Category: Dividend Stocks

Companies return profits to shareholders through two main channels, capital gains and income. A high dividend yield indicates that a company is returning a large amount of cash to shareholders relative to the value of the company. This allows investors to maximize their income received relative to their investment amount. The gross dividend is calculated from the net dividend amount paid to shareholders plus the value of any attached franking credits associated with those dividends. A fully franked dividend will have franking credits equal to 30% of the gross dividend value, which can, therefore, represent a significant source of additional value.

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Dividend Stocks Expert Insights

Ferguson’s coverage to the RMI market enhanced from 31% to 60%

Business Strategy and Outlook

In the United States, Ferguson primarily serves three major end markets: repair, maintenance, and improvement, new construction, and civil infrastructure. Between 2008 and 2020, Ferguson’s exposure to the RMI market increased from 31% to 60%, while new construction decreased from 58% to 32%. Increased exposure to the U.S. RMI market will benefit the company because elevated demand for repair and remodel services due in part to aging housing stock. While the repair and remodel market are less cyclical than new construction, it still tracks housing construction activity. It is projected total housing starts to average approximately 1.6 million units annually this decade, which is above the historical long-run average. 

Ferguson has built leading positions in many different end markets through its roll-up acquisition strategy. The company typically acquires local competitors, gaining access to new brands, suppliers, regions, and customers. Ferguson is projected to continue this strategy, which should augment its scale-driven competitive advantage. Ferguson’s pricing strategy has transformed from being primarily localized to more standardized across the group over the past decade. In the past, branch managers had more discretion over pricing to react to local competitive dynamics. Today, the company employs a more disciplined approach to pricing, allowing it to take better advantage of its economies of scale. 

Ferguson sold its Wolseley U.K. business for approximately $420 million in February 2021. This business struggled to generate value for the group despite being one of the largest distributors in the United Kingdom. There were very few synergies between geographies and little overlap in suppliers. Ferguson’s strategic shift to the United States will be a tailwind for the firm’s prospects, and the listing on the New York Stock Exchange (shares began trading in March 2021) could increase interest from U.S. investors. Shareholders will vote on a U.S. primary listing in spring 2022.

Financial Strength

Ferguson set out to clean up its balance sheet following the great financial crisis, and it improved net debt/EBITDA from 3.5 times before the 2008 crisis to 0.6 times as of Oct. 31, 2021. Net debt at the end of the first quarter of fiscal 2022 (October 2021) was $1.4 billion. Ferguson’s strong balance sheet gives management the financial flexibility to run a balanced capital allocation strategy that augments growth with acquisitions but also returns cash to shareholders. In terms of liquidity, the company can meet its near-term debt obligations, given its strong cash balance. Its cash position at the end of the first quarter of fiscal 2022 stood at $2.2 billion. Ferguson’s ability to tap available lines of credit to meet any short-term needs is making the scenario comforting. The countercyclical nature of industrial distributors’ free cash flow generation, which results from the ability to drawdown inventory during times of economic malaise is also encouraging. Ferguson generated over $1 billion of free cash flow during the great financial crisis, and we expect current economic weakness to push free cash flow levels materially higher as working capital requirements ease. In our view, Ferguson enjoys a strong financial position supported by a clean balance sheet and strong free cash flow prospects.

Bulls Say’s

  • Ferguson’s roll-up strategy in the U.S. should lead to market share gains, boosting revenue growth more than the market average. 
  • Ferguson’s strategic shift to the U.S. away from international markets has strengthened group operating margins. 
  • Ferguson generates strong free cash flow throughout the economic cycle despite serving cyclical end markets

Company Profile 

Ferguson distributes plumbing and HVAC products primarily to repair, maintenance, and improvement, new construction, and civil infrastructure markets. It serves over 1 million customers and sources products from 34,000 suppliers. Ferguson engages customers through approximately 1,600 North American branches, over the phone, online, and in residential showrooms. In fiscal 2021, Ferguson derived 94% of its nearly $23 billion of sales in the U.S. According to Modern Distribution Management, Ferguson is the largest industrial and construction distributor in North America. The firm sold its U.K. business in 2021 and is now solely focused on the North American Market.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Fastenal Co.: To fund a shareholder-friendly capital allocation strategy

Business Strategy and Outlook

Since opening its first fasteners store in 1967, Fastenal has built one of the largest industrial distribution businesses in the United States. For many years, Fastenal’s growth story was driven by its branch count, which now stands at approximately 1,900. While this expansive footprint is still an important component of Fastenal’s business model, other strategies–including expanding its product portfolio, its vending and inventory management services, and most recently, its on-site program–have become increasingly important growth drivers. 

