount $171.84 $85.34 $56.54  

Please read the Dividend Discount Model limitations to fully understand my calculations.

With a stock trading around $90, there is roughly a 15% immediate upside. You may think that a 9% and 7% dividend CAGR is generous, but keep in mind that Microsoft has increased its payout by 282% over the past 10 years for a CAGR of 14.34% and still shows a cash payout ratio under 40%. Therefore, expecting a high single-digit dividend growth rate is justifiable.  MSFT will hit $100 in no time.

Final Thought

Don’t let bears tell you what to do. While the market is currently volatile, there is one thing I’m sure; Microsoft will be thriving in the next 10 years and I certainly don’t want to miss the growth. MSFT shows a great combination of steady cash flow generation and growth vectors insuring years of joy for shareholders.

Disclaimer: I do hold MSFT in my DividendStocksRock portfolios.

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Summary
  • Here is a company with over 100 years of experience paying a 6%+ yield.
  • Management aims for a 5-9% annual distribution increase for years to come.
  • At the current price, BEP shows a strong upside potential along with a healthy dividend. What’s not to like?

If you think that you have missed the mini-market correction because the S&P 500 rapidly bounced back, think again; there is plenty of opportunity lying right in front of you. One of them is Brookfield Renewable Partners LP (BEP) or (BEP.UN.TO).

Investment Thesis

I truly believe the future of energy will be found across hydroelectric, solar, and wind power. 80% of BEP’s portfolio is focused on hydroelectric power. The company has power plants across North America, South America, Europe, and Asia. BEP enjoys large scale capital and expertise to manage its projects across the world. Management aims at a 5-9% annual distribution increase for years to come. At the current price, BEP shows a strong upside potential along with a healthy dividend. What’s not to like?

Understanding the Business

The company is a rare pure play in the renewable energy sector. With over 2,000 employees, $27 billion in power assets and $285B in AUM, BEP is also one of the largest players in this industry. Good news; BEP is only down about 12% (as of March 14th) since the beginning of the year and it is almost trading at its early 2017 level.

Source: Q3 2017 investor presentation

While the stock is down, the company currently surfs on the renewable energy tailwind. This is not just a trendy moment – renewable energy is at the center of our future economic development.

Revenues

Source: Ycharts

Brookfield Renewable Partners strategy uses both organic and acquisitions to boost its revenue. Their goal is to “acquire a renewable power assets and businesses that below intrinsic value, finance them on an investment grade basis, and optimize cash flow and value utilizing our depths of operating expertise,” says CEO Sachin Shah.

The company currently has around $1.5 billion in cash for future investments. As the M&A market is currently boiling, you can expect management to use its liquidity to fund further projects. Over the years, management has developed a strong expertise in such deal. Therefore, I am confident this money will be used wisely to the great pleasure of shareholders.

Dividend Growth Perspective

On its website, BEP shows its distribution history since 2011. The company has successfully increased its payout since then. The small dent in 2014 was due to a change of date in the dividend payment. Therefore, the February payment (which was supposed to be the March payment) was pro-rated (2/3 of the regular dividend). BEP doesn’t qualify as a dividend achiever, but still shows a great dividend profile.

The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

Source: Ycharts

Using the classic payout ratio (and even the cash payout ratio) is not useful to determine BEP’s dividend sustainability. You are better off using the FFO/units. Over the past 5 years, BEP has maintained an 8% FFO/units CAGR while increasing its dividends by 6%.  If you want to know more about how to assess MLP’s, I suggest this guide.

However, since 2016, its generosity pushed the FFO payout ratio to around 98%. In 2017, the FFO/unit was $1.90. Considering the most recent dividend increase (now $1.96 per year per unit) and an FFO growth of 8% ($2.05), the 2018 payout ratio will become 96%.  This is well over management’s target of 70%.

Potential Downsides

As this kind of company is growing mostly through leverage, the debt level is always an issue. BEP currently shows nearly $11 billion in long term debt. As interest rates rise, this will impact BEP future profitability.

