There’s less than a month to go until 2021 arrives.
I’m sure, like me, you’re relieved to see this year end.
While 2020 has been unfortunate in so many ways, it hasn’t been all bad.
Indeed, I can think of at least one great thing about this year.
The massive volatility in the US stock market throughout this year has presented some fantastic deals on high-quality stocks.
I certainly never wish for global devastation.
But if if the stock market is suffering as a result of a major crisis that is already upon us, that’s an opportunity for long-term investors to take advantage of volatility.
Taking advantage of volatility is something I’ve consistently done throughout my decade of investing.
That helped me to retire in my early 30s, as I describe in my Early Retirement Blueprint.
The five-figure dividend income my portfolio produces for me is enough to cover my bills.
I call this real-money, six-figure stock portfolio the FIRE Fund.
I built that Fund using the tenets of dividend growth investing.
This is an investment strategy that involves buying and holding shares in great businesses that pay reliable, rising cash dividends to shareholders.
These rising dividends are the result of rising profit – and that rising profit is the result of running great businesses.
It’s circular in nature, which is why these are some of the best stocks in the market.
The Dividend Champions, Contenders, and Challengers list contains invaluable data on more than 700 US-listed dividend growth stocks.
As great as this strategy is, though, it’s imperative to do your homework.
Fundamental analysis is critical.
And so is paying attention to valuation.
After all, price is only what you pay. It’s value that you get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
These dynamics should reduce risk.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Taking advantage of volatility by buying high-quality dividend growth stocks when they’re undervalued can lead to tremendous long-term wealth and passive income.
Now, valuing stocks might seem like a complicated proposition.
It’s not.
Fellow contributor Dave Van Knapp has greatly demystified it with Lesson 11: Valuation.
Part of a more comprehensive series of “lessons” on dividend growth investing, it provides a valuation template that you can apply to just about any dividend growth stock out there.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Ingredion Inc. (INGR)
Ingredion Inc. (INGR) is a leading worldwide ingredients solutions provider.
Founded in 1906, Ingredion is now a $5 billion (by market cap) global business that employs 11,000 people.
The company turns raw materials like grains, fruits, and vegetables into value-added ingredients and biomaterials for various industries. They also provide products for the animal feed and corn oil markets.
Some of their products include industrial starches, high-fructose corn syrup, dextrose, and refined corn oil.
FY 2019 sales are geographically segmented as follows: North America, 62%; South America, 15%; Asia Pacific, 13%; and Europe, Middle East, and Africa, 10%.
Product categories are as follows: Starch Products, 46% of FY 2019 sales; Sweetener Products, 36%; and Co-products and others, 18%.
This company is uniquely positioned as a crucial part of the global food supply chain.
It’s a simple business model, but it’s one that’s been making money for more than a century.
And I see no reason why that can’t continue for another century, which bodes well for their ability to continue paying a growing dividend.
Dividend Growth, Growth Rate, Payout Ratio and Yield
As it sits, they’ve increased their dividend for 10 consecutive years.
The 10-year dividend growth rate is an astounding 16.2%.
However, recent dividend growth has slowed markedly; the five-year dividend growth rate is half of the 10-year dividend growth rate, for example.
On the flip side, the yield has risen as the dividend growth has slowed.
The stock now yields 3.31%, which is more than 120 basis points higher than the stock’s own five-year average yield.
That yield is also quite a bit higher than what the broader market offers.
And it’s supported by a payout ratio of 50%.
I’ll quickly note that I regard a 50% payout ratio as a “perfect” payout ratio, as that represents a perfect balance between retaining capital for growth and returning capital to shareholders.
These numbers are just plain solid across the board. These metrics might not “wow” you in any particular way, but a market-beating dividend that’s growing like clockwork can quietly perform magic over time.
Revenue and Earnings Growth
That said, this is looking at what’s already transpired.
But today’s investors are putting today’s capital at risk for tomorrow’s rewards.
Thus, I’ll now aim to approximate the company’s future growth, which will later help us estimate the stock’s intrinsic value.
I’ll build this growth trajectory by first looking at what the business has done over the last decade in terms of top-line and bottom-line growth.
Then I’ll compare that to a professional prognostication of near-term profit growth.
Blending the proven past with a future forecast in this manner should allow us to have a pretty good idea as to where the business is going.
Ingredion grew its revenue from $4.367 billion in FY 2010 to $6.209 billion in FY 2019.
That’s a compound annual growth rate of 3.99%.
I usually look for a mid-single-digit top-line growth rate from a fairly mature business like this. Ingredion pretty much delivered.
Meanwhile, earnings per share increased from $2.20 to $6.13 over this period, which is a CAGR of 12.06%.
