Certain sectors of the market lend themselves to creating great dividend stocks. That could be because demand is stable, margins are high, or the industry is experiencing strong growth. Examples include utilities, consumer goods companies and agricultural stocksthree of which we will discuss here.
Great Scots! (Wonder-Gro)
Founded in 1868, Scotts Miracle-Gro (SMG) is a manufacturer and distributor of various lawn and garden care products, as well as indoor and outdoor planting products worldwide. Scotts has three segments: US Consumer, Hawthorne, and others. Through these segments, Scotts offers a huge variety of products, such as its renowned lawn and grass care lines, fertilizers, weed control, pest control, plant nutrition, and certain hardware closely related to its core products, such as spreaders. Scotts owns many of the most recognizable brands in the space, including Earthgro, Ortho, Miracle-Gro, Roundup and of course Scotts.
The company should generate approximately $4 billion in total revenue this year and is trading at a market cap of $2.8 billion after a very large sell-off so far in 2022.
Scotts has built an enviable portfolio of consumable agricultural products that have generally increased in demand over time. This applies to the consumer-oriented portfolio of lawn care products, but in addition Scotts has a variety of products for growers who demand increasingly higher yields from their crops. The massive tailwind Scotts has seen from cannabis growers in recent years has abated and we think the much lower earnings base for this year can afford the company robust 7% EPS growth going forward.
Scotts has also managed to increase its dividend for 12 consecutive years, which is pretty good in an industry as cyclical as agricultural products. In addition, the average dividend increase over the past decade has been about 8%, so the company is serious about returning cash to shareholders. The payout ratio, despite all this growth, is still a little over half of earnings, and given the 7% earnings growth we forecast, we see dividend increases for Scotts for many years to come.
The dividend yield is now up to 5.2%, which is about three times that of the S&P 500, and a yield normally reserved for real estate stocks. Because the yield is as high as it is, as well as the relative safety of the payout, we see Scotts as a huge dividend stock today.
The stock is also trading at just 11 times this year’s earnings estimate, which is significantly lower than our fair value estimate of 15 times earnings. That could give shareholders a medium-single digit tailwind in the coming years as valuations rise. With all of these factors combined, we’re seeing over 16% total annual returns for Scotts in the coming years.
On and ADM!
Founder 120 years ago, Archer-Daniels-Midland (ADM) is a commodities giant that purchases, transports, stores, processes and distributes agricultural products worldwide. It has three segments: Ag Services and Oilseeds, Carbohydrate Solutions and Nutrition. Through these segments, Archer produces, stores, moves and distributes a huge variety of agricultural commodities, including corn, wheat, oats, barley, oilseeds, sweeteners, vegetable oils, animal feeds and more.
The company should generate approximately $98 billion in revenue this year and has a current market cap of $48 billion.
Archer has grown in demand over the years, thanks to its immense size and scale. The company is a dominant player in agricultural commodities in the US, and given the demand for food-related commodities in particular, we view the company’s business model as quite attractive for producing dividends over time. That has helped the company increase its dividend for a staggering 47 years in a row, making it a rare company not just among agricultural stocks, but in every sector in the market. Furthermore, the company’s average growth over the past decade is approaching 9%, meaning Archer scores high on both longevity and growth.
We see earnings growth of 5% going forward and the current payout ratio is only a quarter of this year’s earnings, meaning Archer’s dividend is extremely safe, but also has a very long runway for future growth. The current yield is only 1.9%, but that’s still about 30 basis points higher than the S&P 500, and Archer has a much better outlook for dividend growth than the broader market.
We estimate fair value at 14 times earnings, and stocks are just under 13 times today, indicating a modest valuation headwind. Combined with 5% earnings growth and a 1.9% return, we expect a total return of 8%+ in the coming years.
Our latest stock is Bunge Limited (BG), which operates globally as an agricultural and food company. The company has four segments: agribusiness, refined and specialty oils, milling and sugar and bioenergy. Through these segments, the company supplies a wide variety of products, including oilseeds, grains, protein meals, bulk oils and fats, flours, cornmeal and more.
Founded in 1818, the company has grown to approximately $69 billion in annual sales and $13.6 billion in market capitalization in the two centuries since its founding.
Like Archer, Bunge’s highly diversified agricultural trading activity lends itself to consistency. Bunge has a long list of commodities in its portfolio that cover a wide variety of applications, and the demand for these commodities continues to grow over time. Of course there are periods of cyclicality, but we believe the company’s dividend outlook is favourable.
The current series of dividend hikes will only last two years, but that’s because Bunge has paused its dividend hikes during the pandemic. There was never a reduction, but it went a year without an increase. Still, despite this pause, the past decade has seen an average dividend growth rate of 9% per year, so Bunge is considered a strong dividend stock despite its modest streak.
Bunge’s current earnings are historically high, so we see a slight contraction in earnings in the coming years. However, earnings per share rose from $1.75 in 2019 to $13.64 last year, so the extremely high base means a slight contraction is far from problematic.
That also means that the payout ratio is only 21% of this year’s earnings, so we view the dividend as very safe and with a lot of room for future growth. The current yield is also respectable at 2.8%, so it’s a well-rounded dividend stock.
We’re seeing a fair value of 10.5 times earnings, and today stocks are trading at just over 7 times. That could provide a strong tailwind, and in combination with the contraction in profits and returns, we expect a total annual return of about 8% in the coming years.
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