I’m a diehard dividend growth investor.
It’s a phenomenal strategy for so many reasons.
But one criticism I’ll sometimes hear about DGI goes something like this:
“Companies that pay growing dividends are too focused on yesterday’s products and services.”
Well, that’s just not true.
In fact, there are numerous high-quality companies that offer the products, services, and technology of today and tomorrow – all while paying growing dividends.
This is intuitive.
After all, it’s not possible to fund growing cash dividends for very long if you’re not growing as a business.
Growing as a business requires constantly adapting to the evolution of the world’s trends, demands, and technologies.
I’ve been investing in high-quality dividend growth stocks since the spring of 2010.
I built my FIRE Fund by saving my middle-class income and investing it in world-class enterprises that pay growing dividends.
The FIRE Fund, which is my real-money early retirement stock portfolio, now generates the five-figure and growing passive dividend income I need to live off of.
The Fund contains many of the same dividend growth stocks you’ll find on the incomparable Dividend Champions, Contenders, and Challengers list.
This portfolio allowed me to become financially independent and retire in my early 30s, as I lay out in my Early Retirement Blueprint.
Now, if I weren’t investing in companies that could adapt to the future, I’d be in serious trouble.
I’d probably already start to see a lot of cracks in the portfolio, or I’d be seeing my dividend income suffer along with these businesses.
But it’s not the case.
The vast majority of the 100+ businesses I’m invested in continue to thrive, grow profit, and aggressively grow their dividends.
Of course, we can’t totally “future-proof” our portfolios.
But we can stick to high-quality companies that have a great track record for adapting, which is partly evidenced by a great track record for paying growing dividends.
That said, it’s important to not pay any price for these stocks.
Valuation, as always, is critical.
Price is what something costs, but value is what something is actually worth.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Investment income is given a boost by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a company becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally reduce a company’s fair value. It’s protection against the possible downside.
These favorable attributes should obviously be sought by every long-term investor.
Fortunately, they’re not that difficult to spot and take advantage of.
Fellow contributor Dave Van Knapp has made this easier than ever.
He put together a great valuation process that can be applied to just about any dividend growth stock out there.
You can access that process through Lesson 11: Valuation, which is part of an overarching series of “lessons” on the DGI strategy.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Albemarle Corp. (ALB)
Albemarle Corp. (ALB)Albemarle Corp. (ALB) is a global specialty chemicals company that has leading positions in lithium, bromine, and refining catalysts.
They operate across the following three business segments: Lithium, 36% of FY 2018 sales; Catalysts, 33%; and Bromine Specialties, 27%. All Other and Corporate account for an insignificant remainder of sales.
Dividend growth investing is not akin to looking in the rear view mirror.
DGI is, by its very nature, a forward-looking investment strategy. A dividend growth investor will almost have no choice but to invest in companies that are on the cutting edge of change.
This company is a perfect example of that.
Let’s talk about a major change in the way the world thinks about energy.
One of the biggest revolutions out there is the move toward cleaner energy. This is affecting everything from the way homes and businesses think about and consume energy to the type of cars people are buying.
Our world is changing quickly.
Modern-day society has long required ubiquitious access to abundant, cheap, and reliable energy.
Add clean to that list.
Whereas global energy has long been heavily reliant on hydrocarbon resources, we’re shifting toward cleaner energy sources like wind, water, and solar.
And a key component to this shift is the storage of energy.
That’s where lithium, in particular, comes in. Most of the storage solutions that we now have (like batteries) require lithium. Large batteries (like those in electric cars) require a lot of it. But even smaller batteries (like those in mobile phones) are now everywhere.
Massive producers of lithium, operating at scale, are essential to this energy revolution.
As the #1 lithium producer, Albemarle is positioned perfectly to take advantage of this shift.
And that’s not even to mention their exposure to a variety of other chemicals that are highly profitable and necessary.
This is a highly diversified business beyond lithium, with exposure to industries ranging from pharmaceuticals to construction.
Dividend Growth, Growth Rate, Payout Ratio and Yield
This diversification, along with an aggressive push into lithium, should serve shareholders well.
Indeed, the company has been serving shareholders growing dividends for 25 consecutive years.
The 10-year dividend growth rate is a stout 10.7%.
Even the most recent increase was right in that range, setting us up for a reliable expectation moving forward.
With a payout ratio of 29.5% (using TTM EPS that factors out a one-time gain in Q2 2018), there’s still plenty of room for more dividend growth.
One drawback, though, might be the stock’s yield.
It offers a yield of 1.91% right now.
A bit low, sure.
But the yield is in conjunction with some of the best growth prospects around. I think that’s an important consideration here.
In addition, the current yield is more than 30 basis points higher than the stock’s own five-year average.
So it’s a little bit juicier than it’s typically been over the last five years.
Total return, assuming a static valuation, should be the sum of yield and dividend growth.
A yield of near 2% and low-double-digit dividend growth is setting up long-term shareholders nicely. That paints a picture of ~12% annualized total return moving forward – without any kind of multiple expansion, which is certainly possible.
But this is all built on expectations.
Revenue and Earnings Growth
In order to clarify those expectations, I’ll now take a look at what Albemarle Corp. has done over the last decade in terms of top-line and bottom-line growth.
I’ll then measure that up against a professional near-term forecast for profit growth.
Putting the long-term results up against this forecast should give us a very good idea as to what the earnings power is, which ultimately will fuel dividend growth.
The company has increased revenue from $2.005 billion to $3.375 billion from FY 2009 to FY 2018. That’s a compound annual growth rate of 5.96%.
Not all of this growth was organic, however.
Albemarle Corp. presciently acquired Rockwood Holdings, Inc. in 2015 for $6.2 billion.