The benefits of Fastenal’s vending, inventory management, and on-site services are twofold: Not only do these services drive incremental revenue, but they also embed Fastenal in its customers’ procurement processes, which supports higher retention rates and pricing power. Fastenal has a first-mover advantage in both vending and on-site services, introducing the former in 2008 and the latter in 1992 (although the on-site strategy did not become a focused strategy until the past few years), and we see long growth runways for both offerings. In addition to growth through its vending and on-site initiatives, Fastenal is well positioned to benefit from customer consolidation trends. In recent years, customers have been consolidating their maintenance, repair, and operations, or MRO, spending with large distributors to leverage their purchasing power and increase operational efficiency. With its national scale, broad product portfolio, and inventory management services, Fastenal can capitalize on this trend and take market share from smaller and less capable distributors. 

Because Fastenal’s sales mix is increasingly skewing more toward large national accounts, on-site programs, and more price-competitive MRO products, the company’s gross margins are likely to come under pressure. However, the combination of higher sales volume and containment of selling, general, and administrative costs provide Fastenal the opportunity to realize strong operating leverage and expand operating margins. It is forecasted Fastenal’s operating margin to reach 21% by our midcycle year.

Financial Strength

Fastenal has an outstanding debt balance of approximately $405 million. It is leveraged at only 0.3 times 2021 EBITDA, which is very conservative relative to the other industrial distributors. Fastenal’s earnings provide substantial headroom to service debt obligations. During fiscal 2020, Fastenal incurred only about $10 million of interest expense and generated about $1.3 billion of EBITDA, which equates to an extremely comfortable interest coverage ratio. Even with its expansive store footprint and cyclical end markets, Fastenal has a proven ability to generate free cash flow (defined as operating cash flow less capital expenditures) throughout the cycle. Indeed, it has generated positive free cash flow every year since 2003. Given its conservative balance sheet and consistent free cash flow generation, we believe Fastenal’s financial health is satisfactory.

Bulls Say’s

  • Vending and on-site programs should provide a long growth runway for Fastenal. 
  • Fastenal can capitalize on its national scale, broad product portfolio, and inventory-management services to take market share from smaller and less capable distributors. 
  • Despite serving cyclical end markets, Fastenal’s business model generates strong free cash flow throughout the cycle. Fastenal is likely to continue to use its cash flow to fund a shareholder-friendly capital allocation strategy.

Company Profile 

Fastenal opened its first fastener store in 1967 in Winona, Minnesota. Since then, Fastenal has greatly expanded its footprint as well as its products and services. Today, Fastenal serves its 400,000 active customers through approximately 1,900 branches, over 1,300 on-site locations, and 14 distribution centers. Since 1993, the company has added other product categories, but fasteners remain its largest category at about 30%-35% of sales. Fastenal also offers customers supply-chain solutions, such as vending and vendor-managed inventory.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

JM Smucker Co: At Home Food giving Gains against Market Shares Stabilization still a Hindrance

Business Strategy and Outlook

Despite having leading positions in many categories (fruit spreads, peanut butter, dog treats, coffee, and cat food) it is seen Smucker lacks an economic moat, either via its brand intangible assets or entrenched retail relationships. It is anticipated that for most of its sales base, Smucker does not possess pricing power and its market shares are slipping. This dilemma cannot be attributed to a lack of support, as Smucker’s brand investments exceed that of its peers (with marketing and R&D averaging 7.4% of sales the last three years compared with 5.4% for peers). Rather, it is perceived these expenditures are not as productive as its competitors, a problem not easily resolved in long interpretation.

