Image Source: Mike Cohen
Let’s take a look at the earnings reports of some past, present, and potential simulated Dividend Growth Newsletter portfolio ideas, including that of Novartis, Procter & Gamble, Honeywell, and Kinder Morgan.
By Kris Rosemann
Novartis Reports Solid Volume Growth But Pricing Pressure
Simulated Dividend Growth Newsletter portfolio idea Novartis (NVS) reported third quarter 2018 earnings October 18, and its top line was driven 3% higher as reported thanks to nine percentage points of volume growth, which was partially offset by negative pricing action, generic competition, and currency headwinds. Drivers of the volume growth include Cosentyx, Entresto, its oncology portfolio, and Alcon, but reported operating income faced material pressure as a result of the voluntary withdrawal of CyPass microstent, higher restructuring, and growth investments. Core operating income, which adjusts for a number of the aforementioned one-time items, advanced 9% on a constant currency basis, however. Management expects full-year 2018 core operating income to grow at a mid- to high-single-digit rate, while net sales growth is expected at a mid-single-digit rate.
Free cash flow generation remained robust at Novartis as the measure advanced 10% through three quarters of 2018 on a year-over-year basis to nearly $8.8 billion. Dividends paid in the same period checked in at roughly $7 billion, revealing ongoing coverage of the payout with internally-generated funds, and net debt has fallen by $1.9 billion through the first nine months of 2018 to $17.1 billion at the end of the third quarter. Novartis’ Dividend Cushion ratio sits at 1.7, and shares yield ~3.35% as of this writing. We view the company’s equity as fairly valued at recent prices as shares are changing hands in the upper half of our fair value range.
Procter & Gamble Volumes Advance, Pricing Flat, Guidance Reaffirmed
Former simulated Dividend Growth Newsletter portfolio idea Procter & Gamble (PG) reported its fiscal 2019 first quarter earnings October 19, and net sales in the quarter came in roughly flat with the same period of fiscal 2018 as organic volume (up 3%) and positive mix impact (1% boost) were offset by currency headwinds, acquisitions and divestitures, and neutral pricing. Core operating margin faced pressure as a result of currency headwinds and commodity cost increases but expanded 50 basis points on a currency neutral basis thanks to robust productivity cost savings.
Core earnings per share advanced 3% on a year-over-year basis, and the company maintained its fiscal 2019 core earnings per share guidance for 3%-8% growth to go along with its all-in sales growth guidance of down 2% to flat compared to fiscal 2018. A lack of top-line growth following its massive portfolio reshaping was a core part of our reason to part ways with the consumer product giant in the simulated newsletter portfolio, and its lack of pricing growth seems to support this notion.
Procter & Gamble turned in just under $2.5 billion in free cash flow in the first quarter of its fiscal 2019, which was well in excess of cash dividends paid of $1.85 billion in the period. The company’s $28.7 billion net debt load as of the end of its fiscal first quarter weighs on our opinion of its dividend growth potential, but its Dividend Cushion ratio remains relatively healthy at 1.7 at last check thanks to its free cash flow generating prowess, which is supported by management’s expectations for adjusted free cash flow productivity at 90%+ in fiscal 2019. Shares look a bit pricey following the market’s favorable reaction to its earnings report and reaffirmation of guidance October 19 and are now trading just below the upper bound of our fair value range. Procter & Gamble’s dividend yield is ~3.35% as of this writing.
Industrial Giant Honeywell Plows Ahead With Impressive Dividend Coverage
We’ve had industrial giant Honeywell (HON) on your radars as a top industrial idea for some time now, “Honeywell Remains a Top Industrial Idea,” and the company continues to impress after it adjusted 2018 guidance once again in its third quarter earnings report, released October 19. Organic sales grew 7% on a year-over-year basis thanks to strength in its ‘Aerospace’ and ‘Safety and Productivity Solutions’ businesses, and higher volumes, along with operational excellence initiatives, helped drive 70 basis points of segment margin expansion.
As a result, adjusted earnings per share advanced 17% from the year-ago period to $2.03, and the company altered its full year adjusted earnings per share guidance to a range of $7.95-$8.00 from $8.10-$8.20 as the impact of business separations more than offset increased expectations for the fourth quarter. Organic sales guidance was raised to ~6% from 5%-6% previously, segment margin expansion is now expected to be 19.5%-19.6% compared to 19.4%-19.6% previously, and adjusted free cash flow, which adjusts for one-time costs related to business separations, guidance now comes in a range of $5.8-$6.2 billion compared to $5.6-$6.2 billion previously.
Honeywell’s free cash flow through nine months in 2018 came in at roughly $4.35 billion, which is ~37% higher than the comparable period of 2017 and more than 2.5 times greater than cash dividends paid of less than $1.7 billion in the period. The company’s total debt load of less than $18.3 billion is not a concern given its robust free cash flow generation and cash and short-term investments balance of nearly $11.7 billion. This reasonable financial leverage and strong free cash flow generation helps drive Honeywell’s Dividend Cushion ratio to an impressive 2.7, and shares yield just over 2.10% as of this writing after management raised its quarterly dividend by 10% in September. Shares are changing hands just above our fair value estimate of $151 per share.
Kinder Morgan Makes Notable Progress in Deleveraging
Pipeline operator Kinder Morgan (KMI) falls into both the former and potential simulated Dividend Growth Newsletter idea categories, and we recently touched on the company’s deleveraging progress and dividend growth plans, “Update on 5 Top Energy Stocks: KMI, ETP, EPD, MMP, XOM.” The company reported third quarter earnings October 17, and net income more than doubled in the period to $693 million on a year-over-year basis. Distributable cash flow, an industry-specific measure of cash flow that ignores growth capital spending among other adjustments, advanced 4% from the year-ago period, and it reached a notable milestone in its multi-year balance sheet strengthening plan that began after it slashed its dividend in December 2015 as its adjusted net debt-to-adjusted EBITDA ratio checked in at 4.6x at the end of the quarter. Management adjusted its long-term leverage target to 4.5x from 5.0x, and it received notice from S&P (SPGI) that the rating agency expects to raise Kinder Morgan’s credit rating in January.
Kinder Morgan expects to exceed its $4.57 distributable cash flow and $7.5 billion adjusted EBITDA targets in 2018, and it raised its growth capital spending budget by $300 million to $2.5 billion, which it still expects to fund with internally-generated cash flows with no need for capital market assistance. It expects to maintain its 4.6x net debt-to-adjusted EBITDA ratio through the end of the year, and management is confident that it will be able to deliver on the three major credit rating agencies placing it on positive outlook for an upgrade. Kinder Morgan’s distributable cash flow came in at more than $650 million above its declared dividend in the third quarter, but the company’s unadjusted Dividend Cushion ratio being in negative territory highlights the discrepancy between traditional free cash flow, which accounts for all capital spending, and distributable cash flow, as well as the impact of its still sizable debt load.
Nevertheless, its adjusted Dividend Cushion ratio, which gives credit for ongoing access to the capital markets, currently sits just above parity, and shares yield just over 4.40% as of this writing. If management is able to continue executing on its more appropriate capital allocation plan as it has in recent quarters, we think shares have upside potential, and our fair value estimate currently sits at $24 per share.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.