The second concern could be put toward future dividend growth. With a FFO payout ratio near 100% and management target around 70%, it will become difficult to maintain a steady dividend hike and reach a lower payout ratio at the same time. However, as long as the FFO grows around 8% per year, you can expect a 5-6% dividend growth.

Valuation

In order to determine BEP’s fair value, I’ve used the dividend discount model. I used a 6% dividend growth rate for the next 10 years. While there is a risk BEP doesn’t match my assumption due to the high payout ratio, I still consider this number as the company showed more commitment to increase its payouts than keep its FFO payout ratio in order.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.96
Enter Expected Dividend Growth Rate Years 1-10: 6.00%
Enter Expected Terminal Dividend Growth Rate: 5.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $66.94 $53.40 $44.37
10% Premium $61.36 $48.95 $40.68
Intrinsic Value $55.79 $44.50 $36.98
10% Discount $50.21 $40.05 $33.28
20% Discount $44.63 $35.60 $29.58

Please read the Dividend Discount Model limitations to fully understand my calculations.

If some may think that I was overly optimist, I did the calculation with a 4% dividend growth rate. I kept a 10% discount rate and still find some value at the current price. In both cases, BEP is a buy.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $1.96
Enter Expected Dividend Growth Rate Years 1-10: 4.00%
Enter Expected Terminal Dividend Growth Rate: 4.00%
Enter Discount Rate: 10.00%
Discount Rate (Horizontal)
Margin of Safety 9.00% 10.00% 11.00%
20% Premium $48.92 $40.77 $34.94
10% Premium $44.84 $37.37 $32.03
Intrinsic Value $40.77 $33.97 $29.12
10% Discount $36.69 $30.58 $26.21
20% Discount $32.61 $27.18 $23.30
Final Thought

Renewal energy should be a part of our future. Solid dividend payments should also be part of our future as investors. Therefore, you have the two best reasons  in the world to consider Brookfield Renewable Partners.

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

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Summary
  • One of the only 9 U.S. REITs with at least one “A” credit rating
  • A highly diversified REIT in terms of tenants, industries, geographies and property types
  • 24-year track record of regularly increasing the dividend
Investment Thesis

Realty Income Corporation is the largest net lease real estate investment trust (REIT) in the U.S.The REIT is highly diversified and enjoys a regular stream of cash flows from investment grade tenants. Realty Income deserves to stay in a dividend income investor’s portfolio not only because it has paid dividends for almost five decades, but also because it has a steady cash flow stream from diversified properties and quality tenants, maintaining high occupancy levels consistently which never dropped below 96%.

Understanding the Business

Founded in 1969, Realty Income Corporation (O) is a real estate investment trust (REIT) that engages in the asset management of commercial properties in the U.S. It earns regular revenue in the form of rental income from properties in diverse locations and quality tenants.

The Realty Income’s property portfolio can be broadly classified into retail (80% of revenue), industrial (13%), office (5%) and agriculture (2%). The company’s portfolio consists of more than 5,000 properties across 49 states. Realty Income today has around 251 commercial tenants from over 47 different industries.

Source : Realty Income Investor Presentation

Revenues

Source: Ycharts

The REIT owns and purchases freestanding, single-tenant properties in key locations.Location is the key to the success of a REITbusiness and Realty Income’sproperties in key markets and strategic locations is one of the main reasons for its strong revenue growth.The properties have a high occupancy ratio of more than 98% which indicates the success of its portfolio strategy. In addition, Realty Income typically enters into triple net leases (where tenants pay maintenance, taxes, and insurance costs) with initial lease term of 15 years with provision for annual escalations. The REIT also has a sound track record of lease roll overs. It re-leased 181 properties with expiring leases (by the end of Q3’17), out of which 164 were to same tenant (89%).