It is assumed Smucker’s organic sales growth will average 2% annually over the long term, slightly less than the growth that was seeming for the total at-home food and beverage industry. It was foreseen market share losses in coffee and dog food to persist (Smucker’s two largest categories, at 47% of sales), as Smucker struggles to compete with strong brands such as Starbucks (licensed by wide-moat Nestle) and BLUE (owned by narrow-moat General Mills). Further, the fruit and nut spread categories, another 15% of sales, exhibit minimal growth. Even so, 2% growth represents an improvement from the modest declines in organic sales the firm realized before the pandemic. It is contemplated Smucker will be one of the few packaged food companies to realize lasting benefits from the pandemic, given the high-single-digit increase in pets adopted during the crisis and the likelihood that more flexible work arrangements should result in higher consumption of at-home coffee. This impact will not be immaterial, as collectively, pet food and coffee compose nearly 70% of Smucker’s sales. Further, Smucker’s sales trajectory should improve as Uncrustables (5% of fiscal 2021 sales) becomes a greater portion of the mix, as the brand has grown double-digits in each of the past several years. In addition, recent and pending divestitures of slower-growing brands (Crisco, Natural Balance, private label dry pet food, juices, and grains) should further improve Smucker’s ability to accelerate its top-line growth

Financial Strength

After years of a conservatively leveraged balance sheet, with net debt/adjusted EBITDA consistently below 2 times, the Big Heart Pet Brands acquisition in 2015 increased the ratio to above 6. Smucker paid $5.9 billion for the business, 13 times EBITDA, it is believed to be rich, particularly considering the acquired brands’ poor positioning in the category. It is interpreted management was prudent in its decision to sell the nonstrategic canned milk business shortly thereafter for $194 million to free up capital in order to accelerate debt reduction. Share repurchases were also significantly curtailed in 2015, which could be seen as sensible. Net debt to adjusted EBITDA declined to a manageable 2.8 times by 2018, though it is anticipated, before the firm announced it was acquiring pet food producer Ainsworth for $1.9 billion, which increased leverage to 3.5 times in 2019 before falling to 2.4 times in fiscal 2021. Smucker’s free cash flow (CFO less capital expenditures) as a percentage of revenue has averaged high single digits to low double digits historically, and it is supposed similar results going forward. Smucker seeks to invest half of its capital in growth initiatives (capital expenditures and acquisitions) and return half to stakeholders via dividends, share repurchase, and debt reduction. While it is foreseen Smucker will invest 3.5% of annual sales in capital expenditures over the long term, we model an elevated level of investments in the next two years as the firm adds Uncrustables capacity. We think Smucker will continue to reshape its portfolio through acquisitions and divestitures, although we have not modeled unannounced transactions. We think Smucker’s dividend payout ratio will range between 40% and 50%, in line with management’s long-term targets, it is anticipated 2%-6% annual dividend increasing. It is estimated Smucker to repurchase 0%-5% of shares annually, which is seen as a prudent use of capital if the share price remains below fair value estimates.

Bulls Say’s

  • Smucker’s sales trajectory should improve over time due to the divestiture of slow-growing brands and the increasing mix of Uncrustables, which grows at a double-digit pace.
  • During the pandemic, consumers adopted 11 million pets and purchased 3 million coffee machines, which should provide a lasting benefit for categories representing nearly 70% of Smucker’s fiscal 2021 sales.
  • Executive leadership changes (newly created chief operating officer role, leadership changes for the U.S. sales organization and the pet food segment) should improve execution and enhance accountability.

Company Profile 

J.M. Smucker is a packaged food company that primarily operates in the U.S. retail channel (88% of fiscal 2021 revenue), but also in U.S. food-service (5%), and international (7%). Its largest segment is pet food and treats (36% of 2021 revenue), with popular brands such as Milk-Bone, Meow Mix, 9Lives, Kibbles ‘n Bits, Nature’s Recipe, and Rachael Ray Nutrish. Its second-largest category is coffee (33% across channels) with the number-two brand Folgers and number-six Dunkin’. Other large categories are peanut butter (10%), with number-one Jif, fruit spreads (5%) with number-one Smucker’s, and frozen hand-held foods (5%) with number-one Uncrustables.

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

AstraZeneca’s Continual Focus on Innovative Drug Development Increasingly Sets Up Strong Growth

Business Strategy and Outlook

AstraZeneca has built its leading presence in the pharma and biotech industry on patent-protected drugs. The replenishment of new drugs is offsetting the past patent losses on gastrointestinal drug Nexium and cholesterol reducer Crestor, and the company is well positioned for growth.

