Exxon Mobil Corporation engages in the exploration, production, transportation, and sale of crude oil and natural gas. It also involves in the manufacture, transportation, and sale of petroleum products. The company manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and other specialty products. XOM pretty much operates in all parts of the world such as United States, Canada, Europe, Africa, the Asia Pacific, the Middle East, Russia/Caspian region, and South America. Exxon Mobil Corporation was founded in 1870 and is based in Irving, Texas.

XOM is a part of the dividend aristocrats, S&P500 index, and DJIA index. It has been raising its dividend for last 28 years. The latest increase in dividend was 4.8% in April 2010. My objective here is to analyze XOM to determine fair price range for buying and how will it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: Overall had a growing trend, but dropped significantly in 2009.
• Cash Flows: In general, a slow growing trend, but dropped significantly in 2009. The free cash flow is generally close to net income. Operating cash flow is always higher.
• EPS from continuing operation: In general, growing trend, but dropped in 2009.
• Dividends per share: Consistently growing dividends.

Exxon Mobil: Trend Analysis

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.86. This is a medium risk category (relatively closer low risk) as per my 3-point risk scale. The sudden drop in 2009 (EPS and gross margins) makes it a medium risk-to-dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past ten years.

• Dividend growth rate: The average dividend growth of 7% (stdev. 3.6%) is almost same as average EPS growth rate of 7.6%. Dividends have grown inline with earnings per share.
• Duration of dividend growth: 28 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10% for past 10 years.
• Payout factor: It has been in the less than 30%. It was at 42% (at the end of 2009).
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.9%; and (b) MMA yield is 1.75%. Last 10 years average dividend growth rate has been 7.1%, and I expect XOM dividend growth rate to be 7.1%. With my projected dividend growth of 7.1%, the dividend cash flow is twice the MMA income at the price of $77.0.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $37
• Average high yield price calculated based on past 10 years: $63
• Pricing based on past 8 year relative price-to-earnings ratio. $87
• Pricing based on price-to-earnings ratio of 12: $72
• Graham number: $56

The range of fair value is calculated as $53 to $63.

Qualitative Analysis
XOM is one of the largest vertically integrated oil and natural gas company. It has exploration and production operations in more than 180 countries, full-to-partial ownership in 37 refineries, and high oil and gas reserves.

• The revenue distribution shows that US contributes approximately 30% of the revenue. The rest 70% comes from foreign markets and emerging markets.
• Investing in XOM can be considered as a good proxy for foreign/emerging markets
• It has taken initiatives to expand its capabilities and capacity in natural gas by proposing to acquire XTO.
• The company seems to spend more on share buybacks than on dividends. This is a drawback. The fact that it has cash for share buyback, I would argue why not increase dividends (and reduce the share buybacks). Higher dividend payout could support its prices. But for a large organization like XOM, there could be large number of options exercised that require buybacks, otherwise EPS starts getting affected.
• Contrarily, when we look at dividend growth, it has kept pace with earnings growth.

Conclusion
I like XOM’s large size, worldwide operation, presence in every international market. It has built a global operation with integrated exploration, productions, and refining. This gives it moat for economies of scale. The dividend growth seems to follow the growth in EPS. The stock’s current risk-to-dividend rating is 1.86 (medium risk). This is much closer to being a low risk. I recently added a new starter position in XOM. I will continue to build my position as per my allocation level if the stock stays within my buy price range.

Full Disclosure: Long on XOM.

This article originally appeared on The DIV-Net on May 27, 2010

One the benefit that dividend investors have is lower tax percentage (i.e. 15%) on qualified dividends. In case of lower tax brackets, the qualified dividends are not even subject to taxes. In 2003, President Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act. One of provision in this law was to reduced the tax rates on certain dividends (known as qualified dividends) to 15% for the highest income earners. Furthermore, this provision are to expire at the end of 2010 if Congress fails to renew or modify. So far, it has not been extended.

