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Dividend Growth Potential: Who Has More? Clorox Or Kimberly-Clark?

February 11, 2014

There are a lot of things that one must consider prior to buying stock in a publicly-traded company. Some of these things include the strength of a company's business model, geographic diversification, financial condition, valuation, and earnings growth.

Another important concern is the dividend that the company in question pays out. Strength and sustainability of the dividend are very important for dividend growth investors. In fact, did you know that 42% of the total return of the S&P 500 over the last 80+ years came from dividends? This is why dividends are so important for any investment portfolio.

Today, let's dig into the consumer staples sector and check out the dividends from Clorox and Kimberly-Clark. As most everyone knows, these two companies produce everything from toothpaste to toilet paper to household cleaning products. We will look into the dividend history of each company, its historical dividend growth rates, whether or not each company's dividend is supported by cash flows, and whether the companies can sustain their dividend growth rates in the future.

Dividend Yield

When talking about a company's dividend, the first thing that normally comes to mind is the dividend yield, which is the percentage of your capital that you receive in return over the next 12 months, as long as the dividend amount is not changed. Here are the dividend yields from both Clorox and Kimberly-Clark.

Clorox 3.4%
Kimberly-Clark 3.1%

 

Table 1: Dividend Yields Of Clorox and Kimberly-Clark

Clorox is the clear winner in this category, with a dividend yield of 3.4%, above the 3.1% currently being offered by Kimberly-Clark.

Dividend Growth

The dividend yield is just one of many factors that need to be considered when it comes to the strength of a company's dividend. A company's stock can have a high dividend yield due to an unsustainable dividend payout ratio, or poor fundamentals that have brought down the stock price. These items could then lead to a dividend cut, which will reduce your yield on cost.

Dividend growth should also be considered. This is because a company that increases its dividend payout every year maintains the purchasing power of the income streams that are received by its investors. If dividend growth rates can't keep up with inflation, then investors are really losing money when they consider the loss in purchasing power. Dividend increases also signal a strong outlook by management and underscores their commitment to shareholders. Many companies regard their dividends as a sacred cow. Over time, dividend growth can supercharge an investor's yield on cost. Consider Warren Buffett, who started buying Coca-Cola back in the '80s. Now, he receives a yield on cost of 40%, and growing every year as long as Coca-Cola keeps increasing their payout. Sounds like a pretty good deal, no?

Let's see how the dividends of Clorox and Kimberly-Clark have grown over the last 5 years. The numbers in the table represent the average dividend growth rate over the last five years.

Clorox 9.1%
Kimberly-Clark 6.9%

 

Table 2: Five-Year Dividend Growth Rates of Clorox and Kimberly-Clark

Both of these companies have shown outstanding dividend growth rates over the last five years, easily outpacing the erosive effects of inflation. However, Clorox comes out on top here with an average annual growth of 9.1%, well above Kimberly-Clark's 6.9%. Kimberly-Clark's dividend growth figures are skewed a bit due to only increasing the dividend by 3.4% during 2009. Kimberly-Clark has increased its dividend every year for the last 41 years. Clorox has increased its dividend for 36 years straight.

These strong dividend histories could not have happened without each company's exceptionally strong business models and brand strength. For right now, Clorox is the winner, when looking at dividend growth over the last five years.

Dividend Payout Ratio

High dividend yields and strong growth rates are all well and good, but we need to make sure that the company in question is making enough money to keep the dividends going. This is where the dividend payout ratio comes in. The payout ratio is the percentage of the company's profits that get returned to shareholders in the form of dividends. You usually like to see this ratio at 60% or below, as that will insure that the dividends will continue to get paid, even if the company experiences a downturn over a short period. Dividend payout ratios that approach or exceed 100% may signal future dividend freezes or cuts, which are not good at all for investors.

The table below shows the dividend payout ratios for Clorox and Kimberly-Clark, both on a trailing twelve month and a four-year average basis. The earnings that I used in these calculations are referred to as core earnings, which remove one-time items that don't have an impact on the company's operations.

Company TTM 4-Year Average
Clorox 62% 59%
Kimberly-Clark 53% 55%

 

Table 3: Dividend Payout Ratios of Clorox and Kimberly-Clark

From the looks of Table 3, the dividend payments of both Clorox and Kimberly-Clark are in pretty decent shape. None of them appear to be in any danger of getting cut. The current payout ratios are inline with the four-year averages.

While both companies are looking very good in this category, Kimberly-Clark is just a little bit better here, with a lower payout ratio, both on a trailing 12-month basis and a 4-year average basis.

How About That Free Cash Flow?

A lot of folks would end their analysis after calculating the dividend payout ratio. However, we need to keep in mind that that figure is based on dividend payout as a percentage of earnings, not actual cash that comes into the business over a certain period of time. Earnings often contain items like depreciation, asset impairments, actuarial gains on pension plans, and other non-cash items that can distort the picture as to how healthy a company's dividend really is. For this reason, I like to calculate the free cash flow payout ratio, which shows us what percentage of cash that comes in over a 12-month period gets distributed to shareholders. This paints a more accurate picture when it comes to the dividend safety of the company in question.

Table 4 shows how much of both Clorox's and Kimberly-Clark's free cash flow was paid out in dividends. Note that free cash flow is calculated as operating cash flow, subtracted by capital expenditures. Trailing 12-month and four-year average figures are shown.

