3 dividend aristocrat stocks – a dividend deep dive

Cash is king – an expression that runs as true now as ever.

Interest rates have risen to levels not seen for over a decade. Companies that can generate cash, and put money directly in shareholders’ pockets, have risen in popularity since the end of 2021.

In recent articles, we’ve spoken about the difference between dividends and share buybacks and taken a whistle stop tour of some of the UK’s so called dividend aristocrats.

Here, we dive a little deeper into three businesses with a long history of stable or growing dividends from the UK and US.

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This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments and any income they produce fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future. No dividend is ever guaranteed, and yields are variable.

Halma

Halma technically fits the definition to be included here, with a dividend that’s increased every year for more than 20 years. However, with a 1.0% forward dividend yield and a payout ratio of around 30% (the proportion of its earnings paid out as dividends), this is far from a pure income play.

Instead, Halma’s differentiated business model, geared toward non-discretionary and sustainability related demand, offers other avenues of growth. Halma’s a mash-up of around 45 businesses working to provide technology solutions in the safety, health, and environmental markets.

Once a business is identified and acquired, a host of support functions are made available to help propel the next stage of growth. Each business is managed by its own board, allowing tailored decisions to be made on a business-by-business basis.

Halma - cash generation and mergers and aquisitions (M&A) spend (£m)

Source: Refinitiv Eikon, 13 February 2023

Acquisitions aren’t the core driver of growth, but they are important.

One of the first things we look at in these types of models is the strength of cash generation. Buying businesses isn’t cheap, and if it can be funded by internally generated cash, it’s much more sustainable. Halma ticks the boxes, with strong cash generation giving firepower to look for new opportunities.

Cash conversion over the first half of the new financial year was lower than the 90% targeted, at 63%, as inventory spend increased to support supply chains. While it’s something to keep an eye on, we’d expect cash conversion to push back toward the target level in the second half.

On the topic of first half performance, revenue of £876m was a company record. Looking at the longer-term trend, revenue’s grown at a compound annual growth rate of 11% since the 2013/14 financial year. Of course, there’s no guarantee that continues.

There are challenges, not least on the inflated cost side, and operating margin for the half year was down from 2021 highs, at 17.3%. Though margins more broadly remain ahead of the wider industry.

All in, we’re supportive of Halma’s business model and growth drivers. But we aren’t alone, the group trades on a price-to-earnings ratio ratio of 27.9. That’s come down from its pandemic highs, but is still ahead of the longer-term average and wider sector. There’s plenty of pressure to deliver.

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McDonald’s

McDonald’s has a long history of increasing its dividend, with the payout per share rising every year going back to the early 1990s.

McDonald's – dividend and yield

Source: Refinitiv Eikon DataStream, 8 February 2023.

The heavily franchised model is an efficient beast, with McDonald’s not on the hook for many of your standard restaurant running costs. That’s helped allow the group to convert a high portion of accounting profit into cash flow. Free cash flow for the latest financial year was $5.5bn – that’s cash that can be paid out as dividends, used to buy back shares, or reinvested in the business.

Of course, no returns are guaranteed.

It’s not all been happy meals and smiles, though. Such is the reach of McDonald’s, it finds itself exposed to all manner of geopolitical and economical risks. The closures in Russia and Ukraine, along with a challenging environment in China are prime examples.

But, not resting on its laurels, the ‘accelerating the arches’ initiative pushes on. A greater emphasis on new restaurant openings is the latest offshoot of the ongoing strategy. China is a great example, with 900 new units earmarked for opening in 2023 as restrictions in the region ease.

Looking to operating performance, comparable sales are growing in the low double-digits and margins have been robust. That’s despite an environment with sky-high prices, which is expected to continue into 2023.

We don’t have any major concerns where the balance sheet’s concerned. The ratio of net debt to cash profit (EBITDA) sits just north of three times. That’s been relatively stable over the last seven years and interest costs are well covered by earnings. Still, we’d like to see debt reduced a touch. That’s because a higher interest rate environment means interest costs are on the rise.

Improvements to the online journey, as well as delivery and drive-thrus are helping propel McDonald’s through muddy waters.

Markets aren’t oblivious to the strengths on offer and the group trades at 24.6 times forward earnings as a result. That’s not cheap, and adds an element of risk, but we think it’s deserving of the premium valuation.

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Unilever

It’s not been the easiest ride for Unilever over recent years. Pressure from large shareholders and failed takeover deals sparked unrest and ultimately Alan Jope, CEO of five years, will pass on the reins at the start of July.

Despite that, we remain supportive of the long-term prospects for the owner of brands such as Dove and Ben & Jerry’s.

A refreshed organisational structure and focus on only the most profitable businesses are a couple of the levers being pulled to stoke improved growth. It won’t happen overnight. But in the meantime there’s a solid underlying business that’s generated free cash flows of more than £5bn in each of the last eight years.

That helps support the 3.7% prospective dividend yield, which is a touch ahead of the 3.5% long-term average – yields are not a reliable indicator of future income.

2022 full-year results were relatively robust, with underlying sales growth of 9% reflecting positive contributions from all five divisions.

It’s not all rosy though.

To combat ever increasing cost inflation, prices have had to rise. In fact, last year there was an 11.3% rise in underlying pricing which had a negative impact on volumes.

Underlying volume and price growth

Source: Unilever 2022 full year results.

Therein lies one of the major challenges, how to keep margins from falling without harming volumes. There’s no easy answer, but we’ve been pleased with the relatively small impact on volumes given record levels of price hikes.

Underlying operating margins have still fallen though, as inflation outpaced price hikes, down to 16.1% from 18.4% in 2021. We’re expecting further price hikes into 2023, and all being well on the inflation side, that should help give margins a kick in the right direction.

The reason it’s been able to keep demand somewhat intact is down to the host of strong branded products in the armoury. In unfavorable conditions, brand power is king.

The group’s valuation has come down below the long-term average, which looks to be at an attractive level. Of course, there are no guarantees, and the new CEO has plenty of challenges ahead.

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Unless otherwise stated, estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates aren’t a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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