Dividend stocks can be the foundation of a great retirement portfolio. Not only do the payments put money in your pocket, which can help hedge against any dips in the stock market, but they're usually a sign of a financially sound company. Dividends also give investors a painless opportunity to reinvest in a stock, thus compounding gains over time.
However, not all income stocks live up to their full potential. Using the payout ratio -- i.e., the percentage of profits a company returns to its shareholders as dividends -- we can get a good bead on whether a company has room to increase its dividend. Ideally, we like to see healthy payout ratios between 50% and 75%. Here are three income stocks with payout ratios currently below 50% that could potentially double their dividends.
Kansas City Southern
Income investors looking for a company that has the potential to double its dividend within the next decade, as well as provide share price appreciation, might be wise to take a closer look at railroad operator Kansas City Southern (NYSE:KSU).
Like most railroads, Kansas City Southern struggled in 2015. Crude oil prices nosedived on a year-over-year basis, and coal prices have generally remained weak, reducing demand for petroleum and coal shipments for multiple quarters. Weakened commodity prices have also been a hindrance, with metal and scrap shipments down 30% in the fourth quarter. But in spite of Kansas City Southern's rough 2015, its long-term outlook remains bright.
For starters, Kansas City Southern has done a remarkable job controlling its costs. It's certainly received some help with lower fuel costs, but it's also made the tough decision to cut back on capital spending and on its workforce expenditures. Being tight with its expenses has allowed the company to improve its operating ratio by 330 basis points to 63.4% in the fourth quarter from the prior-year quarter. Having cost-cutting levers to pull has been an important tool for Kansas City Southern.
What really makes Kansas City Southern particularly attractive over the long run is its focus on diverse products that are only expected to increase in demand. For instance, energy (coal, frac sand, crude oil, and petroleum coke) made up only about 12% of Kansas City Southern's Q4 revenue. Yet the U.S. Energy Information Administration in July 2013 forecast that world energy consumption should grow by 56% by 2040. With U.S. drillers sitting on vast fossil fuel reserves, it's likely that Kansas City Southern will play a role in the transportation of these recovered energy assets. By a similar token, agricultural shipments, autos, chemicals, and a host of shipped products should steadily increase in demand over time.
Currently paying out a cumulative $1.32 per year in dividends, Wall Street is forecasting that it could near $7 in EPS by fiscal 2019. Even with aggressive reinvestment, this looks like a scenario where regular dividend increases could be the norm.
Dr. Pepper Snapple Group
Next up, I'd suggest that dividend investors sit back, relax, and sip on the income potential that beverage company Dr. Pepper Snapple Group (NYSE:KDP) can bring to the table.
This biggest obstacle facing Dr. Pepper Snapple Group is the ongoing pressure facing the company's soft drink products, Dr. Pepper, 7UP, and Sunkist. Soft drink sales have fallen for 10 consecutive years, hurt by consumers' desires to lead healthier lives. Additionally, Dr. Pepper Snapple Group is comparatively much smaller than Coca-Cola and PepsiCo., which means it gets easily outspent when it comes to advertising. But there's plenty to like if you're looking to add a strong dividend stock to your portfolio.
Like Kansas City Southern above, Dr. Pepper Snapple Group is seemingly a magician when it comes to improving operating efficiency and cutting costs. In an interview with Dr. Pepper's CFO Marty Ellen in February, The Wall Street Journal highlighted a number of ways the company is looking to save money and boost productivity. Ellen noted that improving inventory turnover and reducing setup times for syrup line sanitation have helped the company improve productivity by $270 million, when only $150 million was targeted over the first three years.
The other factor at work here is that Dr. Pepper Snapple Group's beverage products portfolio has extended well beyond carbonated soft drinks. In the fourth quarter, the company announced that non-carbonated beverage growth totaled 4%, led by, of all things, 21% growth in its bottled water category. For the year, its water category delivered 13% sales growth, led by its Bai and Fiji brands.
Dr. Pepper Snapple Group is already paying out $2.12 in dividends annually, which works out to a nice 2.4% yield. When taking into account its non-carbonated beverage growth, product diversity, and steady mid-to-high single-digit EPS growth, it's not out of the question that Dr. Pepper Snapple Group could be paying in excess of $4 per share in dividends in 10 years or less.
Lastly, we'll turn our attention to one of the most popular sectors for juicy dividends, financials, and briefly look at why East Coast and Chesapeake Bay banking entity M&T Bank (NYSE:MTB) could be a company that dividend investors covet.
M&T Bank's struggles in recent months are more or less on par with those of the rest of the banking industry. Low lending rates have constrained net interest margin expansion, and slowing GDP growth rates in China and the U.S. have put the Federal Reserve's plan to boost lending rates on hold for the moment. Since banks are cyclical, the fear of slowing U.S. growth has weighed on M&T Bank and its many peers. However, if you look beyond the next quarter or two, its outlook appears much brighter.
Arguably the biggest catalyst for M&T Bank is its (finally) completed acquisition of Hudson City. The deal, which was announced in August 2012, took three full years to complete as regulators had concerns with both companies. Following a resolution of these issues, Hudson City adds $19 billion in loans to M&T Bank's balance sheet, and expands the company's reach by an additional 135 branches (which have since been rebranded as M&T Bank). Having a stronger presence on the East Coast should only help it secure additional loans and deposits.
Another positive factor is that as M&T's loan portfolio grows, its credit quality continues to stay very high. Even though credit losses grew to $58 million in Q4 on a year-over-year basis, it was working with a substantially larger loan base. Thus, net charge-offs as a percentage of average loans outstanding dropped to just 0.18% in Q4 2015, down one basis point from the prior-year quarter and six basis points from the sequential third quarter.
Sporting an annual EPS growth rate that could average around 10% throughout the remainder of the decade, and a current payout of $2.80 per year (2.5% yield), it's quite possible that M&T Bank's dividend could double by 2025.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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