AstraZeneca’s pipeline is emerging as one of the strongest in the drug group, and we think the company is developing several key products that hold blockbuster potential. These drugs should also carry strong pricing power, driving the potential to expand Astra’s margins. In addition to internal development, AstraZeneca has aggressively pursued acquisitions, with mixed results. 

As Astra’s next generation of drugs launch, Morningstar analysts expect operating margins to improve based on the strong pricing power of the new drugs and the operating leverage the firm should attain as the new drugs reach critical mass. Also, as the new drugs launch, Astra is reducing the asset divestiture strategy it employed to help bridge the massive patent losses facing the firm over the past few years until the newer drugs were ready. While the asset sales helped prop up earnings and support the dividend during a challenging time, the strategy is not sustainable. As new drugs gain traction, Astra will likely continue to reduce the asset sales, which is strategically sound but will likely create a headwind to earnings growth.

AstraZeneca’s Continual Focus on Innovative Drug Development Increasingly Sets Up Strong Growth

After a deep dive review of several of AstraZeneca’s current and pipeline products, Morningstar analysts have increased their projections for several drugs leading to a fair value estimate increase to $64 from $60. Analysts have continued to view the company with a wide moat, supported by a strong pipeline and a relatively secure current portfolio with limited near-term patent losses.

In looking at the pipeline, we are increasingly bullish on several next generation drugs. In particular, the recent approval of severe asthma drug Tezspire looks like a potential new blockbuster. Also, breast cancer drug camizestrant holds significant potential despite an increasingly crowded area of competitive SERD drugs in development but so far, the data  for the drug looks increasingly solid. 

Financial Strength

Astra continues to generate robust cash flows, and the firm’s balance sheet is in solid shape, closing 2020 with debt/EBITDA of close to 2.4 times. However, the firm needs to offset lost cash flows from products losing patent protection over the next couple of years to generate enough cash flow to fund the dividend. Morningstar analysts expect the recently announced acquisition of Alexion to add close to $16 billion in debt on the balance sheet, but it is expected that the strong acquired drugs will produce robust cash flows to quickly pay down the acquisition-related debt.

 Bulls Say 

  • The company is expanding its oncology presence with several important pipeline products. In particular, the company’s EGFR drug Tagrisso holds major blockbuster potential in lung cancer. 
  • The management team is focusing the pipeline toward unmet medical need, which should increase the odds of success and being strong pricing power for the new drugs. 
  • AstraZeneca has a large presence in emerging markets and should benefit from these markets’ fast growth prospects, especially in China

Company Profile

A merger between Astra of Sweden and Zeneca Group of the United Kingdom formed AstraZeneca in 1999. The firm sells branded drugs across several major therapeutic classes, including gastrointestinal, diabetes, cardiovascular, respiratory, cancer, and immunology. The majority of sales come from international markets with the United States representing close to one third of its revenue.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks Expert Insights

AbbVie’s Next Generation Drugs Are Poised to Help Mitigate Upcoming Humira Biosimilar Pressures

Business Strategy and Outlook:

While AbbVie holds a strong portfolio of marketed and pipeline drugs, the increasing competition to the company’s key drug Humira should slow the growth for the company. At close to 40% of total sales and a higher portion of earnings (due to higher margin revenue), Humira is a key determinant of AbbVie’s earnings performance over the next three years.

Beyond immunology, cancer drug Imbruvica is the next-biggest sales contributor. Imbruvica’s strong clinical data in several forms of blood cancer should lead to peak sales above $6 billion. Additionally, the recent acquisition of Allergan brings several new products, including Botox for both cosmetic and therapeutic uses. Botox’s strong entrenchment bodes well for the treatment as new competition is emerging. Also, AbbVie holds several mature drugs with patent expirations long past, but with manufacturing or specific dosing complexities, which make generic competition less likely. Looking forward, AbbVie’s pipeline is weighted more toward new cancer and immunology drugs. The company should be able to leverage its solid entrenchment with Humira and Imbruvica to launch the new drugs.

