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4 High Quality Dividend Stocks for Income Investors, Part IV

We continue our focus on high quality stocks that represent attractive income or value plays for prudent investors. We evaluate high quality constituents of the S&P High Quality Rankings Index, the stocks that have a record of sustainable long-term earnings power and solid growth and stability of dividends. This time around our attention shifts to four consumer staples companies that offer an average yield of 2.85% on an average payout ratio of slightly more than 50%. These companies are generally dividend growth stocks that boast attractive returns on equity (ROE) or returns on invested capital (ROIC). All four featured companies are dividend aristocrats, representing the companies that have boosted dividends for at least 25 consecutive years.

We believe that high quality dividend stocks can provide solid yields for income investors and strong total returns, outperforming the long-term Treasury bonds over long-term investment horizons.

SYSCO Corporation (NYSE:SYY)

Sysco Corporation (NYSE:SYY) is the largest food distributor in the United States, with a market capitalization of $17 billion. It supplies food and related products to restaurants, schools, hospitals, and hotels. Two thirds of the company’s revenue comes from restaurants. Over the past five years, the company’s EPS grew at 7.8% per year, while its dividends increased at almost the same average annual rate. Analysts forecast that Sysco’s EPS growth will average a little smaller 5.8% per year for the next five years. The stock has a ROE of 25% and ROIC of 15.8%. The company has industry-leading operating efficiency, serves a diverse customer base, and benefits from its position as the largest firm in the stable food service distribution industry. The rebound in the restaurant business in North America bodes well for Sysco Corporation (NYSE:SYY). However, high food price inflation continues to squeeze the company’s profit margins. This trend is expected to continue and may become exacerbated due to a severe drought that is pushing up grain prices.

Sysco Corp. has paid dividends since 1970 and has increased them every year over the past 42 years. The company is currently paying a dividend yield of 3.7% on a payout ratio of 55%. Its rival United Natural Foods, Inc. (UNFI) does not pay any dividends, while Nash-Finch Company (NAFC) pays a dividend yield of 3.8%. The stock appears undervalued based on the trailing and forward P/Es. The shares are trading at $29.2 a share, down 2.3% over the past year. Value investor Jean-Marie Eveillard (First Eagle Investment Management—check out its top picks) had nearly $700 million invested in the stock at the end of the first quarter of 2012.

McCormick & Company, Inc. (NYSE:MKC) is an $8 billion producer and seller of spices, seasonings, and condiments to food producers and foodservice businesses. Over the past five years, the company’s EPS grew at 13.2% per year, while its dividends rose at an average annual rate of 9.2%. Analysts forecast a somewhat lower EPS growth in the future, averaging 8.4% per year for the next five years. The stock boasts a free cash flow yield of 2.4%, ROE of 23.3%, and ROIC of 14.3%. Despite the currently challenging global economy and rising material costs, the company expects to increase revenues, generate cost savings, and deliver solid profit growth this year. Material costs inflation is likely to be sustained in the long run, which poses challenges for the company’s profit margins.

McCormick & Company Inc (NYSE:MKC) has paid dividends since 1925 and has raised them for 26 consecutive years. Currently, the stock is yielding 2.0% on a payout ratio of 44%. Its peers ConAgra Foods (NYSE:CAG) and Kraft Foods (NYSE:KFT) pay higher dividend yields of 3.9% and 2.9%, respectively. On a forward P/E basis, the stock is trading slightly below the food products industry. Its forward P/E is close to the company’s average ratio for the past five years. The shares are trading at $60 a share, up almost 26% over the past year. Among fund managers, the stock is popular with John W. Rogers (Ariel Investments) and billionaire Cliff Asness.

Procter & Gamble (PG) is the largest producer of household and personal care products by revenue. It has a total market cap of $180 billion. Over the past five years, the company’s EPS rose at an average rate of 10% per year, while dividends increased at a rate of 10.5% per year. Over the next five years, P&G’s EPS is forecast to increase at a rate of about 8% per year. Procter&Gamble (NYSE:PG) has a free cash flow yield of 1.8%, ROE of 14.3%, and ROIC of 11.2%. The company has a broadly diversified product mix, which is helping sustain its sales even during the weak global economy. Recently, however, the company lowered revenue and profits expectations, as it struggled to maintain its market share in certain high-margin businesses and was unable to implement higher prices for some of its products, including detergent brands. The stronger dollar is also biting into the company’s sales. It is worth to note that P&G has become a new target of activist investor Bill Ackman. Ackman will likely attempt to reshuffle the company’s board of directors, to replace P&G’s CEO Bob McDonald, and to set a new path for the company either by splitting it up or selling non-core asset.

The Procter & Gamble Company (NYSE:PG) has raised dividends for 56 consecutive years. It currently pays an attractive dividend yielding 3.5% on a payout ratio of 69%. Its peers Kimberly-Clark Corporation (NYSE:KMB), Johnson & Johnson (NYSE:JNJ), and Colgate-Palmolive Co. (NYSE:CL) yield 3.4%, 3.5%, and 2.3%, respectively. P&G’s stock has a forward P/E that is trading below the company’s historical metrics. The company’s price-to-book ratio is also much lower than that for its respective industry. The shares are trading at $65.7 a share, up more than 8% over the past year. The stock is popular with Warren Buffett, D. E. Shaw, and Ken Fisher (see Buffett’s top holdings).

Hormel Foods Corporation (NYSE:HRL) is a $7.4-billion meat and food producer. Over the past five years, the company grew its EPS and dividends at average rates of 11.2% and 14.4%, respectively. Analysts see the company’s EPS growth averaging 10.3% per year for the next five years. The company has a free cash flow yield of 2.3%, ROE of 17.4%, and ROIC of 15.5%. It has been operating in a challenging environment as high meat prices have squeezed margins at this meat processor. Given the severe drought in the United States this year, challenges associated with high meat prices are likely to persist in the future as surging grains prices push up feeder prices as well. Even before the drought, high pork prices were reported earlier this year as a factor exerting the pressure on the company’s margins.

Hormel Foods Corporation (NYSE:HRL) has raised dividends for 46 consecutive years. The company currently pays a dividend yielding 2.2% on a payout ratio of 34%. The company’s competitors Tyson Foods (NYSE:TSN) and Sanderson Farms (SAFM) pay lower dividend yields of 1.1% and 1.8%, respectively. Smithfield Foods (SFD) does not pay any dividends, while ex-Sara Lee’s spin-off Hillshire Brands Company (HSH) pays a dividend yield of 9.1%. Hormel Foods’ stock is attractive on valuation. Its forward P/E is well below that of the peer group. The stock is trading at $28 a share, down 2% over the past 12 months. Quant fund managers Jim Simons and Cliff Asness are bullish about the stock.

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