UVV - Buy Alert: Which Of The 4 Highest Yielding Dividend Kings?

2023-04-17 08:00:00 ET

Summary

• Dividend Kings are the best of the best when it comes to dividend growth stocks, with 50+ year dividend growth streaks.
• Thanks to rapidly rising interest rates and geopolitical and macroeconomic turmoil, you can buy several dividend kings at compellingly high yields today.
• We analyze the four highest yielding dividend kings and share which one we are buying at the moment.
• We also share why the other three are not buys right now.

Dividend Kings are the best of the best when it comes to dividend growth stocks, with 50+ year dividend growth streaks. By investing in stocks belonging to this elite group of just 48 companies, investors are pretty much assuring themselves that they are buying quality businesses. This is because in order to grow a dividend for 50 consecutive years, a business must have:

• a durable competitive advantage that enables it to sustain and grow its profitability through a wide range of economic and geopolitical environments as well as withstand massive technological innovations and disruptions.
• a strong balance sheet that has weathered all kinds of interest rate environments.
• skilled management that excel at allocating capital. Growing a dividend over such a long period of time implies that management has been able to strike an effective balance between returning capital to shareholders in ever-growing amounts while still allocating sufficient capital to the business to sustain its competitive positioning and continue to grow it.
• shareholder friendly management that is committed to growing capital returns to shareholders. After all, the shareholders are the owners of the business, and nothing honors them more than giving them a growing stream of profits in the form of cold hard cash.

With macroeconomic and geopolitical headwinds and risks at levels not seen in a long time, now is a great time to invest in businesses that have a proven track record of coming out on the other side of similarly challenging situations with a higher dividend per share than they had going into it.

The good news is that - thanks to rapidly rising interest rates and geopolitical and macroeconomic turmoil - investors can buy several Dividend Kings at compellingly high yields today. In this article, we analyze the four highest yielding Dividend Kings and offer our take on whether or not they are worth buying at the moment.

#1. Altria Group ( MO )

MO is the leading tobacco manufacturer in the US and as such faces concentrated regulatory risk as it is the only market for its products. Another major challenge that MO faces is the ongoing decline in volumes in its core cigarette business.

Management is pursuing a multi-pronged approach to battle these headwinds in order to sustain earnings per share and dividend per share growth. These include attempting to grow cigarette substitute businesses, including heated tobacco products and an oral tobacco business, regular price increases on its smokable tobacco products which enjoy very strong and sticky customer loyalty, and buying back shares.

While MO's long-term growth potential is still very much in doubt given its struggles with growing the company outside of its core cigarette business (including a disastrously expensive failed investment in JUUL), its core business is highly defensive, has a wide competitive moat, and continues to generate substantial free cash flow.

As the graph shows below, MO has reduced its share count meaningfully over the past decade while also more than doubling its dividend during that period. Furthermore, its free cash flow per share has increased by roughly double over that period as well and continues to comfortably cover its dividend:

While MO is undoubtedly an attractive income stock with its 8.5% projected NTM dividend yield and impressive dividend growth track record, the total return potential is a much more doubtful proposition.

Yes, the P/E ratio is attractive at just 8.9x compared to its five-year average of 10.7x and its EV/EBITDA also looks compelling at the moment at just 8.1x compared to its five-year average of 9.8x. Moreover, the stock price has floundered over the past year and is trading much closer to 52-week lows than 52-week highs:

However, it is important to keep in mind that MO's future growth prospects are very uncertain, and management has given little reason for investors to trust it with allocating capital effectively given its very poor performance with timing share repurchases and its ill-fated investment in JUUL.

Moreover, it financed its buybacks by taking on a heavy debt burden over the past half decade which will weigh on the company and limit its ability to invest aggressively moving forward, especially given how rapidly interest rates have risen over the past year.

Until management proves that it can allocate capital more effectively, we do not think MO warrants a Buy rating, though again, we understand its appeal as a high yielding investment.

#2. Universal ( UVV )

UVV is the world's largest leaf tobacco wholesale purchaser and processor of tobacco, operating as the middleman and import-export agent in between farms and smokable tobacco products.

While it has an impressive dividend growth track record that now exceeds five consecutive decades, given the aforementioned declines in the smokable tobacco industry, UVV is facing gloomy growth prospects.

