When I set out to explore the consumer non-cyclicals, Dial Corp. (NYSE:DL) was precisely what I hoped to find: a business with enduring consumer products, reliable cash flow, pro-shareholder management, and a deliciously reasonable price -- in this case, just 10.8 times free cash flow, including a 1.8% yield.
But don't take my word for it. Let's put Dial through the Rule-Maker paces and see how it fares. I'll assign points (0, 0.5, or 1) based on how the company matches up to each criterion.
1. At least one sustainable competitive advantage -- the more, the better.
Dial's core strength is its four premier consumer brands: Dial, the #1 brand of deodorant soaps; Purex, the #2 brand of laundry detergents; Renuzit, the #2 brand of air fresheners; and Armour, the #1 brand of canned meats (market positions based on volume.) Like General Electric (NYSE:GE), Dial can lay claim to the #1 or #2 market position in all its major segments. Give Dial one point on this one.
2. Dominant in its industry.
Dial's products have superb brand equity, but its overall product portfolio is modest compared to the competition. In its two main businesses -- soap and laundry, accounting for 70% of sales -- Dial is up against giants Proctor & Gamble (NYSE:PG), Colgate-Palmolive (NYSE:CL), and Unilever PLC (NYSE:UL). The smallest, Colgate-Palmolive, has seven times more sales than Dial. The upshot, of course, is that Dial could be a terrific acquisition for one of the big boys. But for Rule Maker purposes, Dial falls short on this one -- zero points.
3. Dominant for more than a decade.
We've established that Dial doesn't make the grade on sheer dominance, but the company does have longevity. Dial has been the leading anti-bacterial soap since its launch in 1948. Further, the company itself has been public for over a decade with available data going back to the early 1990s. Be aware, however: In 1996 "old Dial" split into two separate entities: a services business that changed its name to Viad (NYSE:VVI) and the consumer products business that exists as the "new Dial." Still, based on the Dial soap brand alone, it deserves half a point.
4. Free cash flow margin in excess of 10%.
A Rule Maker should be a virtual cash machine, with a cash profit margin (i.e., free cash flow margin) of at least 10%. Dial qualifies with its margin of 13.5% over the past year. In fact, Dial's free cash flow has been so strong that last week, in an expression of confidence in the company's ability to keep generating cash flow, Dial's board authorized a 125% increase in the quarterly dividend (from $0.04 to $0.09) and a $100 million stock buy-back program. I applaud both moves -- one point.
5. Efficient working capital management, measured by a Foolish Flow Ratio below 1.25.
Part and parcel to Rule Makerhood is not only the ability to generate cash, but to manage it well. Efficient cash management dictates that cash receipts be brought in quickly, while payables should be paid out slowly. All companies try to maximize their cash in this fashion, but only the strong can successfully dictate terms to their advantage. We measure success as a Flow Ratio less than 1.25. Here, Dial scores well with a Flow of 1.08 -- one point.
6. Sales above $4 billion per year and revenues growing at 10% plus.
Dominance of most any good industry should result in annual sales greater than $4 billion. Dial, being less than dominant, doesn't qualify. Over the past year, total sales were $1.3 billion. As for growth, not counting a divestiture of an underperforming segment in Argentina, sales growth has been in the mid-single digit range. That, too, falls short -- zero points.
7. Best-of-class management.
Besides sheer financial performance, one of the ways I gauge management is by their focus. What are management's goals? Since August 2000, Herbert Baum has done a marvelous job of turning the company around after a series of poor acquisitions by previous management. Baum's focus has been to generate cash flow from operations of at least 10% of sales, pay down debt, and earn a cash flow return on invested capital of at least 20%. I applaud both the goals themselves, as well as the fact that Dial achieved them in each of the past two years -- one point.
8. Return on invested capital (ROIC) above 11%.
Management is a steward of shareholder capital and as such is responsible for earning a solid profit on that capital. For a Rule Maker-caliber business, ROIC should be at least 11% and preferably stable-to-rising. Dial more than meets this standard with its ROIC of 21.5% over the past year, up from 19.8% in 2002 and 11.1% in 2001. That's both a superb return and a great improvement in capital productivity -- one point.
9. 1.5 times more cash than debt.
If a Rule Maker is spinning off cash as it ought to, then there should be no need for much debt. Hence, this requirement for at least 1.5 times more cash than debt. Dial, unfortunately, falls short with a cash-to-debt ratio of 0.7, based on $320 million in cash and $465 million in debt, or net debt of $145 million. The problem can be traced to 1999 when, under prior management, the company embarked on a fruitless acquisition spree, compounded by a reckless stock buy-back program. The result was more than $600 million in net debt by mid-2000. While Dial doesn't fully make the grade, the fact that new management has reduced debt by more than 75% is worth a half a point.
10. A reasonable purchase (or holding) price.
As mentioned at the outset, Dial's price-to-free cash flow (P/FCF) is a low 10.8. Why so low? Well, the company is a slow-grower, probably destined for free cash flow growth in the mid-single digits. Also, Dial has been an overly generous issuer of stock options, with annual grants averaging about 2.2% of shares outstanding (I'd prefer option dilution no worse than 1% annually). And yet even taking those considerations into account, I think Dial's business can support a P/FCF of 13, which would put the stock closer to $26. I like the value here -- one point.
Conclusion
Without any flash or flair, Dial earned seven points out of ten on what's admittedly a tough test. A 70% on this test, especially with a positive score on crucial question #10, makes Dial a good business at a great price. It's the type of stock that should perform decently no matter what happens with the economy over the coming year.
Matt Richey ([email protected]) is a senior analyst for The Motley Fool. At the time of publication, he had no position in any of the companies mentioned in this article. To find some straight-shooting, undercovered companies, consider subscribing to Tom Gardner's Motley Fool Hidden Gems.
