In any portfolio, it is important to have a mix of dividend stocks and growth stocks. The proportion of each depends on an individual’s age and risk profile. Among dividend stocks, I like names such as Lockheed Martin (LMT, Financial) and Caterpillar (CAT, Financial) among others. In this article, I will discuss another stock that can be considered for the portfolio considering its value creation through dividends and share repurchase.
Moody’s Corporation (MCO, Financial), which provides credit ratings, capital markets research, economic related research, data and analytical tools worldwide, is a good dividend stock to consider for portfolio. This article discusses the company’s positives with a focus on the cash flow and its potential utilization to create shareholder value.
Since Moody’s is trading near 52-week highs, I will start with the valuations, before talking about the cash flow perspective. For FY15, Moody’s has guided for an EPS of $4.55 to $4.65. Even if the lower end of the guidance is considered, Moody’s is trading at FY15 PE of 24.3 considering the current stock price of $110.4.
In my view, these are not expensive valuations considering the point that according to Shiller PE, broad markets are trading at 26 times earnings. Further, the company’s strong dividend and potential for robust dividend growth justify premium valuations. Therefore, for investors seeking entry in the stock with a long-term investment horizon, the valuations are not very expensive. I would still recommend gradual exposure to the stock to average out on any correction in the coming months.
As I mentioned above, Moody’s is a dividend stock and not a high growth stock. For 2Q15, the company’s revenue increased by 5% to $918 million. However, the following points are critical in the results and outlook –
- First, Moody’s reported robust operating cash flow of $594.4 million for the six months ended June 30, 2015. Considering capital additions of $40.7 million, the company had a robust $553.7 million in free cash flow for dividends, share repurchase and debt repayment. I must add here that the company’s FCF for 1H15 increased by a robust 32% as compared to 1H14.
- Second, Moody’s expects $1.1 billion in operating cash flow for FY15 and considering capital expenditure guidance of $100 million, the annual free cash flow is likely to be $1.0 billion. With 1H15 dividend payment of $137 million, there is significant room to expand dividend payout and continue with share repurchase.
- Third, Moody’s had cash and short-term investments of $2.3 billion as of June 30, 2015. Further, long-term debt of $3.1 billion for the same period implies net debt of just $800 million and I believe that Moody’s can conveniently reduce debt or have zero net debt in the coming quarters.
Therefore, Moody’s has an excellent balance sheet and cash flow position along with moderate revenue growth trajectory. I must mention here that the company’s 2Q15 revenue from US increased by 18% while non-U.S. revenue declined by 10%. However, I see Asia Pacific and EMEA as a key revenue driver in the coming years for Moody’s.
From a revenue sustainability point of view, non-financial corporate have refunding needs of nearly $3.2 trillion over the next 4-5 years according to Moody’s and this factor will ensure that revenue remains steady for the company even if revenue growth is not robust. I must also add that for the company, 49% of revenue in recurring with the remaining 51% being transaction based. Recurring revenue will also ensure that cash flow is steady in the coming years.
As a final point, I want to mention that Moody’s has said that it will be investing in strategic growth opportunities to expand its geographical presence. In the recent past, the company has made small acquisitions and investments in India. Moody’s currently has 50.06% stake in Indian listed rating agency ICRA and Moody’s also owns Copal Amba, which provides analytics and research support services. I believe that India can be a high growth market for Moody’s and these investments will be EPS accretive in the long-term.
Considering these factors, Moody’s is an attractive investment with the company likely to pay high dividends and create continued shareholder value through share repurchase. Even with the stock trading near 52-week highs, I have no hesitation in remaining bullish on the stock. As cash flows swell, Moody’s will continue to trend higher in the coming quarters.
