Digging for dividends in the Basic Materials sector

It’s time for another Sharebuilder purchase and this week I’m looking at dividend stocks in the Basic Materials sector. While this sector has the lowest weight in my dividend stock Portfolio, it also contains many over-valued stocks. Is there any gold to be found or have all the mines been exhausted?

Basic Materials sector

The Basic Materials sector consists of companies involved in the production of raw materials, so it tends to be affected by economic growth. When companies aren’t manufacturing many products, they’re also not buying many raw materials. Within the sector there are several different sub-industries such as chemicals, mining, packaging, paints, building materials and agriculture.

Here’s my portfolio as of 30-June grouped by market sector. Basic Materials is my lowest valued sector and it, along with the Consumer Defensive sector, is outside the +/- 10% rule I made. The 10% rule seems a little too strict right now so I’ll be watching this and possibly tweaking it at the end of the year.

My portfolio as of 30-June grouped by sectors showing Basic Materials in last place, with Consumer Defensive and Energy following.
My portfolio as of 30-June grouped by sectors showing Basic Materials in last place, with Consumer Defensive and Energy following.

My Basic Materials sector stocks

I currently have positions in DOW, APD and ROC in the Basic Materials sector.

Dow Chemicals

Dow Chemicals (DOW) is the largest chemical company in the US with a market capitalization of $62B. It has a wide range of business divisions, including Electronic (including materials for LED displays and semiconductors) , Coatings (adhesives, sealants), Performance Materials (de-icing products, carpeting, personal care), Performance Plastics (adhesives, bottles and other plastic products), Agricultural Sciences (pest management and plant biotechnology products) and Feedstocks / Energy (including the production of chlorine for a variety of downstream products).

The company cut its dividend in 2009 from $.45 per share to $0.15. Since then however it has increased its overall dividend every year, although somewhat inconsistently and it used the increase every-other-year technique in 2013. Its payout ratio is 62% with a current dividend yield of 2.87%.

Its P/E of 13.8 is lower than the industry average of 16.5 and the S&P 500 average of 18.3. The last 5 years’ annualized dividend growth from 2009 to 2014 is about 19.8% but this growth comes immediately after a dividend cut. Its payout ratio is about 35% (Morningstar) although it has been over 100% three times in the last 8 years. S&P Capital’s 12 month target price is $47; around 9% lower than today’s price and its rated a sell with 2 stars. Morningstar gives it 3 stars.

Air Products & Chemicals

Air Products  & Chemicals (APD) is one of the world’s largest industrial gases companies. It’s a $27B company and operates in four main segments – Merchant Gases (oxygen, nitrogen and argon), Tonnage Gases (gases supplied to energy production and refining industry), Electronics and Performance Materials (chemicals for production of silicon and semiconductors) and Equipment & Energy (equipment for processing and refining gases). Its stock price recently jumped after the well-respected CEO from ROC joined the company.

APD has a high (dare I say bloated?) valuation at present with a P/E of 27.2 vs. the industry average of 17.4 and the S&P of 18.3. Looking at the valuation history on Morningstar, the stock has had a higher P/E valuation than the S&P every year since 2004. The company’s current dividend yields 2.4% and has increased for the last 31 years. It is backed by a payout ratio of 61% which is the highest it’s been since 2009. Over the previous 5 years the dividend growth was about 11%. S&P Capital’s 12 month target price is $112; around 13% lower than today’s price and it’s rated as a Sell with 2 stars. Morningstar gives it a 3 star rating.

Rockwood Holdings

Rockwood Holdings (ROC) is the world’s leading producer of lithium products and the second largest supplier of service treatment chemicals with a market cap of $5.5B. It has two main segments, Lithium (producing lithium products for a variety of industries including lithium batteries) and Surface Treatments (metal treatment products for the automotive, aerospace and general industry). It recently lost its CEO to APD as noted above.

