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The 12 Best Dividend Aristocrats- Part 1

The Dividend Aristocrats are a group of 57 high quality businesses with the following characteristics: they have increased their dividend for 25+ consecutive years, they meet certain minimum size and liquidity requirements and they are in the S&P 500, explains Ben Reynolds, CEO and editor of Sure Dividend.

Interestingly, The Dividend Aristocrats Index has outperformed The S&P 500 by an average of 1.5 percentage points annually from 1991 through 2018. Moreover, this strong performance has come mostly in bear markets.

More from Ben Reynolds: Top Picks 2019: AbbVie (ABBV)

Since 1991, The S&P 500 has experienced 5 years with negative total returns (2000, 2001, 2002, 2008, 2018). The Dividend Aristocrats Index outperformed the S&P 500 in every one of those years.

We will be covering 12 of our top Dividend Aristocrat buys over the next 4 weeks; look for upcoming articles each Friday. This first article covers 3 high quality Dividend Aristocrats that have a presence in the health care sector.

Cardinal Health (CAH)

Cardinal Health is a $15 billion market cap pharmaceutical distributor.  It is one of 3 large pharmaceutical distributors — along with Mckesson (MCK) and AmerisourceBergen (ABC) — that together control more than 90% of the industry.

Cardinal Health was founded in 1971 and has increased its dividend payments for 33 consecutive years. The company has managed to raise its dividend every year for so long because in the pharmaceutical distribution industry scale matters. Bigger companies can create more connected and more efficient distribution networks. This durable competitive advantage has led to consolidation within the industry.

While the pharmaceutical distribution industry in the United States is an oligopoly with just 3 large players, it is not as profitable as one would first suspect. Indeed, all 3 of the large players have net profit margins of 1% or lower.  Cardinal Health’s is just 0.5%.  This discourages competitors from entering the market.

But Cardinal Health’s stock price is significantly undervalued today. That’s because the company has not performed particularly well in the last few years. Adjusted earnings-per-share peaked in 2017 at $5.40. They came in at $5.00 in fiscal 2018. 

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We expect another year of adjusted earnings-per-share around $5.00 in fiscal 2019. The cause of slow growth is falling margins in the company’s core business due to increased competition brought about in large part by pressure on the pharmaceutical industry’s high prices. 

Additionally, the threat of Amazon (one of the only companies capable of entering the oligopolistic industry) competing in pharmaceutical distribution has weighed on share prices. Finally, negative publicity and lawsuits from the opioid epidemic have also weighed on the share price.

All in all, Cardinal Health is a high-quality business trading at bargain prices due to weakness over the last few years. The company provides a critical service (pharmaceutical distribution) very efficiently.

We believe the company’s long-term future looks much better than its performance over the last few years. With a price-to-earnings ratio of just 9.8 times expected 2019 earnings and a 3.9% dividend yield, the company’s shares appear meaningfully undervalued.

Walgreens Boots Alliance (WBA)

While Cardinal Health distributes pharmaceuticals to retailers, Walgreens Boots Alliance (WBA) fills prescriptions of the end consumer of pharmaceuticals. While technically a retailer, Walgreens Boots Alliance is very much a part of the pharmaceutical supply chain.

Walgreens has a $67 billion market cap, was founded in 1901 in Chicago, and has increased its dividend payments for 43 consecutive years. The company’s CEO is Stefano Pessina, an Italian billionaire and the single largest shareholder of Walgreens. 

Since being named permanent CEO of Walgreens in 2015, Pessina has helped Walgreens grow adjusted earnings-per-share from $3.88 in 2015 to $6.02 in 2018 — a compound rate of 15.8% annually.  Growth has come from intelligent allocation of capital. 

While rival CVS (CVS) leveraged itself to the hilt acquiring Aetna for $70 billion, Walgreens has been far more selective. The company has acquired Rite Aid stores at excellent prices. The company has also been an avid share repurchases, reducing shares outstanding by 4.4% annually since Pessina took the helm.

Instead of tying up the firms capital in a massive insurer acquisition, Walgreens has strategically partnered with UnitedHealth (UNH) to test out UnitedHealth’s MedExpress Urgent Care centers in 15 Walgreens locations.

In addition, the company has partnered with Kroger (KR) to test out Kroger pickup and Kroger brands in 13 Walgreens stores. Finally, Walgreens is expanding its pilot with LabCorp (LH) to open up 600 LabCorp patient centers in Walgreens stores over the next 4 years after testing the idea in 17 locations.

What we see at Walgreens is a pattern of testing ideas with low cost partnerships before rolling them out (if they are successful) at scale. This is a different (and wiser in my view) approach than CVS’ ‘bet the farm on big acquisitions’ approach.

The best part about Walgreens stock today is that investors do not need to pay up for Messina’s wealth compounding abilities. Walgreens is trading for a price-to-earnings ratio of just 11 times expected fiscal 2019 earnings. The companies 10-year historical average price-to-earnings ratio is 16.2 for comparison. And, the stock offers an above-market-average 2.5% dividend yield at current prices.

AbbVie (ABBV)

Walgreens and Cardinal Health are both involved with moving pharmaceuticals to the end consumer. AbbVie is an actual pharmaceutical manufacturer. It has a $124 billion market cap. The company was spun-off from fellow Dividend Aristocrat Abbott Laboratories (ABT) in 2013 and has increased its dividend each year since.

The company’s flagship drug is Humira. Humira is the largest grossing pharmaceutical in the world…  But it’s slowly losing patent protection. The company’s management and lawyers are fighting vigorously to prolong Humira’s revenue stream. Humira sales have done better than many projected over the last several years, but recently began declining in Europe.

AbbVie has not sat by idly. The company has invested heavily in acquiring new high revenue potential pharmaceuticals both through internal research and development and acquisitions. We don’t expect the company to continue compounding its earnings-per-share at 20.3% like it has from 2013 through 2018 but believe earnings-per-share are likely to grow at around 9.5% annually over the next 5 years.

The real draw of AbbVie shares today are their high dividend yield of 5.5%, reasonable payout ratio of around 50% of expected 2019 earnings-per-share, and high likelihood of future dividend growth.
On top of the company’s high yield, shares look very cheap right now.

The company’s shares are trading for just 9.0 times expected 2019 adjusted earnings-per-share of $8.70.  Its rare to find a company with a 20% annualized historical earnings-per-share growth rate trading for a price-to-earnings ratio in the single digits.

AbbVie’s low price-to-earnings ratio means the company just has to generate mediocre results to see its price-to-earnings ratio expand. Said another way, future expectations are low. But the company’s management team led by Richard Gonzalez has a phenomenal track record of compounding earnings-per-share (and growing dividends) at AbbVie.

(Disclosure: Ben Reynolds is long CAH, WBA, and ABBV.)

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