Financial Strength:

AbbVie’s acquisition of Allergan significantly increased its debt level. The firm’s net debt position to peak at close to $70 billion in 2020, but given the strong cash flows of AbbVie’s base business and the acquired cash flows from the Allergan deal, the firm is expected to rapidly pay down debt while still financing the dividend. However, it is not expected that AbbVie will have much room to make any other significant acquisitions for several years while capital is tied up paying down debt and funding the robust dividend.

Bulls Say:

  • AbbVie supports a strong dividend yield, which should act as valuation support, as the cash flows to support the dividend look secure over the next few years. 
  • AbbVie’s increasing entrenchment in blood cancers should bode well for growth as pricing power remains solid in this therapeutic area of the pharmaceutical market. 
  • AbbVie’s next generation immunology drugs targeting the IL23 and JAK pathways should help mitigate the competitive threats facing Humira.

Company Profile:

AbbVie is a pharmaceutical company with a strong exposure to immunology and oncology. The company’s top drug, Humira, represents close to half of the company’s current profits. The company was spun off from Abbott in early 2013. The recent acquisition of Allergan adds several new drugs in aesthetics and women’s health.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Smucker Continues to Benefit From At-Home Food Consumption but Struggles to Stabilize Market Shares

Business Strategy and Outlook

Despite having leading positions in many categories (fruit spreads, peanut butter, dog treats, coffee, and cat food) Morningstar analysts believe that Smucker lacks an economic moat, either via its brand intangible assets or entrenched retail relationships. Morningstar analysis shows that for most of its sales base, Smucker does not possess pricing power and its market shares are slipping. This dilemma cannot be attributed to a lack of support, as Smucker’s brand investments exceed that of its peers and suspected that these expenditures are not as productive as its competitor.

Morningstar analysts expect that Smucker’s organic sales growth will average 2% annually over the long term, and it is also expected that market share in coffee and dog food will persist as Smucker struggles to compete with strong brands such as Starbucks  and BLUE. As per Morningstar analyst perspective, Smucker will be one of the few packaged food companies to realize lasting benefits from the pandemic, given the high-single-digit increase in pets adopted during the crisis and the likelihood that more flexible work arrangements should result in higher consumption of at-home coffee. This impact will not be immaterial, as collectively, pet food and coffee compose nearly 70% of Smucker’s sales. Further, Smucker’s sales trajectory should improve as Uncrustables (5% of fiscal 2021 sales) becomes a greater portion of the mix, as the brand has grown double-digits in each of the past several years. In addition, recent and pending divestitures of slower-growing brands (Crisco, Natural Balance, private label dry pet food, juices, and grains) should further improve Smucker’s ability to accelerate its top-line growth.

Financial Strength

After years of a conservatively leveraged balance sheet, with net debt/adjusted EBITDA consistently below 2 times, the Big Heart Pet Brands acquisition in 2015 increased the ratio to above 6. Net debt to adjusted EBITDA was 2.4 times in fiscal 2021. Smucker’s free cash flow as a percentage of revenue has averaged high single digits to low double digits historically and similar results are expected forward also. Smucker seeks to invest half of its capital in growth initiatives (capital expenditures and acquisitions) and return half to stakeholders via dividends, share repurchase, and debt reduction. Morningstar analysts expect that Smucker will invest 3.5% of annual sales in capital expenditures over the long term. Analysts also expect that Smucker will continue to reshape its portfolio through acquisitions and divestitures. The estimated dividend payout ratio will range between 40% and 50%, in line with management’s long-term targets, with forecasts anticipating 2%-6% annual dividend increases. Morningstar analysts also expect Smucker to repurchase 0%-5% of shares annually, which we view as a prudent use of capital if the share price remains below our fair value estimate.

Bulls Say

  • Smucker’s sales trajectory should improve over time due to the divestiture of slow-growing brands and the increasing mix of Uncrustables, which grows at a double-digit pace. 
  • During the pandemic, consumers adopted 11 million pets and purchased 3 million coffee machines, which should provide a lasting benefit for categories representing nearly 70% of Smucker’s fiscal 2021 sales. 
  • Executive leadership changes (newly created chief operating officer role, leadership changes for the U.S. sales organization and the pet food segment) should improve execution and enhance accountability.