Its tenants can be grouped into 47 activity segments and 27 other non-reported segments. This provides a good diversification of revenues. More than half of the REIT’s rental revenues come from its top 20 tenants (like Walgreens, FedEx, Dollar General etc.). This insulates the REIT from changing consumer behaviour. Ten out of these tenantsalso have investment grade ratings. All these factors improve cash flow visibility and add to diversification.

Source : Realty Income Investor Presentation

In addition, Realty Income is also expanding its footprint through acquisitions and added 505 new properties worth a whopping $1.86 billion in 2016 alone.

Earnings

Source: Ycharts

Realty Income earns a regular and secure stream of income since its properties are let out under long term leases (remaining lease term of 9.7 years) to a well-diversified customer base from the non-discretionary service industry.

Assets have grown to 5,062 properties from 630 properties in 1994. A solid investment grade balance sheet and strong cash flow generations have enabled the company to raise its AFFO per share by 5% (in 2016) in spite of aggressive acquisitions.

Management expects 2017 AFFO per share of $3.03 – $3.07, representing annual growth of 5.2% – 6.6%.

Dividend Growth Perspective

Source: Ycharts

Realty income is one of only five REITs that is a member of S&P High Yield Dividend Aristocrats index. It is also part of the Dividend Achievers list. Realty Income has grown dividends at a CAGR of 4.6% since its listing in 1994. The REIT has paid monthly dividends for 49 years in a row.Its payout ratio is high at 84% and it last raised its payout by 4% y/y.

The REIT’s highly predictable and diversified sources of cash flow ensure highly stable and growing dividends.

Source : Realty Income Investor Presentation

Potential Downsides

Realty Income holds a large proportion of retail properties in its portfolio. The retail sector is under increased pressure from rising e-commerce threat which has caused many large brick and mortar stores to down shutters.However, Realty Income is quite insulated from this risk as 97% of its total portfolio is protected against retail e-commerce threats and economic downturns.

An increasing interest rate environment is not favourable for REITs. By entering into long-term leases, Realty Income is more sensitive to rising interest rate. However, Realty Income has performed better than most of the other REITs, during a period of steadily rising rates.

Valuation

Source: Ycharts

The stock has slumped 14% so far this year and is trading 22% below its 52 week high.

A conservative balance sheet with investment grade ratings ensures access to low cost of capital. The REIT maintains a higher level of EBITDA margin which has never dropped below 90% since 1998.

I have also used the Dividend Discount Model to determine a fair value for O. Given Realty income’s investment in future acquisitions, its past dividend growth streak and a solid balance sheet, it will continue its payout growth.Realty Income has grown dividends at an average 5% in the past, hence I have assumed a dividend growth rate of 5% in the initial period and reduced it to 4% going forward. As for the discount rate, I never use under 9%. The output shows that the stock is undervalued currently.

Input Descriptions for 15-Cell Matrix                                INPUTS

Enter Recent Annual Dividend Payment:                                         $2.63

Enter Expected Dividend Growth Rate Years 1-10:                         5.00%

Enter Expected Terminal Dividend Growth Rate:                            4.00%

Enter Discount Rate:                                                                               9.00%

                               Discount Rate (Horizontal)                                                                       

Margin of Safety             8.00%                   9.00%                   10.00% 

20% Premium                   $88.96                  $70.96                  $58.96

10% Premium                   $81.55                  $65.04                  $54.05

Intrinsic Value                  $74.13                  $59.13                   $49.14

10% Discount                    $66.72                  $53.22                  $44.22

20% Discount                    $59.31                  $47.30                  $39.31

 

Final Thought

Realty Income is focussing its growth from retail and industrial properties. It has a reliable cash flow from multiple sources and investment grade tenants. It invests in properties operating in attractive industries conducive to economic growth.

The REIT has recorded a growth of 16.4% CAGR in annual shareholder returns since its listing, outperforming other equity REITs and indices.It also offers a reliable dividend income stream which makes it attractive for long-term investors and has earned itself the brand of“the monthly dividend company” due to its long record of paying monthly payouts.