ROC has a high P/E of 87 compared to the industry average of 18.3 and the S&P’s 18.3. A similar valuation occurred in 2009. Historically against the S&P’s P/E, there’s no real pattern to describe; it’s typically lower (or non-existent) about half of the time since 2004. The dividend yield is 2.37% and the dividend has increased since 2012 when it started paying dividends. Its current payout ratio according to Morningstar is 200% although dividend.com shows it as 86%. Either way, it’s still high. S&P Capital’s 12 month price is $84, an increase of 10% over today’s price, and they rate it a Buy with 4 stars. Morningstar gives it 3 stars.

Choosing new stocks to consider

I’ve also picked some other stocks from the Dividends Champion List that caught my eye to see how they compare and if it’s worthwhile to start a new position to diversify into another segment. I have a loose target of around 4-5 stocks in a given sector so there’s room in my portfolio for another couple of Basic Material companies if one stands out.

My initial screening of the Dividends Champion List is as follows:

  • Include only stocks from Champions, Challengers and Contenders filtered by the sector I’m interested in
  • Exclude any stock which is projected to have negative growth in the next 5 years
  • Include only stocks with a dividend yield above 2%
  • Exclude ADRs and non-US companies
  • Exclude the Chemicals industry as I want to diversify within the sector

There were 5 companies meeting the above criteria, all of them having had paid dividends for 5 years or more. I’ve chosen four of them below, each from a different segment.

The new contenders shortlist

Compass Minerals International

Compass Minerals International (CMP) mines and produces salt in the US and the UK with a $3.2B market cap. The company in particular provides salt for de-icing roads and living in Michigan, I can agree that’s a sustainable business!

It has increased its dividend each year over the last 10 years and the current dividend yield of 2.5% is supported by a 55% payout ratio. Its dividend growth has been about 6.9% over the last 5 years and it has a stable history over that period, always increasing its dividend in February. The company has a P/E of 23.7 which is higher than the S&P’s 18.3 but lower than the industry average of 588.2 according to Morningstar. Historically since 2004, CMP’s P/E has been higher than the S&P’s, except for 2004 and 2009. S&P Capital’s 12 month target price is $84 or 11% lower than today’s price, and they rate it a sell with 2 stars. Morningstar gives it 3 stars.

Sonoco Products

Sonoco Products (SON) is a $4.5B company producing both consumer and industrial packaging. It has been in business for over 100 years and paid consecutive dividends since 1925. It’s also a dividend champion, having increased dividends for each of the last 33 years.

The company has a P/E of 20.2, just a little higher than the industry average of 19.2 and the S&P’s 18.3. Historically, its P/E has been higher than the S&P’s value every year since 2004 except for 2007. The current dividend yield is 2.9% with a reasonable 51.2% payout ratio. The dividend growth over the last 5 years has been about 3.3%. S&P Capital’s 12 month target price is $36 or 17% lower than today’s price with a fair value of $39.6 and they rate it as a Sell with 1 star. Morningstar gives it 2 stars.

Fastenal Co (FAST)

Fastenal Company (FAST) is a $14.7B company which sells industrial and construction supplies. It supplies a wide variety of products ranging from threaded fasteners, cutting tools, electrical supplies through to packaging materials and chemicals. Most products sold are made by other companies, although it is diversified and not reliant on any one supplier.

Its dividend yield is 2% with a payout ratio of 60% and it has increased its dividend each year for the last 14 years accounting for stock splits in that time period. Its P/E of 32.7 matches the industry average of 32.6 but is higher than the S&P average of 18.3. Historically FAST’s P/E has been significantly higher than the S&P’s P/E every year since 2004 although the gap has been narrowing for the last 3 years. AFL’s dividend growth over the last 5 years has been about 22%. S&P Capital’s 12 month target price is $54 or 9% higher than today’s price and it’s rated a Hold with 3 stars. Morningstar gives it 2 stars.

