Consumer staple stocks are among the favorite investments for dividend growth investors as these companies often produce steady growth over long periods of time. This steady growth often comes with growing dividends. One consumer staple company that I find to be of interest is Mondelez International Inc (MDLZ, Financial).
Company background and recent earnings results
In 2011, Kraft Foods announced it would split into an international snack and beverage company and a North American grocery company. That international snack and beverage company would become Mondelez in October 2012. Today, Mondelez is a leading manufacturer and distributor of snack foods and beverages, selling its products in 160 countries.
Source: Investor Presentation, slide 3.
The company’s well-known brands include Oreo, Ritz, Triscuit, Chips Ahoy!, Tang and Trident. Mondelez led all other competitors in terms of market share for biscuit snacks in 2019. The company holds second place in terms of market share for the chocolate and gum and candy sector. Mondelez has a market capitalization of $71.5 billion today.
Mondelez released first-quarter earnings results on April 28. Adjusted earnings per share increased 6.2% to 69 cents, topping Wall Street's expectations by 3 cents. Revenue grew 2.6% to $6.7 billion, coming in nearly $97 million higher than expected.
What really stood out about the quarter is the company’s organic growth, which was 6.4%. The market had anticipated organic growth of 4%. Expectations were already very high and Mondelez managed to top them. Even more impressive is that the company had 3.7% organic growth in the first quarter, so the two-year stacked organic growth is more than 10%. That isn’t too common among snack food and beverage companies.
Source: Mondelez First-Quarter Earnings Presentation, slide 6.
Digging down deeper, we see it was developed markets that were really behind the gains in organic growth. These regions had 7.6% organic growth in the first quarter, with double-digit increases in March alone. North America was the clear leader with 13.4% organic growth, led by more than 12% growth in volume and mix. Pricing was higher by almost 2%. Europe, which is Mondelez’s largest market at 39% of total revenue, had 4.3% organic growth, again, mostly due to volume growth.
Currency was a substantial headwind to results for emerging markets. Latin America was down 9.3% and Asia, the Middle East and Africa dropped 2.5% on a reported basis. In terms of organic growth, emerging markets held up fairly well. These regions dropped by low single digits in March, but organic growth for the quarter for these regions was still higher by 4.5%. Latin America had 7% organic growth as pricing increases of 8.9% were partially offset by a 1.9% decline in volumes. However, it should be noted that all of the growth came from Argentina due to higher inflation in the country. Otherwise, sales were flat for the rest of Latin America. Asia, the Middle East and Africa had 2.2% organic growth, almost evenly split between volume and mix and pricing gains.
The growth found in developed markets and the weakness in reported sales for emerging markets can be attributed to the Covid-19 pandemic. Consumers stocked up on products in North America ahead of stay-at-home orders while emerging markets saw more abrupt lockdowns that had an impact on sales and distribution.
Despite these challenges, Mondelez held or increased its share in 80% of the markets that it maintains a presence. Biscuits as a category, which makes up about 45% of total revenue, had a surge in demand that led to at least mid-teen growth in sales for Oreo, Ritz, Triscuit, Wheat Thins and belVita in the U.S. These products added 2.5% to growth in the last three weeks of the first quarter alone. Even China had some positive news, as Biscuits were higher by 7% to close the quarter.
Gross profits declined 320 basis points to 36.5% on account of higher costs for raw materials, currency exchange and disruptions caused by the Covid-19 pandemic. Mondelez returned $1.1 billion of capital to shareholders during the quarter, including share repurchases of $690 million. The company has suspended its share repurchases due to the uncertainty regarding the pandemic. Mondelez also pulled its guidance for the rest of the year for the same reason. Yahoo Finance states that the analyst community expects earnings of $2.55 per share for 2020.
Mondelez’s financials appear to be in decent shape. The company had $1.9 billion in cash and equivalents on its balance sheet at the end of the quarter. This is the highest cash position that the company has had in several quarters. On the flip side, total debt now stands at $20 billion, but just $1.7 billion of this is due in the next 12 months. Interest expense was $471 million over the last four quarters and is covered by free cash flow.