Company Profile

J.M. Smucker is a packaged food company that primarily operates in the U.S. retail channel (88% of fiscal 2021 revenue), but also in U.S. food-service (5%), and international (7%). Its largest segment is pet food and treats (36% of 2021 revenue), with popular brands such as Milk-Bone, Meow Mix, 9Lives, Kibbles ‘n Bits, Nature’s Recipe, and Rachael Ray Nutrish. Its second-largest category is coffee (33% across channels) with the number-two brand Folgers and number-six Dunkin’. Other large categories are peanut butter (10%), with number-one Jif, fruit spreads (5%) with number-one Smucker’s, and frozen hand-held foods (5%) with number-one Uncrustables.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Travelers Commercial have profitable outlook on the commercial side with favourable pricing environment

Business Strategy and outlook

The coronavirus affected the company’s results last year. However, losses were very manageable and have stayed well within the range of historical events that the industry has successfully absorbed in the past. On the positive side, Travelers had some natural hedges against COVID-19, and the pandemic was a material positive for its personal auto business, due to a falloff in miles driven.

There outlook for profitability on the commercials side of the business looks relatively bright, in as per Morningstar analyst view. While investment yields are under pressure, the pricing environment has not been particularly favorable in recent years. However, in 2019, pricing momentum picked up in primary lines, and this positive trend accelerated in 2020 as the coronavirus appears to have acted as an additional spur to pricing.

Travels could also see some headwinds in personal lines going forward, which could partially offset favorable conditions in commercial lines. Pandemic tailwinds in personal auto have dissipated, and pricing has recently declined. Finally, insurers are absorbing a rise in claims costs due to factors beyond the impact of drivers returning to the road. All in all, it is  expected that  mean reversion will take place over time, auto insurers look set to endure a relatively difficult period in the near term. Travelers does enter this period with some compnay-specific question marks, as it appears to have not anticipated the recent rise in social inflation as well as peers and reported adverse reserve development in 2019. 

Financial Strength

 Travelers’ balance sheet structure is roughly in line with its peers’, with equity/assets at 25% at the end of 2020. The company has held this ratio between 22% and 25% in recent years. As per Morningstar analyst this level is adequate, given the nature of the company’s business and its exposure to occasionally large losses caused by catastrophes. From Morningstar analyst prespective, the company invests relatively conservatively. Of its fixed-income securities, 90% are rated A or higher, and the company avoided any major investment issues during the financial crisis, and during the recent turbulence in capital markets. As Travelers is not acquisitive and the inherent volatility of the insurance industry precludes a high dividend payout ratio, stock repurchases have been the predominant use of free cash flow for the company historically, with Travelers buying back about $1 billion-$3 billion annually in recent years. The company did take pause on this front in 2020 due to the uncertainty around the impact of the coronavirus, but we expect this to continue longer term.

Bulls Say 

  • We think Travelers is relatively conservative in its investing choices. 
  • diversification of Travelers’ business insulates it from issues in any specific lines. 
  • Pricing is improving in commercial lines.

Company Profile

Travelers  offers a broad product range and participates in both commercial and personal insurance lines. Its commercial operations offer a variety of coverage types for companies of any size but concentrate on serving midsize businesses. Its personal lines are roughly evenly split between auto and homeowners insurance. Policies are distributed via a network of more than 11,000 brokers and independent agents.

 (Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Strong Growth Returns for MSC Industrial but Operating Environment Remains Challenging

Business Strategy and Outlook

MSC has become one of the largest industrial distributors in U.S., and it is especially well known in the metalworking industry, wherein the firm enjoys approximately 10% market share.While MSC’s sales declined in 2020 (negative 5%) and sales growth was anemic in 2021 (2%) amid the global pandemic, over the longer term, but as per Morningstar analyst perspective it is expected that mid-single-digit growth prospects for the company driven by a return to healthier end-market demand and market share gains from smaller local and regional distributors.

Because MSC has national scale and a robust portfolio of products and value-added inventory management services, it is well positioned to capitalize on the growing trend of manufacturers consolidating spending with large distributors. Although national accounts can generate lower gross profit margins, they can also generate higher volume, which MSC can leverage to improve operating margins. MSC’s focus on providing inventory management solutions has helped the firm expand customer wallet share over the years, and we expect that trend to continue.