Nucor Corp

And last but not least, Nucor Corp (NUE) is North America’s most diverse steelmaker with a $15.6B market cap. It’s another long term dividend champion having increased its dividend each year for the last 40 years. Note: According to Yahoo’s historical dividend data, NUE cut its dividend in 2009 so perhaps there is a missing stock split or something – I’m using the metric from the Dividend Champion list above.

Its dividend yield is 3% with a payout ratio of 67% (dividend.com) or 90% (Morningstar) . The P/E ratio of 30.5 above the S&P’s average of 18.3. Historically NUE’s P/E has always been higher than the S&P’s since 2010 when it spiked to more than 100; before that its P/E was less than the S&P’s. NUE’s dividend growth over the last 5 years has been about 1.0%. S&P Capital’s 12 month price is $58 which is 18% above today’s price and it’s rated a Hold with 3 stars. Morningstar gives it 4 stars.

Special Mention

I did not include Praxair (PX) in this roundup since I already have enough companies in the chemicals segment. Based on my research they are a suitable equivalent to APD and perhaps even higher quality, although their dividend yield is slightly less than APD.

What to buy?

Looking at all 7 choices, my criteria of requiring a 5 year dividend growth history eliminates my current holdings in ROC and DOW from the start. ROC did not pay dividends prior to 2012 and DOW lowered dividends in March 2009 but has been increasing them ever since.

The remaining 5 companies have suitable dividend yield, however my criteria requiring a 3% dividend growth rate eliminates NUE (and very nearly SON), leaving APD, SON, CMP and FAST.

The dividend yield from the 4 stocks ranges from 2 to 3% and in general for these 4, the higher the yield, the lower the dividend growth. In estimating their future dividend payment, I include the predicted 5 year growth value and average it with the historical dividend growth. This method ranked FAST as highest followed by ADP & CMP in joint second then finally SON.

However, ADP and CMP gain extra credit for consistently increasing their dividends over the last 5 years (ADP every December, CMP every February). SON wasn’t quite as consistent missing out in May 2009) and FAST was the worst with dividend increases all over the map. The reason I think this is valuable as it shows me management’s commitment to dividends such that they make and follow a long term plan.

Putting it all together, I’ve decided to increase my current position in ADP rather than buy a new position this time around. I’m content with ADP’s current 2.4% yield for this purchase and I’m not too worried about the P/E valuation.

SON ranked lowest of the four because of its low growth, smaller size and inconsistent dividend history. CMP was next but lost out to ADP due to its shorter dividend history; it was fairly equivalent otherwise. And finally, while FAST had ranked high due to its higher growth opportunity, it lost out to ADP’s maturity in dividend history and stable increases.

Here’s the outcome visually.

Yield #Yr DivGr5 Projected Stable Score Status
APD 2.3 31 11.3 39 5 58 Buy
FAST 2.0 14 22.7 49 0 54 Buy
CMP 2.5 10 11.1 39 5 53 Buy
SON 2.9 33 3.3 36 4 52 Buy
DOW 2.9 4 19.8 59 0 0 Hold
ROC 2.4 3 0 30 4 0 Hold

I added the score column which is the ranking I’m using, it’s calculated from a weighting of the different criteria added together and aids me in putting one stock over another. It’s like my very own Chowder number I guess but it’s still under development.

So no new huge vein of gold, but I did come across some valuables in my analysis. I think ADP is a good long term investment. I find it interesting comparing the different star ratings from different analysts (especially when they’re at odds with each other), but I don’t live by them since they’re valuing different qualities. I’m trying to favor well managed companies committed to sustainable dividends in my selections.

My purchases this week

So total purchases (including my ongoing fund investing) this week will be:

  • $330 Individual Stocks (APD)
  • $250 Vanguard High Dividend Yield Index (VHDYX)
  • $100 Vanguard High Yield Corporate Bonds (VWEHX)
  • $100 Vanguard Total International Index (VTIAX)

These purchases should increase my yearly dividend income by about $21.

Full disclosure: I am long ROC, ADP & DOW.


Quote of the day

When you’re in a hole, stop digging.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.