This move instantly transformed the company into the major lithium player it now is.
Earnings per share advanced from $1.94 to $4.98 over this period, which is a CAGR of 11.04%.
I factored out a $1.36 gain from Q2 2018, related to the sale of the polyolefin catalysts and components business for $416 million, which artificially skewed FY 2019 EPS. Sale proceeds were partially used to initiate a $250 million accelerated share repurchase program.
We can see some accretive growth here, as the business started to accelerate after the Rockwood Holdings, Inc. acquisition.
Margins have expanded nicely in recent years, proving out the strategy thus far.
Looking forward, CFRA is predicting that Albemarle Corp. will compound its EPS at an annual rate of 12% over the next three years. Status quo, essentially.
The thesis is underpinned by strong growth in the Lithium segment, driven by increasing battery demand.
CFRA also cites concurrent improving fundamentals across the other two business segments.
Albemarle Corp. is taking the lithium revolution very seriously.
If the Rockwood Holdings, Inc. acquisition wasn’t proof enough, the company has been recently busy shoring up its assets in this space.
In late 2018, the company agreed to buy a 50% stake in an Australian lithium mine for $1.15 billion. Australia is quickly becoming a major source of lithium, competing aggressively with Chile.
Meanwhile, the company heavily relies on the Salar de Atacama mine in Chile (the largest salt flat in Chile), which offers a very low cost of production due to a high concentration of lithium in the salt.
Supporting CFRA’s forecast is Albemarle Corp.’s own guidance for 2019, which calls for 11% to 19% YOY growth in adjusted EPS.
Even being conservative here, the company should be able to deliver future dividend growth right in line with the demonstrated long-term average.
That is to say, investors aren’t unreasonable to expect low-double-digit dividend growth for the foreseeable future.
Financial Position
Moving over to the balance sheet, the numbers are surprisingly solid.
Even with some busy M&A activity in recent years, the company has maintained a very strong balance sheet.
The long-term debt/equity ratio is 0.39, while the interest coverage ratio is over 16.
Furthermore, the company has a relatively large amount of cash.
For an asset-heavy business like this, I’d say the balance sheet is excellent.
The company continues its quality over to profitability, which is robust.
Over the last five years, they’ve averaged annual net margin of 12.20% and annual return on equity of 12.46%.
These averages have been hurt by one-off events, but the profitability picture is clearly one of strength and improvement.
Overall, this is a high-quality business that’s right on the forefront of one of the biggest worldwide trends of all.
If you believe cleaner energy is here to stay (it’d be tough to argue otherwise), this could be one of the best long-term investments to make.
Some investors might think DGI is staid. But you can invest in a cutting-edge company and still get your growing dividends. This is a classic example of that.
Best of all, you still get a boring chemical operation with the other two business segments. Through their Bromine and Catalysts businesses, they have exposure to a variety of industries ranging from refineries to industrial water treatment.
However, investors should consider risks.
Regulation, litigation, and competition are omnipresent risks for any business.
Albemarle Corp. has unique geopolitical risks to consider, too, due to its heavy exposure to Chile.
Swings in raw material costs can shift profitability dramatically.
And any drop in lithium battery demand, or a wholesale change in battery technology, would have a material effect on the company’s revenue and profit.
Lastly, capital expenditures have been high lately, limiting FCF. This is a trend to keep an eye on.
This is, in my opinion, a wonderful business.
What makes it an especially wonderful investment idea right now, though, is the valuation…
Stock Price Valuation
The stock trades hands for a P/E ratio of 15.42.
I used adjusted TTM EPS to calculate that ratio, which factors out a favorable one-time gain.
That multiple is obviously well below the broader market. It’s also about 1/3 the stock’s own five-year average P/E ratio, although that average has been heavily skewed.
If we want to really drill into things here and cut past the noise, the P/CF ratio is only 15.4. That’s substantially lower than the stock’s three year average P/CF ratio of 24.2.
Admittedly, I think the stock spent some of this period in overvalued territory, but I’d argue all the same it’s now spending time in undervalued territory.
Further to the point, the current yield is notably higher than its own recent historical average.
So the stock does look cheap by most measures. But how cheap? What would a reasonable estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
Due to the low yield and high growth characteristics, I used a two-stage DDM.
I factored in a 10% discount rate.
Then I assumed 12% dividend growth for the first 10 years, with a long-term dividend growth rate of 8%.
What I’m assuming here is just a slight acceleration in near-term dividend growth, along with a flattening out of things past 10 years.
Based on 10-year EPS growth, the forecast for forward-looking EPS growth, the low payout ratio, and the fact that we’re apparently just in the early innings of an energy revolution, this seems fair. I’d actually argue it’s quite conservative.
The DDM analysis gives me a fair value of $111.31.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
A conservative valuation model shows significant undervaluation, which isn’t a surprise. The basic metrics reveal the same.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates ALB as a 4-star stock, with a fair value estimate of $130.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates ALB as a 5-star “STRONG BUY”, with a 12-month target price of $115.00.
I came out a bit low. But we’re all in agreement that the stock looks very cheap. Averaging out the three numbers gives us a final valuation of $118.77, which would indicate the stock is potentially 55% undervalued here.
Bottom line: Albemarle Corp. (ALB) is a high-quality company that has positioned itself perfectly for a revolution in the world’s energy. This is a business that’s focused on tomorrow’s technology. With 25 consecutive years of dividend raises, double-digit long-term dividend growth, a very low payout ratio, a yield near 2%, and the possibility that shares are 55% undervalued, this could be one of the most electrifying and undervalued dividend growth stocks in the world.
-Jason Fieber
Note from DTA: How safe is ALB’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 97. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, ALB’s dividend appears very safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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