Buybacks that reduced the outstanding share count by ~12% over the last decade helped to propel some of this excess bottom-line growth.
In addition, FY 2010’s earnings were depressed after coming off of the Great Recession.
The long-term picture here looks great, but growth has been flattish over the last five or so years.
Looking forward, CFRA believes that Ingredion will compound its EPS at an annual rate of -1% over the next three years.
It looks like the big picture here from CFRA’s perspective is that Ingredion’s tailwinds and headwinds are almost evenly matched over the short term.
On one hand, there’s the secular decline of high-fructose corn syrup, the COVID-19 impact to Ingredion’s foodservice exposure, and the commodity-like nature of the core business model.
On the other hand, the demand for the company’s natural sweeteners should increase, the company’s growing portfolio of specialty ingredients offer greater pricing power, and investments in plant-based proteins position the company for growth.
Regarding the latter point, Ingredion recently announced that it will acquire the remaining stake of Verdient Foods Inc. that it didn’t already own, which means Ingredion will produce concentrates and flours from peas, lentils, and faba beans.
There’s also a cost savings program that Ingredion initiated in order to reach $125 million in savings by FY 2021.
I think it’s worth pointing out that the company has marched through the pandemic admirably, coming out relatively unscathed.
FY 2020 Q3 results showed a 4.5% drop in YOY revenue and a 7.5% drop in YOY GAAP EPS. With a once-in-100-year type of worldwide disaster currently playing out, this is impressive stability from Ingredion.
CFRA does admit to “low visibility” when it comes to Ingredion’s short-term growth, and it would make sense to be prudent in that case.
I do think the company’s long-term growth could easily be in the mid-single-digit range, if not better. And that sets the company up similar dividend growth, which would be layered on top of a safe 3%+ yield.
Financial Position
Moving over to the balance sheet, the company has a strong financial position.
The long-term debt/equity ratio is 0.65, while the interest coverage ratio is almost 8.
Notably, unlike a lot of other businesses I follow, Ingredion’s balance sheet has not swelled or deteriorated in recent years. The debt position is roughly flat compared to five years ago. They remain flexible.
Profitability is really solid, especially considering that some areas of the business operate in a commodity-like fashion. And Ingredion’s growth in specialty ingredients could improve these numbers further.
Over the last five years, the firm has averaged annual net margin of 7.28% and annual return on equity of 17.46%.
This is an under-the-radar business that has held up very well throughout the crisis. And they’re making moves to position the business even better in the future.
With global scale and pricing power in a growing portion of the product portfolio, Ingredion does have competitive advantages.
Of course, there are risks to consider.
Regulation, litigation, and competition are omnipresent risks in every industry.
Volatile input costs can affect profitability, as does currency exchange rates.
High-fructose corn syrup makes up a little less than 10% of sales. This product has faced backlash out of health concerns and is in secular decline.
I also see a rising risk in the sense that there’s a trend moving toward simpler foods with less ingredients, which would not benefit Ingredion.
Overall, balancing everything out, I think Ingredion makes a lot of sense as a long-term investment when the valuation is attractive.
With the stock down 22% from its 52-week high reached in February, I think the valuation is now attractive…
Stock Price Valuation
The P/E ratio is 15.28, which is well off of the stock’s own five-year average P/E ratio of 17.3.
It’s also well below the broader market’s earnings multiple.
Then there’s the disconnect on cash flow.
The P/CF ratio of 6.9 is much lower than the three-year average P/CF ratio of 10.6.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 7%.
This DGR can look aggressive or conservative. It all depends on which way you’re looking at it.
Compared to the 10-year EPS growth rate and 10-year dividend growth rate, it’s conservative.
However, when you compare it to more recent business growth and CFRA’s near-term EPS growth projection, it looks aggressive.
The truth might lie in the middle after we split the difference. I believe it’s a balanced and reasonable long-term expectation from Ingredion when looking at the big picture of the business.
The DDM analysis gives me a fair value of $91.31.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
After a down-the-middle valuation model, the stock looks cheap.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates INGR as a 5-star stock, with a fair value estimate of $120.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates INGR as a 3-star “HOLD”, with a 12-month target price of $81.00.
Again, I came out down the middle. Averaging the three numbers out gives us a final valuation of $97.44, which would indicate the stock is possibly 26% undervalued.
Bottom line: Ingredion Inc. (INGR) operates as a crucial player in the global food supply chain. Recent investments in specialty ingredients and plant-based proteins position the company for new growth avenues. With a market-beating 3%+ yield, a “perfect” payout ratio, double-digit long-term dividend growth, and the potential that shares are 26% undervalued, this is an under-the-radar stock that dividend growth investors ought to take a good look at.
-Jason Fieber
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Note from DTA: How safe is INGR’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, INGR’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
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