Disclosure: I do not hold O in my DividendStocksRock portfolios.

Additional disclosure: 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.

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Summary
  • One of the top three self-storage REITs with good properties and an expanding portfolio
  • Growing strongly through both organic and inorganic routes
  • Macroeconomic factors like a growing population and rising rents acting as tailwinds

This article has been written by Sneha Shah for The Dividend Guy.

Investment Thesis

One of the main reasons to invest in REITs is their attractive returns  (at least 90% of its income is required to be distributed). REITs, which focus on self-storage properties, are even better as they are less sensitive to economic downturns than other real estate product types.

CubeSmart is amongst the top three national owners and operators of self-storage facilities in the United States. Its portfolio of high quality properties in good locations and a diversified customer base have enabled long term value creation for its shareholders. CubeSmart has been regularly increasing its payout over the last seven years and is just three years away from making it to the Dividend Achievers list. It offers a yield of over 4% and its strong cash flows imply investors have nothing to fear about future payouts as well.

Understanding the Business

Founded in 2004, CubeSmart (CUBE) is a real estate investment trust (REIT) that engages in the ownership, operation, acquisition and development of self storage facilities in the US. It operates a portfolio of 908 stores, more than half of which is owned by CubeSmart, in 23 states and District of Columbia. Its high quality portfolio focuses on supply constrained markets with good demographics.

The REIT earns its revenues principally from rent received from customers under month-to-month leases, which provides good short-term visibility and the ability to upwardly adjust rents in case of inflation.

Source : CubeSmart Investor Presentation

Revenues

Source: Ycharts

The REIT caters to the needs of a wide range of residential and commercial customers. Its properties have an average occupancy rate of 93.3% and are located near densely populated retail centers. Stores in metropolitan cities like Florida, New York, Texas, and California accounted for 17%, 16%, 10% and 8%, respectively, of CubeSmart’s total 2016 revenues.

The self-storage industry in the US is highly fragmented and consists of around 51,000 facilities having 2.6 billion rentable square feet space. About 16% of the total rentable square footage is owned by the top 10 operators collectively, which indicates that CubeSmart has a huge market to grow.

In addition to growing organically, CubeSmart is also focusing on acquisitions and has invested and estimated $50 million in making strategic acquisitions and adding 123 new properties (till November 2017).

Source: CubeSmart Investor Presentation

Earnings

Source: Ycharts

Cube Smart has successfully grown both its revenues and earnings over the last few years. Its funds from operation (FFO) have grown continuously every quarter in 2017, with the last quarter reporting an increase of 10.5% y/y.

The company is looking at maximizing its cash flows by increasing rents, occupancy levels and number of facilities; and by controlling operating expenses. In addition, CubeSmart’s Third Party Management program has allowed to leverage its operating platform, and develop an additional revenue stream.

As a publicly traded REIT with a BBB/Baa2 investment grade balance sheet, CubeSmart also has easy and multiple sources of access to capital.

Management estimates full year 2017 FFO per share, to range in between $1.57 and $1.58, which represents an increase of 9.4% y/y.

Source: CubeSmart Investor Presentation

Dividend Growth Perspective

Source: Ycharts

CubeSmart has an impressive dividend growth track record, increasing payouts by 28% CAGR over the last five years and by 23% in the last year itself. It has also grown its payout for the last seven years in a row and has a current yield of 4.2%. Its payout ratio stands close to 71% which is reasonable for REITs.

Strong cash flow generation and a disciplined investment strategy has allowed for meaningful increases in distributions to shareholders.

Source: Ycharts

Self-storage businesses are expected to perform better in good economies where people end up buying more things but have little space to store.

Potential Downsides

Rising interest rate is the biggest risk for CubeSmart, which reduces the attractiveness of investing in REITs. With US Treasury yields increasing sharply in 2018, CUBE might come under pressure.

An increasing population choosing to start families late and an older generation downsizing their homes could pose potential challenges for CubeSmart. Oversupply concerns and heightened competition are also potential risks.

