Thursday, July 16, 2009

CBY – Stock Analysis for Dividend Growth Portfolio

Cadbury Plc, a UK-based Company, is world’s leading confectionery company. In year 2008, it divested its beverage business into separate entity. Now Cadbury Plc is solely a confectionery company. It offers chocolate, gum/mints, and candy products under various brand names, including Bubbaloo, Cadbury Creme Egg, Cadbury Dairy Milk, Clorets, Dentyne, Eclairs, Flake, Green & Blacks, Halls, Hollywood, Stimorol. It operates in 60 countries.

CBY is an international dividend achiever has been raising its dividends for last 11 years. The most recent dividend increase was in February 2009. CDY can play a role of international equity in a dividend portfolio. It can also be viewed as a hedge for dollar and emerging markets (20% revenue from emerging markets). My objective here is to analyze if CDY still continues to be a good dividend growth stock and how does it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

  • Revenue: In general, a growing trend since 1999. The reduction in 2008 is due to divestiture of business unit. The average revenue growth for last 10 years has been approximately 9%.
  • Cash Flows: Operational and free cash flow has been more or less stable until 2005. Although year 2008 cash flow issues can be arrtibuted to divestiture of business unit, it is difficult to understand what happened in year 2006 and 2007. Not a good observation.
  • EPS from continuing operation: In general, it is range bound, but there is no consistency in earnings.
  • Dividends per share: Dividends in local currency (i.e. GBP) has been growing consistently since 1997. Minor differences or reductions are reflection of currency fluctuations.
Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 2.00. This is a medium risk category as per my 3-point risk scale. The reduced operating margin and lower current yield (relative to historical average) makes it a medium risk to dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.
  • Dividend growth rate: The average dividend growth of 8.7% (stdev. 10%) is higher than average EPS growth rate of 6.8% (stdev. 29.1%). Dividends have grown faster than earnings per share.
  • Duration of dividend growth: 11 years.
  • 4 year rolling dividend growth rate for past ten years: Less than 10%
  • Payout factor: In the past 10 years, the average has been 75%. Presently it is at 63%. Historically, the company has maintained high payout ratio.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.9%; and (b) MMA yield is 3.4%. Last 10 years average dividend growth rate has been 8.7%, however, my projected dividend growth rate is 6.8%. With my projected dividend growth of 6.8%, the dividend cash flow is equal to MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $21.12 (i.e. yield 4.9%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $19.3
  • Average high yield price calculated based on past 10 years: $24.1
  • Pricing based on past 10 year relative price-to-earnings ratio. $35.6
  • Pricing based on price-to-earnings ratio of 12: $20.4
  • Graham number: $20.3

The range of fair value is calculated as $21.9 to $23.6. This is determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis
CBYs history can be traced back to 1824. It has survived all the significant ups and downs in the global. This demonstrates that it keeps adapting to changes in the market place.

  • CDY continues to maintain its leadership position in confectionery business, with its unparalleled reach across the global, multiple brands, and diversified revenue streams.
  • It is operates in a consumer staples industry, which historically does not get affected by recessions. However, history apart, CDY has shown signs of slowing growth.
  • Year 2007 and 2008 results may show erratic cash flow. However, I believe those are due most likely due to divestiture of business unit.
  • One significant concern that I have is the reduced operating margins and high payout factor. Both on these metric may affect the near future dividend growth. Management has acknowledged this as an issue and has been focusing on profitability. Most of which is centered around cost cutting.

I like CBY’s global presence. Overall, it is a company that will provide international exposure, hedge against dollar fluctuation, and proxy for emerging markets. It has been raising dividends for last 11 years. The stock’s current risk-to-dividend rating is 2.00 (medium risk). However, the current pricing of $35.87 is much higher than my fair value range. I would buy a long position, when it falls into my buy price.

Full Disclosure: No position at the time of writing.

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