Imagine that Berkshire had only $1, which we put in a security that doubled by year-end and was then sold.Image further that we used after-tax proceeds to repeat this process in each of the next 19 years, scoring double each time

At the end of the 20 years, the 34% capital gains tax that we would have paid on the profits from each sale would have delivered about $13,000 to the government. We would have left with about $25,250. Not bad.

If, however, we made a single fantastic investment that itself doubled 20 times during the 20- years, our dollar would grow to $1,048,576.

Were we then to cash out, we would pay 34% tax of roughly $356,500 and be left with about $692,000.

— Warren Buffett in Berkshire’s 1989 annual report.

This is not directly applicable to dividends. But the reason I bring this up, is it highlights the importance of taxation in growth of investments over time.

In the event that Congress does not take any action, this existing law will expire and taxes will be reverted back to pre-2001 level. In accordance to pre-2001 level, the dividend income will be treated as ordinary income. So for many, depending upon their tax bracket, this could mean 30% or even 40% tax on dividends.

With our government under debt and running large deficits, it appears that our President may take this as an opportunity to raise tax. If not to pre-2001 era, then at least to some higher level. The proposal is to raise dividend income tax to 20% for married couples earning $250,000 or more, while keeping it same at 15% for lower income tax bracket.

These increase in dividend taxation may seem like a small increase. However, in my view this is likely to affect the macro-environment around dividends, for example:

• Will it affect stock valuations? Increase in dividend taxes for large shareholders will result in reduced returns. To increase their returns, they may likely pay less for buying a stocks, thereby affecting valuations. In addition, it is also likely that they may start influencing management about payout ratios.

• Will it affect share buybacks? It is also likely that share buyback paradigm may get a boost because it is believed to provide a floor. Large shareholders would tend to prefer higher stock prices when compared to dividends.

• Will cash flow into IRA? If we combine all taxation (dividends, capital gains, etc), then using tax deffered account becomes more attractive. It is likely that financial advisors will start recommending dividend companies in IRA account rather than individual portfolios.

To small individual investors like me, I does affect a bit, but not by a significant amount. The only impact is slowing down of dividend reinvestment which will not be visible immediately. One could argue that similar taxation, pre-2001 era, did not affect the dividend policy of good companies. That’s true to a certain extent. However, we need to realize that US companies may not have similar earnings growth as seen in pre-2001 level. Therefore, it is likely that the environment surrounding dividends, the motivation behind, etc, may get affected.

This post originally appeared on The DIV-Net on May 20, 2010.

(Photo Credit)

LOWE’s Company (LOW) is a home improvement retailer. It focuses on retail do-it-yourself (DIY) customers and do-it-for-me (DIFM) customers who utilize LOW’s installation services, and commercial business customers. Its product lines include products and services for home decorating, maintenance, repair, remodeling, and the maintenance of commercial buildings. It has approximately 1650 retail stores in US and Canada.

LOW is member of Dividend Aristocrats, Mergent’s Broad Dividend Achiever Index, and S&P500 Index. The most recent dividend increase was in July 2009.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts is shown in image below.

• Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years has been approximately 14 (std dev of 6.8%). Growth has slowed down in last few years and expected to be negative in 2009.
• Cash Flows: Overall, until 2008, a growing trend of operating cash flow. It is above net income. The free cash flow is consistently less than net income.
• EPS from continuing operation: In general, it had an increasing trend until 2007. Negative since 2008 and it is reflection of economic downturn.
• Dividends per share: Very slow anemic, albeit growing trend.

Trend Analysis : LOWE'S Company

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.43. This is a low risk category as per my 3-point risk scale. Other than negative EPS growth, all other parameters are positive.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 49% (stdev. 15%) is more than average EPS growth rate of 20% (stdev. 16.4%).
• Duration of dividend growth: Consecutive dividends growth for more than 25 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10%.
• Payout factor: It has been less than 25% since 2000.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 1.5%; and (b) MMA yield is 2.9%. With my projected dividend growth of 8.2%, the dividend cash flow is 1.41 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $14.1 (i.e. yield 2.2%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $26.0
• Average high yield price calculated based on past 10 years: $26.8
• Pricing based on past 10 year relative price-to-earnings ratio. $39.0
• Pricing based on price-to-earnings ratio of 12: $22.3
• Graham number: $22.7

The range of fair value is calculated as $24 to $27.3.

