Spectrum Brands has stated its intentions to grow its pet supplies and home & garden products businesses by way of selective bolt-on acquisitions to increase its scale. While I acknowledge that acquisitions are common in the branded consumer products space, acquisition driven growth is inherently risky, exacerbated by its weak balance sheet which reduces operational flexibility.
Finally, I prefer dividend paying stocks with strong free cash flows, debt-free balance sheets, and minimal growth capital expenditure needs. While Spectrum Brands is a free cash flow generator, its huge debt load on top of an acquisition growth strategy suggests that dividends are of a lower ‘quality.’ Although Spectrum Brands’ forward dividend yield of 1.70% is not very significant, I prefer that Spectrum Brands uses the excess cash flow set aside for dividends to reduce debt instead.
Peer comparison
Spectrum Brands’ peers include Energizer Holdings, Inc. (NYSE:ENR) and The Procter & Gamble Company (NYSE:PG).
Energizer Holdings, Inc. (NYSE:ENR) has put in place several initiatives in the past year to boost its share price. Firstly, its cash conversion cycle was pretty long at around 120 days for fiscal 2012, and it has targeted a 400 basis points reduction in working capital-to-sales ratio, which will result in savings of up to $200 million based on management estimates. Secondly, like Spectrum Brands, it initiated its first quarterly dividend in July 2012, representing a 25% payout of 2012 earnings.
Last but not the least, Energizer Holdings, Inc. (NYSE:ENR) stepped up its investor relation efforts by organizing quarterly conference calls and providing annual financial outlook. Energizer Holdings, Inc. (NYSE:ENR) has been rewarded for its efforts with a 34% increase in its share price for the past 12 months. Trading at 1.22 times PEG, Energizer Holdings, Inc. (NYSE:ENR) is cheap relative to its peers, but still overvalued on an absolute basis.
The story for The Procter & Gamble Company (NYSE:PG) in the past few years has been one of it ceding market share in many of its product categories. Critics point to issues such as noncompetitive pricing and insufficient investment in marketing and innovation. In May 2013, it announced that Alan George Lafley has rejoined The Procter & Gamble Company (NYSE:PG) as President and Chief Executive Officer; he was previously President and Chief Executive Officer from 2000 to 2009.
I am optimistic that Lafley’s return will help steady a boat that has seen significant management turnover in recent years. Among the three stocks, The Procter & Gamble Company (NYSE:PG) has the highest forward dividend yield of 3.10% and the best balance sheet with a gearing of 47%.
Conclusion
I love the branded consumer products business just like Warren Buffett, but at the same time, I am averse to weak balance sheets and acquisition driven growth. Spectrum Brands does not meet my expectations in these areas. In addition, it also used its free cash flow to pay dividends, instead of reducing debt. Furthermore, it is overvalued at 1.9 times PEG. I will not consider this stock, unless it reduces gearing to a more acceptable levels and valuations become more reasonable.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Energizer Holdings and Procter & Gamble. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article A Good Business With a Weak Balance Sheet originally appeared on Fool.com is written by Mark Lin.
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