In an attempt to bolster future growth prospects, Mondelez completed its agreement to purchase a $1.2 billion majority interest in Give & Go on April 1. Give & Go supplies fully finished fresh products to in-store bakeries. This category has a mid-single-digit growth rate over the past few years and strengthens Mondelez's presence in a number of snack channels, such as brownies, cupcakes, pastries and muffins.
Mondelez had an excellent first quarter. Growing top and bottom lines in a difficult environment is a strong sign of the company’s business. Mondelez’s ability to maintain and grow market share in the vast majority of its markets is also a point in the company’s favor. Total debt is a concern, but the company has taken on debt to grow its business and has a solid cash position. Still, results lead me to believe that Mondelez is worthy of investment if the dividend looks secure and the valuation isn’t overly expensive.
Dividend and valuation analysis
Following a 9.6% dividend increaser for the Oct.14, 2019 payment, Mondelez dividend growth streak stands at eight years. The company makes up for its short dividend history with aggressive growth. The company has increased its dividend by an average of:
- 13.9% per year over the past three years.
- 12.9% per year over the past five years.
The most recent raise is slightly below these averages, but still a fairly high increase. With an annualized dividend of $1.14, Mondelez trades with a yield of 2.3%. The stock has traded with an average yield of 1.8% since it became an independent company.
Using the annualized dividend and expected earnings per share for the year, Mondelez has a projected earnings payout ratio of 45%. This is higher than the average payout ratio of 37% that the company has had since becoming an independent entity, but not at a spot where the dividend might be at risk for a cut.
The earnings payout ratio looks solid, though the company may need to grow earnings at a higher rate or else dividend growth could slow as the company seems intent on maintaining a sub-50% payout ratio.
What about free cash flow?
Mondelez distributed $409 million of dividends in the first quarter, while free cash flow totaled just $70 million for a payout ratio of nearly 600%. Free cash was down significantly in the quarter, primarily due to lower-than-usual operating cash flows. Mondelez stated that this was in line with company estimates due to non-recurring discrete tax payments.
Longer term, the free cash flow payout ratio looks stronger. The company paid out $1.5 billion in dividends last year while free cash flow came to $3 billion for a payout ratio of 50%.
For the three previous years, dividends distributed totaled $3.7 billion while Mondelez generated free cash flow of $6 billion for a payout ratio of 62%.
Mondelez’s dividend looks safe from a free cash flow perspective as long as future quarters look like the longer-term trend and not like the most recent quarter.
Mondelez closed Friday’s trading session at around $50. The company earned $2.47 per share last year, which gives the stock a one-year trailing price-earnings ratio of 20.2. Using estimates for this year, the forward price-earnings ratio is 19.6. The stock has a average price-earnings ratio of 20.7 since being spun off.
Given the company’s ability to perform well during the pandemic and its market leadership, I believe a price-earnings range of 20 to 22 seems appropriate for the stock. The midpoint of this range would be slightly above the stock’s average multiple.
Applying EPS estimates for the year to my target range would result in a share price of $51 to $56. Reaching these target price would result in a 2% to 12% improvement in the share price. Added to this total return would of course be the dividend.
Final thoughts
Mondelez had a very nice start to the year even in the face of a pandemic. The company increased its market share in a number of key categories and its highest grossing line had improved demand. While the Covid-19 pandemic and the resulting lockdown directives played a part in this growth, Mondelez can use these new-found customers to increase business if and when the spread of the coronavirus subsides.
The company doesn’t have a terribly long history of dividend growth, but the annual growth rates are of the generous variety. Shares trade with a current yield that is 50 basis points above average, giving income investors more reason to consider owning Mondelez. Though quarterly free cash flow was on the low side, this metric is less worrisome when taking in a longer-term view.
Using analyst earnings estimates and my valuation target range, I find that investors could be rewarded with low double-digit capital gains. That plus a safe dividend makes Mondelez a solid investment for investors looking for a consumer staple stock to own.
Disclosure: The author has no position in Mondelez International.
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