Which Household Products Stock Is Most Attractive?

CL, CLX, KMB, PG, UL.  Titans of dividend growth investing.

Key Brands

Long term investors are attracted to companies with brand power that sell every day products consumers have to buy whether the economy is reaching new heights or we're stuck in the middle of a recession.  While I don't know which brand of smart phones consumers will favor 20 years from now, or what social media site will be all the rage.  I can tell you with certainty we will still brush our teeth, do laundry, wash our hair, and clean are homes.  Companies that sell these types of products are boring and will not make you rich over night.  In fact they usually command a higher than average valuation, which makes sense because the stock market loves certainty. 

What sets these companies apart from other consumer staples stocks (in my my mind) is the very nature of the products sold.  With cigarettes (MO, PM, LO) you have to deal with declining smoking rates and draconian government interference.  Sodas (KO, PEP) seem to face headwinds as consumers become more health conscious and move away from sugary beverages.  Staples retailers such as WMT appear to be doing well right now, but the industry is littered with failing businesses (K-Mart anyone?).  Look at the products and brands these household products companies sell.  If you're looking for a high quality company to hold the next 2-3 decades, here are some ideas:

Colgate-Palmolive (CL): Colgate, Palmolive, Softsoap, Fabuloso, Irish Spring, Speed Stick.
Clorox (CLX): Clorox, Pine-sol, Liquid Plumr, Kingsford, Glad, Brita, K.C. Masterpiece, Hidden Valley.

Kimberly-Clark (KMB): Kleenex, Scott, Huggies, Kotex, Depend, Poise, Viva, Cottonelle.  KMB has a professional division which include products such as napkins you might find at a food court and also has a healthcare business it plans to spin off into a separate company.

Procter & Gamble (PG): Tide, Gillette, Duracell, Crest, Pantene, Old Spice, Ivory, Charmin, Tampax, Pampers, Mr. Clean, Bounty, Swiffer, Febreze, Dawn, Cascade, Ariel, Gain, Pepto Bismal, Scope, Oral-B, Metamucil, Vicks, Bounce, Head & Shoulders, Herbal Essences, Cover Girl, Olay.  PG recently sold its Iams pet food business in an attempt to improve margins.

Unilever (UN/UL): Dove, Axe, Lux, Ponds, St. Ives, Surf, Tressemme, Vaseline, VO5, Ben & Jerry's, Bertolli, Hellman's, Knorr, Lipton.  Unilever is moving away from foods.  It is currently selling Ragu spaghetti sauce and sold Skippy peanut butter last year.

Valuation

CL: 20.6 times forward earnings

CLX: 20.1 

KMB: 16.8 

PG: 17.6 

UL: 18.5 

Colgate and Clorox are clearly the most expensive from the group based on current prices and forward earnings guidance.  I don't follow CLX and I'm actually really surprised to see it's almost as expensive as Colgate!  KMB stock should provide the most earnings per invested dollar.  Always important.

Capital Structure

CL:  80.3% debt / AA credit rating

CLX: 98.0% debt / A- 

KMB: 57.5% debt / A 

PG: 34.4% debt / AA 

UL: 44.5% debt / A+ 

As you can see from the credit ratings, all these companies are high quality and will not be going out of business anytime soon.  PG has the best balance sheet which is also backed by its AA credit rating.  CLX's use of heavy leverage is the reason I don't follow the company.  In general I prefer low leverage since I'm a conservative investor.  That said, if I was going to lever the hell out of a business, it would be something stable like a consumer products or an utility company.  Investors who are more daring might not be as concerned.

Growth (3-5 yr EPS growth estimates)

CL: 8.9%

CLX: 6.4%

KMB: 6.9%

PG: 8.4%

UL: 1.5%

This all important metric is what will fuel higher dividend payments in years to come for income investors like myself.  It will also fuel capital gains/total return for traders & those who plan to fund a retirement with asset sales.  I took the listed numbers from Fidelity.com, but it's important to note analysts are sometimes a bit too optimistic.  I look at it from more a relative basis meaning I would expect CL earnings to grow faster than the others, and UL's earnings to improve at the slowest rate.  With that in mind, analysts aren't terrible and they certainly have more insight than I do!  Anyways Colgate is expected to grow the fastest which might explain the high p/e.  Not looking so good for UL.  Deal breaker.

