dividend growth investing with FMCG

Investing in consumer staples and FMCG for dividend growth investing

A new series – consumer staples and FMCG for dividend growth investing

One of my favorite sectors to invest in is the consumer staples – particularly focusing on the household products that we all need all of the time. In my mind, this turns into a good investment as the sales are enduring and there are many powerful brands here that consumers know and love and come back to time and time again. As an avid devotee of dividend growth investing, this provides me with comfort and security.

These links will be created and edited over time. This series will be relatively short articles, focusing on:

Unilever (UL) as a choice for dividend growth investing

One of my students used to work for this company and so I have some insights into the type of management and some of the opportunities here. What is undoubted is that the firm has had a long period of underperformance, relative to what I consider to be their nearest and closest competitor: P&G. As a consequence, P&G has performed better for most dividend growth investors, with more consistent growth of the distributions and enhanced capital appreciation and share price growth. These attributes are key reasons that I love dividend growth investing.

Over the last decade, I believe UL has made a number of strategic mis-steps, including the pursuit of the GSK line of consumer products, for which they likely would have over-paid. This would not have provided them with value, or at least required a far too long a period to recover the investments while slowly growing the new addition to the portfolio. The new CEO appears to be in a position where they are able to right the ship and return this to a more consistent firm.

In the last five years, the analyst estimates appear less shaky and, while earlier estimates were often poor (substantial misses against actual earnings performance), the recent several years of more successful estimates indicate that the company is providing more reasonable guidance and is operationally better equipped to meet these guidance’s with their operational changes. As such, I am placing a reasonable level of confidence on current analyst estimates for the future growth of earnings for UL. In line with past experience and wider industry growth, analysts expect just over 5% long-term earnings growth. This seems reasonable to me and should be achievable. They will continue to deliver on lower costs with the global focus on cost management and eliminating wastes. This should help to improve or maintain margins in the competitive marketplace. If there are further acquisitions, I would hope that they are judiciously pursued with a clear focus on the development of synergies in their portfolio and not an overly expensive brand that is brought into the fold.

As I note, over the last several years, this firm seems to be edging t into the right direction, with firmer estimates from analysts, fewer negative surprises from the firm, and steady and strong execution. In contrast, however, P&G has provided fewer analyst misses over the last decade with much stronger and consistency in their expected earnings. This consistency has made it a superior firm for the investor, coupled with enhanced dividend growth rates. Both P&G and UL are large enough to be core components of this segment of a portfolio, while other smaller (but possibly high-quality) firms, such as Church & Dwight, may perform better but often trade at higher valuations, with more growth opportunities, but also with more downside potential if the market becomes unstable or we enter a recession.

dividend growth investing to generate cash
dividend growth investing to generate cash

PE multiples

We can see that UL’s PE has reduced to a reasonable value of 13.7x. This is certainly not bargain territory, but UL has quality brands and a robust portfolio. (In contrast, during the GFC, they approached a PE of 9.25x, suggesting further PE compression is possible during tough times) While they could decrease further with additional market sell-offs, I doubt that it will be substantial as such FMCG firms tend to perform well and hold up well even in weaker economic periods. (Again, they sell what we all need, all the time!) this gives some confidence in the on-going earnings growth for the firm.

What can we expect over the next few years? As I note elsewhere, I am not looking for home runs from this company and I sincerely doubt that given the likely macroeconomic environment and the company performance that there will be  PE multiple expansion. As such, I would be happy with it continuing at the approximately same PE, with a near 9% pa growth over the next several years. I suspect that over the coming months the prices may slide a little further and  we may see the PE contract further, but this is not a significant problem for me as a long-term investor as I work to build a position and I am happy to average in a little further at these multiples.

If we get a return to the recent average PE ratios, at about 19-20x, then we may see a powerful total annual rate of return of nearly 16% pa for the next several years (Figure 1).

UL - dividend growth investing
Figure 1. UL PE chart with several years of analyst estimates and an estimated rate of return based on a return to historical PE ratios. Historical Graph – Copyright © 2011-2021, F.A.S.T. Graphs™ – All Rights Reserved

Operating margins

The firm reports an operating margin of 18.37% (Gurufocus), which reflects favourably against the wider industry. They have a ROC (beloved by Greenblatt) of 84.4% which, again, reflects well against the wider industry. For dividend growth investing, I like to see margins that are favorable relative to key competitors, as it provides assurance that they should be able to shift value to investors over time.

Dividends

They are currently at about 4.11% with just over a 6% CAGR over the last five years (SeekingAlpha). We do not expect strong or larger dividend growth rates in the near future with mid-single digit DGRs expected.

Future growth and return expectations

The Factsec analysts expect approximately 5.5% long-term earnings growth per year for the next five years. Yahoo Finance suggests 6.9%pa long-term earnings growth, which I think over-states the situation. On top of this, the stock has a 4.11% yield. This suggests that, over the next five years, we might expect annual returns of just under 10% pa, meaning that this is a steady-growing choice for dividend growth investing.

Investment thesis

This is a time where we can buy into a holder and manager of some of the most successful brands on the product that all people use all of the time. Ask your kids or nieces or nephews – they will know and be familiar with the UL brands. As such, I see UL as a timeless classic company that is currently trading at a reasonable valuation.

The current price provides a good entry point with some margin of safety and a good yield that provides a little buffer against further downturns. Over time, I expect the dividend to grow, albeit slowly, but it provides buffer and the opportunity to re-invest dividends received at a lower cost if the price declines further.

As an investment, this is not a portion of the portfolio that I expect to grow at a breakneck pace, surging ahead with strong gains. Instead, this is one of my safer positions with limited downside expected, but one that gives me the opportunity to grow my investment alongside a world-leading firm, seeking approximately 10% returns each year.

A new series – consumer staples and FMCG for dividend growth investing One of my favorite sectors to invest in is the consumer staples – particularly focusing on the household products that we all need all of the time. In my mind, this turns into a good investment as the sales are enduring and there…

A new series – consumer staples and FMCG for dividend growth investing One of my favorite sectors to invest in is the consumer staples – particularly focusing on the household products that we all need all of the time. In my mind, this turns into a good investment as the sales are enduring and there…

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