That said, the positive side of things is that by operating from a strong competitive position in a gradually declining industry, UVV can manage its business for cash and return a lot of it to shareholders. While UVV's annual dividend growth is generally not significant, it has grown its dividend quite substantially over the past decade thanks to a large hike in 2019 as the result of a strategic review for the company:

While the dividend yield is pretty attractive at just under 6% and likely to continue creeping higher in the coming years, UVV's total return potential is even less appealing than MO's is in our view. It suffers from similar growth headwinds, but trades at a ~50% higher price to earnings ratio and its dividend yield is considerably lower. Moreover, its shareholder returns over the past decade have been quite lackluster and we see no evidence that they are likely to pick up anytime soon:

#3. 3M ( MMM )

MMM is a widely diversified industrial and consumer products business with ~60,000 products spread across four business divisions (Safety & Industrial, Healthcare, Transportation & Electronics, and Consumer). Moreover, it is a true multinational behemoth with operations and/or products in over 200 countries while employing ~95,000 people. The company operates through four divisions:

MMM has powerful competitive advantages which have fueled its 64 year dividend growth streak. These stem from its economies of scale, which give it lower per unit production costs, a more efficient and better diversified supply chain, a greater capacity to invest in research and development (thereby developing better products at a lower percentage of revenue than peers can), and the ability to invest more in marketing to enhance its brand power. As a result, it enjoys well-deserved sticky customer loyalty for its brands and has been able to generate relatively stable results through periods of economic disruption.

That said, in recent years it has struggled to grow earnings per share due to a plethora of headwinds ranging from supply chain headwinds, inflationary challenges, a slowing global economy, and costly litigation have weighed on the stock. As the chart below illustrates, MMM's normalized diluted earnings per share have gone nowhere over the past decade and neither has the stock price:

Moving forward, we do not anticipate earnings per share growth picking up in the near-term as an expected recession and ongoing litigation issues will likely continue to weigh down growth. As a result, while the 5.7% dividend yield looks appetizing for a business with such an entrenched competitive advantage, industry headwinds are just too much to make us want to invest at the moment.

#4. Leggett & Platt ( LEG )

LEG is a large industrials and consumer products manufacturer that produces products ranging from furniture and bedding components to die castings and other industrial products. While its industry is cyclical, management's astute capital allocation practices and careful balance sheet management have enabled it to achieve 51 years of consecutive dividend increases.

A recent example of this is LEG's focus on deleveraging its balance sheet fairly aggressively in recent years:

This - combined with its ~$1 billion in liquidity - puts it in much better position for dealing with current headwinds from inflation and a slowing economy. As management stated on the Q4 earnings call:

Our financial strength gives us confidence in our ability to successfully navigate challenging markets while investing in long-term opportunities.

Furthermore, their cash flow levels should be pretty strong in 2023, with management even stating on the earnings call that they "feel really confident about our cash flow generation." In addition, with management guiding for "definitely minimal participation in activity around share repurchases as well as M&A activity for the upcoming year" (which would provide up to $143 million in cash savings from 2022), the dividend should remain in fine condition.

In fact, they are guiding for a dividend payout of $240 million this year, which translates to a 4.7% increase relative to the total payout in 2022. As a result, it appears that they are planning to grow the dividend per share at a mid-single digit amount once again this year (though of course this could be revised downward if performance comes in on the low end of their wide-ranging guidance).

While there are no guarantees, the flexible balance sheet, 5.7% forward dividend yield, very impressive long-term dividend growth track record, and guidance for continued solid growth this year all make LEG an intriguing long-term contrarian play.

LEG is still battling current macroeconomic headwinds and faces ongoing short-term uncertainty. However, it remains well-positioned over the long-term with a strong balance sheet and battle-tested business model that has made it a Dividend King. When combining the attractive 5.7% current yield with an expected normalized earnings per share CAGR of 8.1% through 2027, the share price at the moment is opportunistic for patient investors and it remains an attractive Strong Buy in the Retirement Portfolio.

Investor Takeaway

Dividend Kings are proven business models that can make for great risk-adjusted income growers during challenging economic times. However, given their illustrious track records and strong reputations, it is rare to buy them on sale and there is almost always a good reason when they are available at attractive prices. In the case of the four highest yielding Dividend Kings of the moment, LEG is the only one that stands out to us as a compelling Strong Buy at the moment and therefore is the only one that we hold along with dozens of other high yield, high quality undervalued picks at High Yield Investor.

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