Dividend Safety

CL: 50.3% payout ratio

CLX: 68.0%

KMB: 58.2%

PG: 63.3%

UL: 66.4%

To calculate payout ratios I didn't use the standard trailing twelve month earnings you'll see plastered all over finance sites.  Those numbers are filled with one time restructuring costs, one time settlements, asset sales, and a bunch of other junk that will not affect a business moving forward.  Basically I don't trust those numbers and I want to use something better.  Instead I used Fidelity's adjusted actuals which strips out the one time events.  For example, Starbucks (SBUX) has a p/e ratio of 381 using the standard GAAP number.  Does that sound reasonable to you?  My way it has a p/e ratio of 30.5  Anyways the same principles work with payout ratios or anything based on trailing EPS. 

Dividends from each of these companies are safe at current levels, but as a whole I expect EPS growth to match or slightly outpace dividend growth from this point forward.  That trend seems to already ready be under way with lackluster increases from KMB and CLX this year.  Colgate has a bit more wiggle room.

Dividend Payments

CL: 2.12% yield / 51 year dividend growth streak

CLX: 3.28% / 37 years

KMB: 3.04% / 42 years

PG: 3.23% / 58 years

UL: 3.46% / 34 years

Since I invest for the sole purpose of building an income stream, I need to get paid!  Overall it's really easy to find a yield over 3% in this industry.  Take your pick with the exception of Colgate.  

A reader (thanks Mark!) emailed me evidence showing Unilever actually has a 34 year streak in British pounds.  Anyways these companies are all dividend champions with crazy streaks compared to average dividend stocks.

Conclusion

At current levels I'm most interested in KMB and PG.  PG most of all.

PG has a reasonable valuation compared to peers, a rock solid balance sheet, decent EPS growth expectations, and a safe dividend paying more than 3%.  I will consider adding additional PG shares to my portfolio if prices remain under $82.  Hopefully under $80... better yet $75.

I think CLX and UL are the worst options given current prices.

Finally valuations and expectations do change over time.  That's why I periodically check up on companies and recalculate fair values.  I did grab some Unilever shares a few months ago when its p/e ratio was lower and growth estimates were more optimistic.  I'm still not impressed with Clorox.  No plans to add it to my portfolio or watch list at this time.  Perhaps another day...

The Most Expensive Stocks I Follow

#1) Automatic Data Processing
ADP looks especially hideous right now.  At 22.8 times forward earnings, it's pretty hard to justify buying new shares of this business. ADP recently lost its AAA credit rating which didn't seem to phase the stock price one bit.  I was hoping the credit downgrade might spook investors into selling (so I could pick up some shares).  Guess I'll have to keep waiting for an opportunity to add this one.  That day may never come...

#2) Colgate
CL is a fantastic company, and you can expect to pay a premium if you want to own shares of this business.  At 20.6 times forward earnings the premium price is getting a bit stretched... even by CL standards.  I already own PG & UL and don't have room for this one anyways.

#3) Aqua America
Man, I'd really really like to grab shares of WTR, but at 19.7 times forward earnings, that dream will not become a reality anytime soon. I'm saving a spot in my portfolio for WTR, and if it declines 10-15% I might get interested.

#4) American States Water
This company is slightly cheaper than WTR with a 19.6 forward p/e, but then you have to consider its PEG ratio is an absolutely terrible 20.6.  That's outrageously bad.  Apparently water utilities will have to be put on hold for a while.  Yuck!

#5) Sysco
A 19.5 forward p/e for SYY?  No thanks.  The only saving grace here is that it does have a juicy yield of 3.1%, unfortunately that's really low by Sysco standards.

#6) Air Products & Chemicals (APD) 19.4 times forward earnings
#7) Walgreens (WAG) 19.1 times forward earnings.  Does have a PEG ratio of 1.5 to make up for it.
#8) Compass Minerals (CMP) 18.7 times forward earnings
#9) Dominion Resources (D) 18.7 times forward earnings
#10) Coca-Cola (KO) 18.3 times forward earnings

I didn't include REITS or MLPs in this list.

