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W.W. Grainger: A Top Dividend Aristocrat to Buy Today

- By Ben Reynolds

Investors looking for high-quality dividend growth stocks should take a closer look at the Dividend Aristocrats, a select group of 57 stocks in the S&P 500 Index with at least 25 years of annual dividend increases. The Dividend Aristocrats represent the premier dividend growth stocks in the entire market, as they have strong business models and durable competitive advantages that have fueled their long track records of dividend growth.

Grainger's impressive dividend history is the result of a highly profitable business model and steady growth each year. The stock appears to be undervalued, with plenty of room for continued growth in the years ahead. As a result, Grainger is one of the best dividend stocks to buy today.

Business overview and growth prospects

W.W. Grainger is one of the world's largest business-to-business distributors of maintenance, repair and operations supplies. The company was founded in 1927 and generates sales of approximately $10 billion per year. The company trades with a market capitalization of $15.5 billion, which makes it a large-cap stock.

Grainger reported its first-quarter earnings results on April 22. The company was able to generate revenues of $2.8 billion during the first quarter, which represents a revenue growth rate of 1.4% compared to the prior-year quarter. This was less than what the analyst community had forecasted. Grainger's organic revenues, adjusted for forex rates and days in the quarter, rose by 4.5% year over year, primarily thanks to higher sales volumes.

Through the impact of operating leverage, Grainger was able to grow its operating profits by 8% year over year despite the fact the revenue growth rate was not particularly high. The company managed to lower its operating expenses compared to the prior-year quarter, which allowed Grainger to grow its operating margin to 13%, up 80 basis points versus the previous year's first quarter. Grainger was able to grow its adjusted earnings per share to $4.51, which was up 8% from a year ago.

Grainger's guidance for 2019 looks promising as management forecasts a net sales growth rate of 4% to 8.5%, with earnings per share seen in a range of $17.10 to $18.70. At the midpoint of the guidance range, $17.90, Grainger would grow its earnings per share by 7.2%.

The company's strategic shift of lowering its pricing, thereby creating higher demand and growing its revenues, seems to have worked well during the last couple of quarters as operating profits grew at a solid pace. We believe growth will moderate somewhat, but Grainger should nevertheless be able to grow its sales as well as its profits further throughout the next couple of years.

Profit growth will not only be driven by rising revenues, but also by a reduction in the company's share count. Grainger's share repurchases have lowered the share count by roughly 25% since 2009. Future share repurchases will be beneficial for Grainger's earnings per share growth rate.

Grainger is a very shareholder-friendly company. Not only does it have a 2.1% yield and a long history of dividend increases, it also returns cash via share repurchases. In addition to its recent dividend increase, the company authorized a repurchase of up to 5 million of its own shares. Since 2014, the company has reduced its number of shares outstanding by more than 15%.

Competitive advantages fuel long-term growth

Grainger's long history of dividend growth is due to its excellent business model. Despite all of these increases, the company's dividend payout ratio has not risen to a high level, as it remained below 50% throughout the last decade. 2018's massive earnings growth rate has made the payout ratio decline further to 31% expected for 2019. The low dividend payout ratio and a very long dividend growth track record, coupled with a relatively stable performance during the last financial crisis, indicate that Grainger's dividend is very safe.

Another important factor behind Grainger's nearly 50-year streak of dividend increases is the company's durable competitive advantages. The company is not active in a spectacular or high-tech industry, but the services it provides are essential for other businesses. This makes Grainger's business relatively immune to recessions and economic downturns, as its business is not overly cyclical. During the last financial crisis, W.W. Grainger's earnings per share declined by just 15%, whereas the bottom line of many other companies was devastated during those years.

Grainger: Attractive value and dividend stock

Based on its expected earnings per share for 2019, the stock trades for a price-earnings ratio of 15.6. Our fair value estimate for Grainger is a price-earnings ratio of 18. If the valuation expands to our fair value estimate, shareholders would see a 2.9% boost to annual returns. Along with 7% expected earnings per share growth and the 2.2% dividend yield, total expected returns exceed 12% per year. Grainger's attractive valuation, promising future earnings per share growth potential and the solid dividend yield combine for satisfactory expected total returns.

At a recent share price of $279, Grainger stock is meaningfully off its 52-week high of $370 per share. Global trade worries have weakened investor sentiment over the past several months, but these short-term concerns are not likely to impact the long-term growth of the company. As a result, Grainger is an attractively valued dividend stock and a buy for long-term dividend growth investors.

Disclosure: No positions in any stocks mentioned.

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This article first appeared on GuruFocus.