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
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 packaged foods sector and
check out the dividends from General Mills and Kellogg. 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.
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
General Mills and Kellogg.
Table 1: Dividend Yields Of General Mills and Kellogg
Here, the dividend yields of both companies are the
exact same. So, there's no clear winner in this area.
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 General Mills and
Kellogg have grown over the last 5 years. The numbers in the table
represent the average dividend growth rate over the last five years.
Table 2: Five-Year Dividend Growth Rates of
General Mills and Kellogg
Both of these companies have shown outstanding
dividend growth rates over the last five years, easily outpacing the
erosive effects of inflation. However, General Mills comes out
on top here with an average annual growth of more than 12%, nearly
double that of Kellogg. General Mills has increased its dividend every year for
the last 10 years. Kellogg has increased its dividend for 9 years straight.
We should consider that the most recent dividend
increase of General Mills was by 15%, while that of Kellogg was
These strong dividend histories could not have happened
without each company's exceptionally strong business models and
brand strength. For right now, General Mills 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
General Mills and Kellogg, 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.
Table 3: Dividend Payout Ratios of General Mills and
From the looks of Table 3, the dividend payments of
both McDonald's and Yum Brands are in very good shape. None of them
appear to be in any danger of getting cut. The current payout ratio
of General Mills is significantly higher than its four-year average,
due in large part to its 15% dividend increase.
While both companies are looking very good in this
category, Kellogg is just a tad bit better on a trailing 12-month
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 the free cash flows of
General Mills were 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.
Table 4: Free Cash Flow Payout Ratios of General
Mills and Kellogg
Here, we see that the dividends that are currently
coming from each company are more than well-supported. These
relatively low free cash flow payout ratios show potential for
dividend growth going forward, not only through earnings growth, but
through expansion of the payout ratios.
While Kellogg looks pretty good in this category,
General Mills looks even better. So, when it comes to the free cash flow payout ratio,
General Mills 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
Table 5 shows the interest coverage ratios of
General Mills and Kellogg over the last 12 months.
Table 5: Interest Coverage Ratios of General Mills
Table 5 shows us that while Kellogg was able
to cover its interest obligations more than 9 times last year,
General Mills takes the cake, with an interest coverage ratio of 12. So, while both companies are excellent in this regard,
General Mills looks the best.
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
Table 6: Net Debt To Equity Ratios of General Mills
Table 6 shows that while neither of these two
companies look very good in this category, General Mills gets the
edge here. However, before we leave this segment, we need to
consider that both companies have large amounts of treasury stock on
their balance sheets. Since treasury stock represents a reduction in
the equity positions of these two companies, these ratios are
artificially inflated. Many companies don't require a lot of equity
in order to run their businesses, so they will often use that equity
to buy back stock. This then, increases the net debt to equity
ratio, making the company appear to be more financially distressed
than it really is. For this reason, I like to calculate what I call
the adjusted net debt to equity ratio, which is calculated the same
way as the normal net debt to equity ratio, except that the negative
component of the treasury stock is stripped out of the equation.
When we do this, we find that General Mills has an
adjusted net debt to equity ratio of 0.71, while Kellogg comes in at
1.08. As you can see, treasury stock can make a big difference, and
by stripping it out, we see that neither company is in financial
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 General Mills and Kellogg over the next
couple of years. These numbers come from the analysts at S&P Capital
Table 7: Forecasted Earnings Per Share Growth for
General Mills and Kellogg
Both companies are expected to grow their earnings
per share by an average of 7% over the next couple of years. This is
decent growth that should fuel some dividend growth in the future.
Unless both companies choose to expand their payout ratios in the
future, then we should expect to see dividend increases in the mid
to upper single-digit area over the next few years.
Today, we have looked at a number of different
factors in order to determine the strength and sustainability of the
dividends of General Mills and Kellogg. 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.
Kellogg has a 56% free cash flow payout ratio, a
dividend growth rate of 6% over the last 5 years, and expected
annual earnings per share growth of 7% over the next two years. For
these reasons, I think we should continue to expect mid single-digit
dividend growth in the near future with Kellogg, unless management
decides to expand its payout ratio.
General Mills has an even lower free cash flow payout
ratio, and has already shown a willingness to expand its payout
ratio with its recent large dividend increase of 15%. Its five-year
dividend growth rate is 12%, with expected annual earnings per share
growth of 7% over the next two years. While we can't expect a 12%
dividend growth rate to last forever, I think we could still see
double-digit dividend growth over the next couple of years,
especially if the company is willing to expand its payout ratio even
With more dividend growth, a lower free cash flow
payout ratio, and a balance sheet with less leverage, I give the nod
to General Mills.
Of course, before making a final decision between the
two, you must consider other items like valuation, product and
geographic diversification, and business models.