3 mid-cap stocks with fast-growing dividends

All of these could one day be among the world's best income producers.

By StreetAuthority Apr 22, 2014 10:13AM
Arm & Hammer Baking soda boxes
© Richard Drew/APBy Tim Begany

Because no one can predict the future with 100 percent accuracy, spotting tomorrow's best income-producing blue-chip stocks today is extremely difficult.

However, I recently profiled one company I strongly believe is well on its way to achieving blue-chip status -- filtration technologies manufacturer Pall Corp. (PLL) -- and there are several others I think have the same type of potential.

Aside from being in retail, these three companies aren't much alike. One is a sodium bicarbonate maker best known for the Arm & Hammer brand, and the second is a leading discount clothing chain based in California. The third has carved out a profitable niche as a provider of farm and ranch supplies in rural areas.

One thing they do have in common, though: Their dividends have been growing really fast -- more than 50 percent a year, in one case -- for some time now.

And that's just one of the main reasons I think that all three companies, like Pall Corp., are on track to take their place among the world's best dividend-paying blue-chip stocks. These three stocks also display other key characteristics of up-and-coming blue chips such as strong balance sheets, sustainable payout ratios, ample cash flows, and market leadership.

1. Church & Dwight Co. (CHD)​​​​

Market cap: $9.4 billion
Recent stock price: $68.75
52-week range: $56.36 - $69.44
Payout ratio: 40 percent
Dividend growth rate (past 9 years): 31 percent
Dividend per share: $1.24
Yield: 1.8 percent​​ 

Along with Arm & Hammer products, Church & Dwight sells a range of household, personal care, and specialty goods (Oxiclean stain removers, Aim toothpaste, Orange Glo household cleaners and Trojan condoms are among its most recognizable products.).

Annual revenue has climbed to $3.2 billion, more than double 2004's $1.5 billion. Since 2004, CHD's earnings per share (EPS) have more than quadrupled to $2.79 from $0.68. Its impressive dividend growth rate has resulted in more than an 11-fold increase in the payout from 2004's $0.10 total.

Many factors point to rapid dividend growth for CHD in the future, such as the rejuvenation of the mature Arm & Hammer brand, which stagnated during the recession but has grown 10% a year during the past several years due to increased marketing. Arm & Hammer products now generate sales in excess of $1 billion a year -- a third of Church & Dwight's total revenue. Gummy vitamin sales, currently about $300 million annually, have been rising 20 percent a year and should greatly boost earnings and dividends, especially after the completion of a new manufacturing facility in 2015 that will increase production capacity by 75 percent.

Church & Dwight's reasonable payout ratio leaves plenty of room for dividend increases, particularly when you consider the firm's strong cash situation. For instance, its per-share cash total of $3.62 is more than triple the current dividend.

2. Ross Stores

Market cap: $14.7 billion
Recent stock price: $69.50
52-week range: $62.04 - $81.99
Payout Ratio: 18 percent
Dividend growth rate (past 8 yrs.): 25%
Dividend per share: $0.80
Yield: 1.2 percent​​   

Although ROST meets the generally accepted definition of a large-cap stock, it's still acting like a mid-size company, increasing EPS by 27 percent a year from 2005 through 2013. That just isn't something you typically see from much larger discount clothing retailers, and it's obviously a big reason for ROST's exceptional dividend growth. By comparison, Target (TGT), which is currently worth $38 billion, increased EPS by only 3.2 percent a year (from $3.51 to $4.52) during the same eight-year period.

To achieve its success, Ross operates two chains -- Ross Dress for Less and DD's Discounts -- that sell brand-name clothing, accessories and footwear at 20 percent to 60 percent below normal retail at about 1,100 locations, primarily in California, Florida and Texas. Ross can offer such deep discounts because it's a closeout retailer that buys extra cheap from manufacturers and vendors who want to jettison excess inventory. What's more, its customers are willing to sacrifice service and nice store locations for ultra-low prices.

With so much economic uncertainty, this winning formula should continue driving industry-leading profits that allow Ross to keep rapidly increasing its dividend. Like Church & Dwight, it already has enough cash on its balance sheet to cover the current payout several times over, and maintaining the current pace of dividend growth should be no problem for the foreseeable future.

3. Tractor Supply (TSCO)​
Market cap: $9.3 billion
Recent stock price: $66.20
52-week range: $51.78 - $78.17
Payout Ratio: 21 percent
Dividend growth rate (past 3 yrs.): 52%
Dividend per share: $0.52
Yield: 0.8 percent   

TSCO has been offering dividends for only a few years now, but it's a strong bet to keep paying and quickly raising them. That's because the company serves a specialized but substantial niche of ranchers, farmers and outdoors enthusiasts who remain loyal because Tractor Supply provides products they need but can't easily get anywhere else. These include things like horse and livestock feed, rugged work clothing and footwear, farm equipment maintenance products, and barnyard accessories like feeding troughs and large water tubs.

Because Tractor Supply attracts customers by meeting needs most other retailers neglect, it also ends up generating substantial revenue on more ubiquitous items such as tools, hardware, and lawn and garden equipment. Of the firm's $5.2 billion of annual revenue, 20 percent is from seasonal products such as mowers and snow blowers, while hardware and tools account for 23 percent of sales. Farm and ranch-related products are, of course, Tractor Supply's biggest draw, bringing in 42 percent of total revenue.

Despite having a unique target market, Tractor Supply is geographically diverse and operates about 1,200 locations in 45 states, giving it plenty of opportunity for more rapid growth. What's more, it has no real competition thus far to hinder that growth. So I'm confident the company can keep up a rapid pace of dividend raises, especially since it too has a manageable payout ratio, ample cash on its balance sheet, and solid free cash flow, as well as no short- or long-term debt.

Risks to consider:
CHD in particular is exposed to the risk of commodity and raw material price increases, while ROST may find it more difficult to acquire high-quality merchandise if full-price retailers start seeing more foot traffic. TSCO's success could begin to attract competition.

Action to take:
Investors looking for tomorrow's best dividend-paying blue chips today should consider CHD, ROST and TSCO for the reasons I've discussed. What's more, all three stocks still have plenty of attractive appreciation potential in the coming five years -- about 50 percent for CHD, 60 percent for ROST, and 90 percent for TSCO.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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