Weekly Purchase - BAX

4 shares BAX, 2.82% yield, $8.32 annual income

Picked up some new Baxter shares this week.  BAX trades for a very reasonable 14.3 times forward earnings and will contribute to my passive income stream with a healthy yield above 2.8%.  Unfortunately BAX went ex June 4th so this batch of shares won't start paying till Q4. That's okay because I believe shares of the business should be worth $80.  Therefore a small discount might be available right now. Calculating fair values isn't an exact science, but I do prefer to accumulate shares that appear discounted when possible.

Baxter plans to spinoff its biopharmeceutical business into a separate company next year.  The rationale is that two separate companies will be more profitable long term than if they remained as one.  Ok... Maybe they will be better off as two, or maybe not.  I'm buying shares of Baxter as a business right now, not because I think I'll make out like a bandit because of a spinoff.  That said, recent spinoffs (COP/PSX, ABT/ABBV) worked out well.  I ended up selling PSX and ABBV.  I don't regret selling Abbvie with its looming patent cliff at all.  Certainly not a sleep well at night stock.  But boy do I ever regret selling PSX!  Huge mistake on my part.

BAX now has a 1.65% income weight.  I'm not opposed to adding more shares.

Today's purchase was commission free.  I currently have 8 free trades left and plan to use 4 during June / 4 during July.

Symbol: BAX
Core Position: No
Speculative Position: No
Expectations: Steady income; 7% (average) annual dividend growth
Automatic Sell: Dividend cut (post spinoff), frozen dividend (post spinoff)
Consider Selling:  Business fundamentally changes, management becomes untrustworthy, fundamentals deteriorate, wildly over valued stock price, or position fails to meet expectations

1 share GE, 3.29% yield, $.88 annual income (FRIP purchase from last week)

Weekly Purchase - DE

3 shares DE, 2.63% yield, $7.20 annual income

I purchased new Deere shares today being very impressed with last week's dividend boost.  DE trades at 11.9 times forward earnings which is pretty darn cheap on an absolute basis.  It comes standard with a very attractive yield of 2.6%, especially when you consider that over the past 5 years Deere's yield averaged only 2.0%.

I calculate shares to be worth approximately $103.50.

The catch is that DE is highly cyclical.  Earnings are actually supposed to decline the next few years.  During the past twelve months EPS was a solid $9.15 per share.  However DE is expected to earn $8.51 in fiscal year '14, then $7.69 in fiscal year '15.  That being said, I really like this business as a long term investment.  The fact is the world's population and standard of living will only rise over time.  A nice tailwind for farm equipment manufacturers like John Deere.  You'd have to think they'll be selling more tractors 20 years from now.  I could be wrong, but it's hard for me to imagine a different scenario.

Anyways Deere maintains a very low payout ratio because it places more emphasis on stock buybacks and because earnings fluctuate so much.  Management isn't stupid, this business doesn't sell steady demand products such as toothbrushes and toilet paper.  I expect dividends will continue to grow over time, but I'm prepared for sporadic intervals which I wouldn't tolerate from other holdings.

DE now has an income weight of only 0.48% for me.

Symbol: DE
Core Position: No
Speculative Position: No
Expectations: Steady income; 8% (average) annual dividend growth
Automatic Sell: Dividend cut
Consider Selling:  Frozen dividend, business fundamentally changes, management becomes untrustworthy, fundamentals deteriorate, wildly over valued stock price, or position fails to meet expectations

May Recap

I believe I did an okay job selecting moderately attractive stocks in an otherwise heated market this month.  You'd have to think prices might plummet some time soon, yet nobody really knows for sure.  Even if stock prices do end up declining, I'll still be on track to meet my 2014 financial goals because a falling stock market doesn't affect an income stream.  In fact a correction would only make my job easier.

AT&T became my first holding to pay $1,000 dividend income.  It doesn't surprise me that T achieved the milestone first since it has a high yield and is one of my oldest positions.   I originally acquired a piece of the business late 2010 then purchased more the following year.  LTC Properties is set to power through the $1,000 mark during June, but past that one it ought to be a while for the rest.