Qualitative Analysis
LOW is a founded in 1952 and is the second largest retailer in home improvement segment. Its growth model consists of growing market share by expanding more markets.

• Its revenue is pretty much focused in US markets (with some presence in Canada and Mexico).
• It continues to have very stable gross and operating margins. It continues to generate operating cash flows.
• One would expect that with housing market crash, LOW’s earnings would also crash (similar to financial sector banks). However, it was not the case, and it indicates the strength of its business model.
• Even though the housing market is grim, I believe the repair and maintenance segment will continue to generate revenue and income for LOWs.
• The risk factor is that continued slackness in housing market.

Conclusion
Lowe’s Corporation is a stable and slow growing company in long term. It is expected to continue to have a sustainable cash flow over next few years. One issue with Lowe’s is that, historically, it has had a very low dividend yield of less than 2%. At such a low yield, it is less attractive relative to any high yield bond or CDs. However, LOW shares bought at fair value or below would make up of the lack of dividends. In addition, the low payout factor and low dividend risk provides stability for dividend cash flow. The current pricing of $23.4 is less than my buy range. I would continue to add to my existing position based my allocation levels.

Full Disclosure: Long on LOW.

This article was originally published on The DIV-Net, on December 31, 2009

The wheat is getting separated from the chaff. While big names were cutting dividends to manage their debt, there are slew of mid to small cap companies that are continuing to show resilience, and  continuing to show how to manage sustainable and profitable business even in recession. Many companies are continuing to make sure shareholders have a stake in the business by increasing dividends. Among these dividend growers, following are three companies that have received by attention for the dividend increase.

Lincoln Electric Holdings Inc. (LECO): LECO manufactures and sells welding and cutting products worldwide. The products are mostly sold to industrial customers in general metal fabrication, power generation and process industry, structural steel construction, heavy equipment fabrication, shipbuilding, automotive, pipe mills and pipelines, and offshore oil and gas exploration and extraction markets. The company was founded in 1895 and has headquarters in Cleveland, Ohio. It is part of S&P 400 MidCap index.

• It is a dividend achiever has paid growing dividends for last 15 years. Most recent dividend increase of 3.7% was in December 2009. The quarterly dividend is $0.28 per share
• The 3Q09 earning per share was $0.30 including impact of acquisition.
• The key highlight was improving operating profits and net earnings because of controlling cost and cost savings initiatives.
• The cash flow improved to $231 million for first nine months.
• Annual dividend of $1.09 per share appears to be barely covered by the earnings. The cash flow and reserves provide some room for flexibility.
• This payout ratio is more than 80% and current dividend yield is 2.00%.

McCormick & Company Inc. (MKC): MKC is a specialty food company, engages in the manufacture, marketing, and distribution of flavor products and other specialty food products to the food industry worldwide. Its products include spices, herbs, extracts, seasoning blends, sauces, marinades, and specialty foods. Their customers are direct retail consumer and industrial business houses. The company was founded in 1889 and has headquarters in Sparks, Maryland.

• It is a dividend achiever and has been increasing dividends for more 24 years. The most recent dividend increase of 8.3% was in November 2009. The quarterly dividend is $0.26 per share.
• It has paid dividends since 1925, and dividends have tripled in last 10 years.
• The 3Q09 earning per share was $0.57 (vs. $0.52 in 3Q08).
• The key highlight was increased earnings due to combination of acquisition, tad higher sales, and cost reduction initiatives.
• The year 2009 earnings per share is estimated to be $2.26 to $2.28
• The yearly dividend of $1.04 per share appears to be well covered with expected earnings for year 2010.
• The payout ratio is approximatley 46% and current dividend yield is 2.6%.

