There are a lot of businesses out there providing necessary and ubiquitous products and/or services, yet largely go unnoticed.
These are the types of companies I love focusing on when looking for a new, high-quality investment.
And that’s because when a company is providing the world with something necessary, there’s often a great source of recurring revenue there, which can lead to rising profits and…drum roll please…rising dividends.
[ad#Google Adsense 336×280-IA]My entire portfolio is predicated on rising dividends, which is a growing source of passive income that can one day completely pay for my expenses and render me financially independent.
As such, I look for only the greatest companies in the world, where I’m fairly confident dividends will continue to roll in and continue to grow.
Well, I may have found an interesting candidate here and I’m going to share it with you readers. Donaldson Company, Inc. (DCI) manufactures and provides filtration systems and replacement parts.
Sounds boring, right?
Boring can be beautiful, however, especially when we’re talking about making money and collecting dividend checks.
Donaldson’s products are absolutely necessary for a number of applications, ranging from aircraft equipment to engines to gas turbine inlets.
The company differentiates itself via broad geographical diversification – 100 location across 44 countries – as well as proprietary filtration media. The company has more than 1,000 scientists/engineers working for them as well as 1,500 worldwide patents issued, active, or pending. Their approach allows them to work directly with their clients to develop products that suit their needs, and with 100 years of experience behind them, it seems to be working.
How well is it working?
Let’s take a look at the company’s growth to find out.
Revenue was $1.596 billion in fiscal year 2005, which grew to $2.473 billion in FY 2014. That’s a compound annual growth rate of 4.99% over the preceding decade. Not bad.
Meanwhile, earnings per share increased from $0.64 to $1.76 over this period, which is a CAGR of 11.90%. That’s a bit more like it! EPS growth was partially fueled by generous buybacks, which reduced the share count down from approximately 174 million to 148 million over the last decade, or 15%.
Apparently, selling filtration systems is indeed quite profitable.
Even better, Donaldson is sharing those profits with shareholders.
They’ve increased their dividend for the past 28 consecutive years, spanning almost three decades including multiple wars in the Middle East, the financial crisis, and the Great Recession.
This means they’re a “Dividend Champion” as defined by David Fish’s Dividend Champions, Contenders, and Challengers list, which is an invaluable resource that tracks the more than 600 US-listed stocks that have increased their respective dividends for at least the last five consecutive years. Dividend Champions are those stocks with at least 25 consecutive years of dividend raises, which qualifies DCI.
And shareholders’ raises have been generous – the 10-year dividend growth rate stands at 18.9%.
The only downside to this stock – that I can see – is the low yield, at only 1.73%.
That dividend growth rate is very high, higher even than what EPS has grown at. While that compensates for the low yield, it can lead to a high payout ratio if it’s unsustainable. However, DCI’s payout ratio is only 37.7%. So the company could theoretically remain fairly aggressive with the dividend raises for the foreseeable future. At some point, though, the dividend will only be able to grow in line with earnings.
One other aspect of this company that speaks to its quality is its balance sheet. The long-term debt/equity ratio is only 0.24. And the interest coverage ratio is very high, at over 36. These are great numbers.
I also really like this company’s profitability. Not only does the company compare well to competitors, but its profitability is improving. Net margin finished at 10.52% last fiscal year and the company posted return on equity of 24.93%. Net margin has been steadily improving over the last ten years.
This is a high-quality business across the board. You have products that are necessary across multiple industries across multiple geographies. And Donaldson differentiates itself via proprietary offerings.
Their international diversification is impressive, as approximately half of its sales come from outside the US. And its customer diversification is also notable, as no one customer accounted for more than 10% of net sales over the last three fiscal years.
However, there are a few risks that should be considered. There are general macroeconomic concerns to consider, as Donaldson’s growth largely depends on orders from a variety of industries. Because of their international exposure, there are currency effects that can adversely affect their profitability. Lastly, they operate in a highly competitive industry.
Shares in DCI are available for a P/E ratio of 21.79, which compares That’s more or less in line with their five-year average, which is 22.9.
I valued shares using a two-stage dividend discount model analysis with a 10% discount rate and a 12% growth rate for years 1-10, with a terminal growth rate of 7.5%. This seems pretty reasonable considering the quality of the business, their competitive position, profit growth, and the low payout ratio. The DDM analysis gives me a fair value of $41.28, which means this stock is potentially slightly undervalued right now.
Bottom line: Donaldson Company, Inc. (DCI) is a high-quality company. It provides products that are absolutely necessary across a multitude of industries. Their business model has allowed them to prosper for 100 years and raise their dividend for almost three consecutive decades, and I see no reason why this will change anytime soon. Proprietary products, numerous patents, and a penchant for working with clients to develop proper applications should continue to serve the company and its shareholders well for years to come. This is a stock to strongly consider here.
— Jason Fieber, Dividend Mantra
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