DOW: 16,717 /// S&P 500: 1,924 /// 10-YR BOND: 2.46%

New Purchases:
1) 14 shares OMI at $31.75: $14.00 annual income
2) 17 shares GE at $26.74: $14.96
3) 6 shares PG at $79.79: $15.44
4) 20 shares SBSI at $25.595: $16.80
5) 15 shares GE at $26.47: $13.20
6) DRIP: 1.490 shares OHI: $2.98

Sales:
none

Dividends Received: $440.47
AT&T (T) $84.18
Deere (DE) $4.59
General Mills (GIS) $28.92
Raytheon (RTN) $34.49
iShares Emer Mkt Bnd (EMB) $2.49
Air Products (APD) $23.87
Abbott Labs (ABT) $12.98
Omega Healthcare (OHI) $52.97
Procter & Gamble (PG) $50.20
Realty Income (O) $15.69
Realty Income Series F (O-PF) $6.76
Kinder Morgan, Inc. (KMI) $68.04
HCP (HCP) $26.71
LTC Properties (LTC) $28.58

Dividend Increases:
1) BAX: $.49 to $.52 per quarter: $5.28 annual income
2) DE: $.51 to $.60 per quarter: $3.24
3) SBSI: $.20 to $.21 per quarter: $3.36
4) TU: $.36 to $.38 (Canadian) per quarter: ~$5.28

New Deposits:
$1,700 to taxable account, $100 to Lending Club

Lending Club Interest:
$13.58

Stock Split:
SBSI (21:20) gained 4 new shares since Fidelity was gracious enough to round up from what would have been 3.57 shares.  This is the third 5% stock split while SBSI has been part of my portfolio.

Deere (DE) Dividends No Longer Frozen

Today Deere & Co (DE) announced it raised dividends 17.6% from $.51 to $.60 per quarter.

I do not intend to write a post about every dividend raise; it's way too tedious.  I do have interests besides investing by the way :) However this one is important to me because the dividend was technically frozen back in February.  I'm happy to see payouts are growing once again because it gives me confidence to increase my position.  DE now has an income weighting of only 0.36% so I need to more than quadruple it.

It's a shame this announcement wasn't released yesterday.  I think shares are undervalued and would have bought more.

Weekly Purchase - GE

15 shares GE, 3.32% yield, $13.20 annual income

My final May purchase is General Electric.  I continue to think GE is a half way decent buy at current levels.  No, it's not a steal but it does trade at a most reasonable 14.5 times forward earnings.  I think shares of the business are worth about $27.50 so perhaps I got in with a small margin of safety this week?  Again these are not bargain prices in my opinion, but I don't think I'm paying a premium either.

At any rate GE comes with a juicy yield over 3% which should grow faster than inflation.  My objective as an income investor is to replace employment income with investment income.  Nothing more.  Nothing less.  While I always wish the stock market would go down, I can and will achieve my goals even if Mr. Market won't cooperate.  These GE shares are certainly valuable towards building passive income and a passive income stream is what I'm about!

General Electric is now weighted .76% (by income) for me and I'd ultimately like to for it to be weighted around 1.5% to 2.0%.

1.49 shares OHI, 5.63% yield, $2.98 annual income (DRIP purchase)

OHI is the only stock I DRIP simply because it offers a dividend reinvestment discount.  I actually received a dividend of $52.97 from the company, but a 1% discount was applied so $53.50 worth of new shares were credited to my account.  Well that's nice and all (love me some discounts), but I think I'll have to stop DRIPing Omega.  It has a 3.57% weight (by income) which is too high for a non core stock.  Think I'll take dividends in cash and use it to maintain a better income balance moving forward.  One thing I seriously hate about DRIPs is that they make portfolio balance difficult to maintain.  Especially with high yielders.

The money I deposit each month is now less than 1% portfolio value.  Since that barely moves the needle I feel I need to start paying closer attention to weightings.  That said, I think I can achieve the weightings I want over time without rebalancing.