In part one of this series, I looked at two solid dividend stocks that would provide a decent backbone for any portfolio. In the second part, I looked at the high yield sector and in part three, I looked at two companies that offered the potential for capital growth as well as a strong dividend payment.
In this final part, I am going to look at three companies that have strong fundamentals for increasing future dividend payouts.
The other burger joint
McDonald’s Corporation (NYSE:MCD) offers investors some of the best returns around, the company returns most of its net income to shareholders every year through both buybacks and dividends. However, for the future I believe investors should look to McDonald’s’ smaller competitor, Burger King Worldwide Inc (NYSE:BKW).
Burger King shares many of McDonald’s Corporation (NYSE:MCD) strong fundamentals and the company’s cash generative nature. Indeed, Burger King Worldwide Inc (NYSE:BKW) has a gross margin of 79% compared to McDonald’s’ gross margin of 39%, but McDonald’s has a net margin of 20%, while Burger King’s is 6%. Moreover, McDonald’s’ shareholder payouts are only just covered by operating cash flow Burger King Worldwide Inc (NYSE:BKW)’s has plenty of free cash for further payout increases.
| Metric | McDonald’s | BKW 2011 | BKW 2012 |
|---|---|---|---|
| Operating cash flow | $6,970 | $406 | $224 |
| Investing cash flow | -$3,200 | -$41 | $34 |
| Dividends | $2,900 | $7 | $14 |
| Dividend cover by cash flow (operating-investing) | 1.3x | 52x | 18x |
| Free cash flow | $1,020 | $316 | $104 |
2012 was a relatively poor year for Burger King Worldwide Inc (NYSE:BKW), however, the company still produced a larger free cash flow as a percentage of operating cash flow than McDonald’s Corporation (NYSE:MCD). Indeed, during 2012 the company converted just under 50% of its operating cash flow into free cash flow. Furthermore, the company’s dividend payout is covered 18 times by operating cash flow after the deduction of investing activities. McDonald’s Corporation (NYSE:MCD) on the other hand, converted a smaller portion of its operating cash flow into free cash flow and its dividend is only covered slightly more than once by operating cash flow, after the deduction of investing activities.
Burger King Worldwide Inc (NYSE:BKW)’s high cash conversion ratio leads me to believe that shareholders will be in-line for growing returns in the future.
Plastic is the new cash.
Two other companies that I believe are set to significantly improve shareholder returns in the future are the highly cash generative card payment-network providers Mastercard Inc (NYSE:MA) and Visa Inc (NYSE:V)
MasterCard and Visa have a virtual monopoly across the world and will always have plenty of customers. Moreover, because they are not involved in the process of lending money to customers, neither company has any real credit risk. Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA) just process transactions and take a fee, a lucrative and almost risk-free business model.
As the plastic money revolution continues to gain traction, Visa and MasterCard’s sales and income are growing rapidly.
| Company | 3-yr Compounded Revnune Growth | Revenue 3-yr CAGR | Net Income 3-yr CAGR |
|---|---|---|---|
| Visa | 30% | 14% | -16.3% |
| MasterCard | 34% | 16% | 21.4% |
Visa’s net income for 2012 was hit with a one-off charge so it has skewed my figures.
Excluding the one-off charges, Visa Inc (NYSE:V)’s net margin for 2012 was around 41%, and Mastercard Inc (NYSE:MA)’s was 36%. These wide net profit margins indicated to me that both companies will be able to improve shareholder returns in the future. Indeed, even now both Visa and MasterCard are sitting on large cash balances with no debt and these cash piles are rising, burning a hole in their balance sheets.
| Metric | MasterCard | Visa |
|---|---|---|
| Current Ratio | 1.9 | 1.5 |
| Net Cash | $6.5 | $7.3 |
| Operating cash flow | $3 | $5 |
| Investing cash flow | $2.8 (excluding on offs $1) | $2.4 |
| Dividends | $0.13 | $0.6 |
| Dividend Cover by cash flow | 15x (excluding one-offs | 4x |
| Free cash flow | $2.7 | $4 |
$US Billions
Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA) have good current liquidity ratios with current assets easily covering current liabilities and net cash positions almost twice their yearly free cash flow. Excluding one-off events, MasterCard’s dividend payout is covered 15 times by cash flow and Visa’s payout is covered 4 times, indicating that both companies have plenty of room for further payout growth.
Conclusion
Looking for future dividend starts can be a risky business but these three companies listed above all have solid balance sheets and highly cash generative operations that will support stronger dividend payouts in the future. Even though it is impossible to predict future company actions, past performance indicates that these three company’s will be able to boost shareholder returns in the not-to-distant future.
Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide Inc (NYSE:BKW), Mastercard Inc (NYSE:MA), and Visa Inc (NYSE:V). The Motley Fool owns shares of MasterCard.
The article Stocks for the Dividend Investor, Part 4: Future Potential originally appeared on Fool.com.
Rupert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
