Recap from April’s Picks
On a price return basis, the Dividend Growth Stocks Model Portfolio (-2.3%) underperformed the S&P 500 (+0.4%) by 2.7% from April 27, 2023 through May 23, 2023. On a total return basis, the Model Portfolio (-2.1%) underperformed the S&P 500 (+0.4%) by 2.5% over the same time. The best performing stock was up 8%. Overall, eleven out of 30 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from April 27, 2023 through May 23, 2023.
The methodology for this model portfolio mimics an “All Cap Blend” style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.
Featured Stock for May: Matson Inc.
Matson Inc. (MATX) is the featured stock in May’s Dividend Growth Stocks Model Portfolio.
Matson has grown revenue by 13% compounded annually and net operating profit after tax (NOPAT) by 43% compounded annually since 2017. Longer term, the company has grown NOPAT by 26% compounded annually since 2012. The company’s NOPAT margin increased from 6% in 2017 to 20% over the trailing twelve months (TTM), and invested capital turns remained unchanged at 1.0 over the same time. Higher NOPAT margins drive return on invested capital (ROIC) from 6% in 2017 to 20% over the TTM.
Figure 1: Matson’s Revenue & NOPAT Since 2012
Free Cash Flow Supports Regular Dividend Payments
Matson has increased its regular dividend from $0.82/share in 2018 to $1.22/share in 2022, or 10% compounded annually. The current quarterly dividend, when annualized, equals $1.24/share and provides a 1.8% dividend yield.
More importantly, Matson’s free cash flow (FCF) easily exceeds its regular dividend payments. From 2019 through 1Q23, Matson generated $906 million (23% of current enterprise value) in FCF while paying $181 million in dividends. See Figure 2.
Figure 2: Matson’s FCF vs. Regular Dividends Since 2019
Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.
MATX Is Undervalued
At its current price of $70/share, Matson has a price-to-economic book value (PEBV) ratio of 0.3. This ratio means the market expects Matson’s NOPAT to permanently fall 70% from TTM levels. This expectation seems overly pessimistic given that Matson has grown NOPAT by 26% compounded annually since 2012 and 14% compounded annually since 2002.
Even if Matson’s NOPAT margin falls to 13% (compared to 20% over the TTM) and the company’s revenue falls 3% compounded annually over the next decade, the stock would be worth $98/share today – a 40% upside. See the math behind this reverse DCF scenario. In this scenario, Matson’s NOPAT would fall 9% compounded annually through 2032. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.
Add in Matson’s 1.8% dividend yield and a history of dividend growth, and it’s clear why this stock is in May’s Dividend Growth Stocks Model Portfolio.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in Matson’s 10-K:
Income Statement: I made $64 million in adjustments with a net effect of removing $8 million in non-operating expenses (1% of revenue).
Balance Sheet: I made $623 million in adjustments to calculate invested capital with a net decrease of $312 million. The most notable adjustment was $72 million (2% of reported net assets) in asset write-downs.
Valuation: I made $1.4 billion in adjustments, with a net decrease in shareholder value of $1.4 billion. One of the most notable adjustments to shareholder value was $646 million in net deferred tax liabilities. This adjustment represents 26% of Matson’s market value.
Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.
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