This Dividend Aristocrat is on Sale

I tend to be drawn to companies that make tactile products. I like goods with a physical presence. If it rusts in the rain, all the better. Companies that manufacture durable goods offer a sense of permanence and durability, as opposed to the ethereal, fleeting offerings found in cyberspace.obscure dividend aristocrat

I’m especially drawn to companies that make tactile products with management teams focused on maximizing shareholder value. It’s no surprise, then, that I’m drawn to Graco Inc. (NYSE: GGG).

[ad#Google Adsense 336×280-IA]Graco is no surprise to me, but it might be a surprise to you.

Graco is small – $3.9 billion market cap – and its business is pedestrian.

Graco provides fluid handling equipment to manufacturers, construction companies and maintenance companies worldwide.

The equipment refers to pumps, meters, mixers, dispensers and sprayers.

Despite its diminutive stature and the ho-hum nature of its products, Graco is remarkably diversified: More than 53% of its sales are generated outside U.S. borders. Its products are sold by over 30,000 independent distributors worldwide.

Graco is also remarkably dominant. Over the past 12 months, it sold $1.3 billion worth of its fluid-handling equipment. The market isn’t huge, but Graco is master of the domain. It holds a 25% share of the $2 billion industrial market, a 58% share of the $500 million contractor market, and a 9% share of the $1.1 billion lubricant market.

As for sales, they continually move forward. In 2005, Graco generated $732 million in annual sales. Last year, its generated $1.3 billion. The growth is unexceptional. The 10-year annual average is slightly more than 5%, but the capital allocated to generate that growth has been unarguably exceptional.

Graco grows through investment in its own operations and through strategic acquisitions. Neither will be undertaken if it means sacrificing return on capital. Over the years, Graco has continually maintained high returns on its capital, which keeps margins high and earnings growing. Return on assets (ROA) averages 17.2%, while return on equity (ROE) averages 41.1%.

High returns on capital translate to consistently high earnings growth. Earnings of $1.80 per share in 2005 swelled to $5.70 for the past 12 months. An efficiently run operation can keep the bottom line growing briskly, even if the top line isn’t.

High returns on capital, in turn, are a byproduct of efficient capital allocation. Since Graco’s 1972 IPO, the culture has been imbued with the need to allocate capital efficiently. Superior capital allocation is Graco’s history, and the source of its long-term success. Over the past 30 years, Graco shares have appreciated 6.5 times more than the S&P 500.

Superior capital allocation means smartly managing capital structure. The key is to buy and issue equity at opportune times.

When Graco’s share price climbed, so did its share count. In 2010, Graco had 60.8 million shares outstanding. By 2013, the share count had climbed to 62.8 million. By 2014, the share price had plateaued and moved lower. Management saw value and took some shares off the table. Shares outstanding now stand at 59.6 million.

Management has reversed course over the past 18 months. Graco has repurchased shares using cheap debt. In 2014, it repurchased $195 million of stock. In April 2015, it announced a new authorization to buy back up to six million additional shares.

Returning cash to shareholders is another smart use of capital. It’s also the most important. Graco’s dividend yields 1.9%, but it grows roughly 10% annually, and it has grown for the past 30 years. The latest dividend increase, which occurred this month, lifts the annual payout to $1.32 per share.

Graco continues to do the right things for the business and for its investors, but Wall Street is hardly impressed. Graco shares trade at a 15% discount to their 52-week high of $82.14. They trade at only 12 times current earnings; 20 times earnings is the historical norm.

In other words, an exceptional capital allocator and burgeoning Dividend Aristocrat is on sale. But don’t expect the sale to last indefinitely; exceptional capital allocators and Dividend Aristocrats rarely trade at a discount for long.

— Stephen Mauzy


Source: Wyatt Investment Research