Company TTM 4-Year Average
Clorox 70% 67%
Kimberly-Clark 58% 63%

 

Table 4: Free Cash Flow Payout Ratios of Clorox and Kimberly-Clark

Here, we see that the dividends that are currently coming from each company are more than well-supported. With that said, the current free cash flow payout ratio of Clorox is a bit elevated. With the free cash flow payout ratio in the 70% area, I would expect to see the dividend growth of Clorox slow down a bit in the years to come unless the company can show some growth in free cash flow.

Kimberly-Clark on the other hand, looks really good here, with a lower free cash flow payout ratio that shows more potential for dividend growth going forward.

When it comes to the free cash flow payout ratio, Kimberly-Clark is the winner here.

Any Ways To Predict Dividends Going Forward?

A lot of folks would end their analysis here, especially after looking at the free cash flow payout ratios. However, these figures are all based on what happened in the past. We need to find some clues as to whether the company can continue paying steadily increasing dividends in the future.

Interest Coverage Ratio

The interest coverage ratio illustrates the size of the company's pre-tax profits relative to the company's interest payments. Generally speaking, the more debt a company has, the more interest it has to pay, and the less that the company has left over to pay out dividends. The interest coverage ratio is calculated by dividing the company's earnings before interest and taxes (EBIT) by the company's interest payments made over the same period of time. Low interest coverage ratios (usually below 2) generally show that the company is having a hard time just trying to make its interest payments. That may signal dividend cuts or eliminations in the future. For this reason, we like to see high interest coverage ratios.

Table 5 shows the interest coverage ratios of Clorox and Kimberly-Clark over the last 12 months.

Clorox 9.03
Kimberly-Clark 11.8

 

Table 5: Interest Coverage Ratios of Clorox and Kimberly-Clark

Table 5 shows us that while Clorox was able to cover its interest obligations 9 times last year, Kimberly-Clark covered its interest obligations almost 12 times. So, while both companies are excellent in this regard, Kimberly-Clark is the winner here.

Net Debt To Equity Ratio

The amount of debt that a company has can ultimately influence the future direction of the company's dividend. Companies that have more debt typically pay more in interest. It should also be noted that at some point, the company's debt will need to be repaid. While many companies are working around this by refinancing the debt at low interest rates, this option might not be as attractive when interest rates head back up. When the company finally does extinguish its debt, it may have an adverse effect on whether it can continue paying dividends.

The net debt to equity ratio can offer us some clues as to how much of a problem debt will be when it comes to paying out dividends. It is calculated by subtracting the company's cash position from the company's short and long-term debts, and then dividing that by the company's equity position. The lower this ratio, the better it is for not only the company in question, but for us as investors. Ratios under one are typically considered to be good.

Clorox 13.9
Kimberly-Clark 0.92

 

Table 6: Net Debt To Equity Ratios of Clorox and Kimberly-Clark

 

Table 6 shows that Kimberly-Clark is the clear winner in this category.

 

Forecasted Earnings Per Share Growth

Dividend growth can be driven by a couple of different factors. One of these factors is the expansion of the company's payout ratio, where the company decides to pay out a higher percentage of its earnings or free cash flow to shareholders as dividends. However, you can only expand the payout ratio so much. Eventually, you must have free cash flow growth in order to pay steadily increasing dividends. And, we all know that free cash flow growth comes from earnings growth. To get a good idea as to the prospects of a company's future dividend payments, it may behoove us to look at analyst projections for future earnings per share growth over the next couple of years. Table 7 shows the forecasted earnings per share growth rates for Clorox and Kimberly-Clark over the next couple of years. These numbers come from the analysts at S&P Capital IQ.

Company 2014 2015
Clorox 6% 7%
Kimberly-Clark 11% 8%

 

Table 7: Forecasted Earnings Per Share Growth for Clorox and Kimberly-Clark

Both Clorox and Kimberly-Clark are expected to post solid earnings per share growth over the next couple of years. Kimberly-Clark, however, has more favorable estimates.

Conclusion

Today, we have looked at a number of different factors in order to determine the strength and sustainability of the dividends of Clorox and Kimberly-Clark. These factors include the dividend yield, historical dividend growth rates, payout ratios, interest coverage ratios, net debt to equity ratios, and analyst projections for future earnings per share growth. After giving careful consideration to all of these factors, we can conclude that none of the dividends being paid by either of these companies appear to be in any danger as of this writing.

While Clorox has a slightly higher dividend yield and more dividend growth over the last 5 years, Kimberly-Clark has significantly lower payout ratios that indicate that there is plenty of room remaining for more dividend increases. The balance sheet of Kimberly-Clark shows a lower amount of leverage than Clorox. Investors in Kimberly-Clark should continue to expect robust dividend growth in the years to come.

While the dividend of Clorox is well-covered, a 9% average annual dividend growth rate will be hard to maintain with a 70% free cash flow payout ratio and expected earnings per share growth of only 6-7%. I would expect the dividend growth of Clorox to eventually match the earnings per share growth, so I would expect dividend growth to moderate a little bit here.

For all of these reasons, I conclude that the dividends of Kimberly-Clark are more sustainable and have more growth potential going forward.

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WallStreetBeerMoney.com

"Do Your Own Due Diligence, But By God, Don't Drink Away Your Equity!"

dave@wallstreetbeermoney.com