Natural calamities can also adversely impact operation. CubeSmart estimates $1.4 million in repair costs, net of insurance proceeds, for damages caused by hurricanes Harvey and Irma.

Valuation

CubeSmart is a one of the biggest players in the self-storage market and should continue to grow through industry consolidation. Its market capitalization value is just $4.7 billion compared to $32 billion for Public Storage (PSA), industry’s largest player.

CUBE is currently trading at higher valuation relative to the industry median. It maintains a net debt-to-EBITDA ratio of 4.8x which is lower than industry average of ~6x.

Source: Ycharts

I have also used the Dividend Discount Model to determine a fair value for CUBE. Given CubeSmart’s strong cash flow growth, a conservative balance sheet and past growth I have assumed a dividend growth rate of 6% in the initial period and reduced it to 5% going forward. As for the discount rate, I never use under 9%. The output shows that the stock is currently reasonably valued.

Input Descriptions for 15-Cell Matrix                                     INPUTS

Enter Recent Annual Dividend Payment:                                             $1.11

Enter Expected Dividend Growth Rate Years 1-10:                            6.00%

Enter Expected Terminal Dividend Growth Rate:                              5.00%

Enter Discount Rate:                                                                                 9.00%

Discount Rate (Horizontal)

Margin of Safety             8.00%                   9.00%                   10.00% 

20% Premium                   $50.71                  $37.91                  $30.24

10% Premium                   $46.48                  $34.75                  $27.72

Intrinsic Value                  $42.26                  $31.59                  $25.20

10% Discount                    $38.03                  $28.43                  $22.68

20% Discount                    $33.81                  $25.27                  $20.16

Please read the Dividend Discount Model limitations to fully understand my calculations.

Final Thought

The self-storage business is a slow changing, relatively stable and predictable business because consumers need a place to store their stuff even during recessions. CubeSmart being an industry leading name with a strong operating performance and a conservative balance sheet should continue to grow steadily in the coming years.  It is in a good position to acquire high-quality assets in select markets and leverage the expertise of its partners to generate attractive returns.

Disclosure: I do not hold CUBE in my DividendStocksRock portfolios.

Additional disclosure: 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.

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Summary
  • Robust presence in the global Diabetes care market, with 27% market share
  • Extensive geographical presence, strong product pipeline and 90 years of R&D expertise
  • Emerging market and new products are key growth drivers

This article has been written by Sneha Shah for The Dividend Guy.

Investment Thesis

Healthcare stocks offer a safe dividend stream for investors given their nearly recession-proof nature. The sector offers immense potential owing to a growing senior population that drives demand for medical products.

Novo Nordisk is a leading global pharmaceutical company having a strong leadership position in diabetes care.  About 27.7 million people use its diabetes care products worldwide. The company has developed strong R&D expertise and a strong product pipeline pumping out market leading medicines. It is also slowly but steadily expanding its footprint in emerging markets, given the pricing challenges that healthcare companies are currently facing in the USA.

Given Novo Nordisk’s leadership, the company stands in a good position to benefit from a growing population suffering from chronic diseases like diabetes, obesity and others.

Understanding the Business

Novo Nordisk is a global healthcare company. Headquartered in Denmark, Novo Nordisk has operations in 79 countries and markets its products in more than 170 countries. The company has over 90 years of experience in diabetes care and other serious chronic conditions such as haemophilia, growth disorders and obesity.

By geography, North America constitutes its largest market accounting for 52% of total sales in 2017, followed by Europe (19%), AAMEO region (11%), China (10%), Japan, Korea (5%) and Latin America (3%).

By product line, diabetes care is the largest revenue generator accounting for 81% of 2017 revenues, followed by haemophilia (9%), growth hormones (6%), obesity (2%) and other biopharmaceuticals (2%).