Graco Inc. (GGG): It is provider of fluid handling systems and components and its products are used to move, measure, control, dispense, and spray a wide range of fluids in Industrial, Contractor and Lubrication applications. The company was founded in 1926 and has headquarters in Minneapolis, Minnesota.

• This company has been increasing dividends for last 10 years. It will most likely be added to Dividend Achievers list in 2010. The most recent dividend increase of 5.0% was in December 2009. The quarterly dividend is $0.20 per share.
• In last 10 years, the annual dividends have increased from $0.13 per share to $0.80 per share.
• The 3Q09 earning per share was $0.29 (vs. $0.54 in 3Q08).
• While the operating cash flow (for y-o-y) is steady at approximately $110 million, the key lowlight is the significant reduction in earnings in year 2009.
• The yearly 2009 earnings is expected to significantly less than year 2008.
• It is likely that the yearly dividend of $1.00 per share would not be covered by the earnings. However, cash flow and reserves provide some flexibility.
• This year’s payout ratio would be more than 75% while the current dividend yield is 2.6%.

These three companies are from two different markets viz., food industry and industrial, which show businesses focusing on core competency have resilience to wither recession and US companies are being run profitability.

(Photo Credit)

Brown & Brown, Inc. (BRO) and its subsidiaries, provides insurance and reinsurance products and services, as well as risk management, employee benefit administration and managed health care services. It is a diversified insurance agency and brokerage firm, markets and sells to its customer’s insurance products and services, primarily in the property and casualty area. BRO has operations in 219 locations and in 37 states.

BRO is member of Mergent’s Dividend Achiever Index and S&P Mid-Cap 400 Index. The most recent dividend increase was in October 2009.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: In general, a growing trend since 2000. The average revenue growth for last 9 years has been approximately 13.8%. Year 2009 revenues are expected to be flat.
• Cash Flows: Overall, until 2008, a growing trend of free cash flow and operating cash flow. FCF is consistently more than net income.
• EPS from continuing operation: In general, it had an increasing trend until 2007, drop in 2008, and expected to remain flat in 2009.
• Dividends per share: Very slow anemic albeit growing trend.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.57. This is a low risk category as per my 3-point risk scale. Other than negative EPS growth in 2008, all other parameters are positive.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 18.9% (stdev. 4.81%) is more than average EPS growth rate of 12.3% (stdev. 14.5%).
• Duration of dividend growth: 16 years of consecutive dividends growth.
• 4 year rolling dividend growth rate for past ten years: More than 10%.
• Payout factor: It has been less than 30% since 2001.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 1.7%; and (b) MMA yield is 2.9%. With my projected dividend growth of 8.2%, the dividend cash flow is 1.41 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $14.1 (i.e. yield 2.2%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $20.3
• Average high yield price calculated based on past 10 years: $24.8
• Pricing based on past 10 year relative price-to-earnings ratio. $29.5
• Pricing based on price-to-earnings ratio of 12: $15
• Graham number: $16.4

The range of fair value is calculated as $18.2 to $21.2.

Qualitative Analysis
BRO is a 70 year old company, and is in top 10 independent insurance intermediaries in US. Its growth model consists of growing market share by acquisition of insurance agencies.

• Its revenue is pretty much focused in US markets; with approx 70% of revenue is concentrated in 9 states.
• It continues to have very stable gross and operating margins. It continues to generate relatively stable free cash flows.
• Being in financial service and insurance industry, I am surprised it does not seem to be affect as other major companies. Perhaps demonstrates its resilience and/or quality of its management taking calculated risk.
• The risk factor is that other than acquisition mode of growth model, there is not other source of growth.

Conclusion
Brown and Brown Inc is stable and slow growth mid-cap company. It is expected to continue to have a sustainable cash flow over next few years. It is typical dividend growth company where dividends grow in excess of 10%. However, the dividends yields are less than 2%. The stock’s current risk-to-dividend rating is 1.57 (low risk). The current pricing of $18 is within my buy range. I would be open to initiating a position based my allocation levels.

Full Disclosure: No position at the time of this writing. I may buy in near future.