MSC has proved to be a consistent free cash flow generator throughout the business cycle, and in our view, it has allocated its free cash flow in a balanced, shareholder-friendly manner. We expect MSC to continue to use its excess cash to increase its regular dividend and repurchase shares. The company also occasionally pays special dividends, most recently in fiscal 2021 ($3.50 per share) and 2020 ($5.00 per share).

Strong Growth Returns for MSC Industrial but Operating Environment Remains Challenging

MSC Industrial Direct enjoyed strong year-over-year revenue growth during its fiscal first quarter ended Nov. 27. Sales increased nearly 10% as the company executed on its growth initiatives and end market demand improved (industrial production has expanded at a steady pace for much of 2021). In terms of the growth initiatives, MSC saw notable growth during the quarter from its industrial vending and in-plant initiatives as well as from its e-commerce platform (MSCDirect.com). 

While MSC’s first-quarter revenue growth was encouraging (and caused us to increase our full-year fiscal 2022 revenue growth projection to 8% from 6.5% previously), supply chain challenges and inflationary headwinds persist. CEO Erik Gershwind said the company is seeing little evidence of easing supply chain bottlenecks, labor shortages are severe, and inflation is the most extreme he can recall. Yet, despite these challenges, MSC managed to expand adjusted operating margin 30 basis points year over year 11.3%. Management was disappointed with its gross margin, which contracted 30 basis points year over year (to 41.6%) as the firm’s price/cost dynamic had not been as favorable as management would have liked (price/cost was slightly positive during the quarter). However, MSC realized nice leverage on its operating expenses (7.5% growth compared with 10% top-line growth). MSC intends to increase prices by more than 2% in fiscal 2022 to improve gross margin, and management is still targeting about a 42% gross margin (unchanged year over year), which we think is achievable.

Morningstar analyst have increased fair value estimate about 2% to $87 per share due to our stronger revenue growth outlook and the time value of money.

Financial Strength 

MSC has historically operated with a very conservative balance sheet, and it has only significantly flexed its balance sheet for large acquisitions (2006 and 2013) and large share buybacks (MSC spent $384 million to repurchase 5.3 million shares in 2016) a handful of times. At the end of its fiscal first-quarter 2022, MSC had an outstanding debt balance of $763 million. MSC’s earnings provide the firm with substantial headroom to service its debt obligations. During fiscal 2021, MSC incurred about $15 million of interest expense and generated $441 million of adjusted EBITDA, which equates to a comfortable interest coverage ratio of about 30 times. MSC has a proven ability to generate free cash flow throughout the cycle. It has generated positive free cash flow every year since 2001, and the firm’s free cash flow generation tends to spike during downturns due to reduced working capital requirements. This dynamic played out in 2020 with free cash flow increasing 26% despite sales declining 5%. Given the firm’s relatively conservative balance sheet and consistent free cash flow generation, it is believed that MSC’s financial health is satisfactory.

Bulls Say  

  • As end-market demand improves, MSC could return to mid- to high-single-digit sales growth and highteens return on invested capital. 
  • MSC’s national scale and focus on value-added inventory management services should help the firm take market share from smaller regional and local distributors. 
  • MSC generates consistent free cash flow and runs a shareholder-friendly capital-allocation strategy. The company should continue to utilize its free cash flow to increase its regular dividend, repurchase shares, and occasionally pay special dividends.

Company Profile

MSC Industrial Direct is a value-added industrial distributor with a focus on metalworking and maintenance, repair, and operations products and services. The company offers 1.9 million products through its distribution network which has 11 fulfillment centers. Although MSC has a presence in Canada, Mexico, and the United Kingdom, it primarily operates in the United States. In fiscal 2021, 94% of the firm’s $3.2 billion of sales was generated in the U.S.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Despite wobbles at the top, Bapcor’s core is expected to be positive

Business Strategy and Outlook:

Bapcor’s narrow economic moat is contingent not on the CEO, but rather its scale. Bapcor’s scale allows not only additional buying power, but also the ability to source an extensive range of inventory (over 500,000 SKUs, many of these slow-moving, for over 20,000 different vehicle types) and the flexibility to efficiently allocate inventory between stores. Smaller players, lacking this scale, will be unable to replicate Bapcor’s low cost position. 