Revenues

Source: Ycharts

Novo Nordisk commands a 27% market share in diabetes care and 45% in insulin volume market share. It is the only company with a full portfolio of novel insulin and GLP-1 products. Diabetes care and obesity have become widespread in the U.S., with an increasing diabetic population in the U.S. and Novo Nordisk stands to benefit from this trend.

Tresiba and Victoza (drugs for diabetes care) are the largest growth drivers, growing by 85% and 18% respectively. Its semaglutide product, Ozempic, also received FDA approval and should further fuel growth of its diabetes-care line of products. Saxenda, which is a global leader in the anti-obesity market is also showing good growth. Further, Novo Nordisk is also investing to roll out a new generation insulin portfolio.

More than 90 years of research and an extensive geographical presence are Novo Nordisk’s other strengths. International operations, which cover more than 190 countries, grew by 5% last year. The company is adopting a ‘market fit’ approach to grow this business. Emerging markets also present a compelling growth opportunity for Novo Nordisk as can be seen from the graph below:

Management expects sales growth of 2%-5% (in local currency) in 2018.

Earnings

Source: Ycharts

The diabetes care and obesity segments accounted for 78% of the total operating profit while the biopharmaceuticals segment constituted the remaining 22%.

Sales and distribution are the biggest cost and accounted for nearly 30% of sales in the most recent quarter.

The company is making investments in additional production capacity and expenses to support the commercialisation efforts for the launch of Ozempic. In addition, Novo Nordisk is also expanding its R&D efforts into other serious chronic diseases with unmet medical needs. It is developing stem cell therapy for type 1 diabetes, and developing a biological medicine in a tablet.

Novo Nordisk is targeting an operating profit growth of 5% on average and expects to convert 90% of its earnings into cash for shareholders. The company is expecting to drive margins through continuous cost control measures and sales growth. It has a strong pipeline of medicines which should further fuel growth.

Dividend Growth Perspective

Source: Ycharts

Source: Novo Nordisk

Novo Nordisk is a shareholder friendly company offering a dividend yield of 2.35% along with large share buybacks every year. The company has paid uninterrupted dividends for 20 years in a row. Once you bring NVO’s cash dividend in its currency, you can see that the company could make the Achievers list if it was a U.S. company.

The company’s next payout is expected to increase by 3%, with a reasonable payout ratio of 50% indicating room for further growth.

The company has a good cash balance and management has the flexibility to take on debt in case of any cash shortfalls.

Source: Ycharts

Investors have reasons to be happy as the company also announced a new share repurchase programme of up to DKK 14 billion (US$ 2.24 billion) for the year.

Potential Downsides

Novo Nordisk faces competition from generic drug companies. Teva Pharmaceuticals’ new generic drug poses a big threat to Novo Nordisk’s flagship diabetes drug Victoza, which is one of its biggest brands.

Moreover, U.S. healthcare budgets and prices will continue to remain under pressure as healthcare costs in the country are quite high as compared to other nations. There is tremendous pressure on the healthcare system to lower cost. This might adversely affect sales growth and profitability.

New products from competitors and competition for older drugs also affect volumes and create pricing pressure.

Having a large international presence, Novo Nordisk is also sensitive to currency fluctuation. In fact, the company reported disappointing FY 17 results owing to the fact that almost every currency in the world declined against the Danish krone in 2017.

Valuation

Source: Ycharts

NVO is trading at P/E of 19.48x which is lower than the industry average of 29x. Its debt to equity is also lower at 0.03, when compared to the industry median.

Final Thought

The International Diabetes Federation (IDF) estimates that the number of diabetic people will increase to 629 million by 2045 from 425 million today. Novo Nordisk has a huge growth potential as only 6% of the diabetes population is being treated with its products. Even though growth has slowed in recent times, Novo Nordisk remains profitable given its heavy R&D expenditure, expansion into other therapy areas and partnerships. The company has a good long term visibility given its dominant position in the diabetes market. The recent correction offers a good entry point for investors with a long term horizon.

Disclosure: I do not hold NVO in my DividendStocksRock portfolios.

Additional disclosure: 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.

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