Bapcor’s trade network’s extensive reach also means Bapcor is able to provide parts to more customers in a timelier manner than smaller competitors, often within the hour, even for slow-moving SKUs. Bapcor’s trade customers consist of principally chain and independent mechanic workshops. These businesses are relatively price inelastic, as costs are passed through to the end consumer, and these businesses instead value parts availability and convenience, allowing service bays to turn over quickly. The number of registered vehicles in Australia will grow at low single digits over the next decade, marginally outpacing population growth. There are currently more than 19 million passenger vehicles in Australia, with an average age of over 10 years, and more than 14 million older than five years– squarely in Bapcor’s target market.

Financial Strength:

While it is expected that the near-term earnings momentum may slow down, analysts anchor on the firm’s long-term fundamentals and defensive earnings. The dividend yield generated by the firm is also substantial.

The financial outlook for the firm remains unchanged. Bapcor has benefitted from elevated government stimulus and pent-up demand, boosting fiscal 2021 sales as consumers opt to maintain and improve their existing cars rather than upgrade to newer vehicles. Australian retail sales were the standout in fiscal 2021, with sales from the Autobarn and Autopro network up 26% compared with fiscal 2020. It is expected that much of the growth was discretionary, rather than maintenance expenditure–retail sales outperformed 16% sales growth in Bapcor’s maintenance focussed trade business.

Company Profile:

Bapcor is one of the largest automotive spare parts and accessories businesses in Australia and New Zealand. The firm principally distributes automotive spare parts and accessories to independent and chain mechanic workshops in Australia and New Zealand through Burson-branded stores. Bapcor also operates a retail automotive spare parts and accessories business in Australia, catering to the DIY customer, under the AutoPro and Autobarn brands. The specialist wholesale business is a brand owner and wholesaler of specialised parts.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks Expert Insights

Paychex Is Well Placed to Benefit From the Economic Recovery and a Complex Regulatory Landscape

Business Strategy and Outlook

Paychex’s offering appeals to businesses wishing to outsource mission-critical functions, manage and attract employees, and remain compliant with increasingly complex and evolving regulations. Paychex’s solutions span from do-it-yourself payroll with add-on human capital management modules to full-service HR outsourcing via an administrative services organization or professional employer organization model. The ASO and PEO solutions allow a business to outsource critical HR functions to Paychex, including payroll, compliance, and benefits administration, and access support from onsite HR professionals. The main difference between the two models is that under a PEO, Paychex enters a co-employment arrangement and acts as the employer of record for tax and insurance purposes. 

Financial Strength

Paychex is in a strong financial position. At the end of fiscal 2021, Paychex had a net cash position of over $300 million including restricted cash and total corporate investments. In fiscal 2019, the company issued $800 million of fixed-rate long-term debt to fund the $1.2 billion acquisition of PEO business Oasis. Paychex has returned nearly $7 billion of capital to shareholders during the eight years to fiscal 2021 primarily through dividends and to a lesser extent share repurchases. It is expected that  Paychex’s strong free cash flow generation will support an 80% dividend payout ratio over our forecast period. 

Paychex’s medium-term outlook due to resilient revenue retention and stronger demand for complementary HCM solutions than previously anticipated, underpinning our 4% fair value estimate increase to $110 per share. At current prices, Paychex’s shares screen as overvalued trading at a 21% premium to our updated fair value estimate. Management now expects fiscal 2022 adjusted EPS growth to be about 19%, from about 13% previously.

Bull Say’s

  • Paychex is well placed to benefit from increased regulatory complexity under a U.S. Democratic administration. 
  • Paychex benefits from high customer switching costs, a scale-based cost advantage, and strong brand assets and a referral network built over many decades. 
  • Paychex dominates the small-business outsourced payroll market with strong prospects of further market penetration.

Company Profile 

Paychex is a leading provider of payroll, human capital management, and insurance solutions servicing small and midsize clients primarily in the United States. The company, established in 1979, services over 710,000 clients and pays over 1 in 12 U.S. private-sector workers. Alongside its traditional payroll services, Paychex offers HCM solutions such as benefits administration and time and attendance software, as well as human resources outsourcing and insurance brokering.

(Source: BanyanTree)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.