ABM Industries (ABM): A Dividend King Improving Its Profitability and Dividend Growth Outlook

Dividend kings, companies with 50+ consecutive years of dividend growth under their belts, tend to be large, stable, and well-known businesses that are often a favorite among income investors.

 

However, occasionally small, lesser-known companies make it into this venerable group.

 

ABM Industries (ABM) is one example and has been a remarkably stable business over the decades.

 

The company’s management team is pursuing ABM’s largest ever corporate restructuring effort to further enhance the firm’s competitive position, too.

 

While ABM’s current dividend yield is below the yields offered by companies on our best high dividend stocks list here, ABM’s dividend growth profile could be set to improve with management’s restructuring plan.

 

Let’s take a closer look at this dividend king to see if it could be a good bet for long-term dividend growth investors.

 

Business Overview

Founded in 1909 in New York City, ABM Industries’ 100,000 employees serve over 20,000 corporate clients, both big and small, across over 300 offices in the US and in 20 international markets.

 

 

Essentially, ABM is a kind of corporate “handy man,” providing integrated solutions to a variety of logistical and mechanical engineering needs including energy solutions, HVAC (air conditioning), electrical systems, lighting, general maintenance and repair, as well as lawn care, janitorial, and parking services.

 

 

The company is currently undergoing its largest ever corporate restructuring that will result in six main business units which collectively represent $38 billion to $48 billion in global annual sales potential.

 

 

Business Analysis

A key factor to becoming a dividend king is a stable business model, as well as steady growth in sales, earnings, and free cash flow (FCF).

 

As you can see below, ABM Industries has a solid track record of steady top line growth, mainly due to large scale acquisitions in this highly fragmented industry.

 

 

However, the company has struggled somewhat to convert that acquisitive growth into higher returns.

 

In fact, while ABM’s adjusted EBITDA margin (management’s preferred profitability metric) has been flat over the past few years, its overall profitability and returns on shareholder capital have been headed in the wrong direction.

 

Companies that maintain a return on invested capital in the mid-single-digits typically have few competitive advantages.

 

In ABM’s case, it has larger size than most of its rivals and can offer customers a wider array of services to win their business, but contracts are usually awarded based on price because the services provided are undifferentiated and commoditized.

 

 

This has led to ABM generating below industry average profitability as well as poor EPS and FCF per share growth, which somewhat explains why management launched its Vision 2020 turnaround plan.

 

 

 

Now in fairness to the company, a large reason that these metrics look so poor is because the company recorded substantial one-time charges that resulted in very poor GAAP earnings in 2016.

 

Specifically, the company recently changed its self insurance safety standards, which resulted in a $49.5 million one-time insurance cost last year. In addition, as part of the turnaround plan the company sold its government services business in 2016, thus incurring a $22.5 million writedown.

 

But what exactly is ABM’s Vision 2020 turnaround plan and what does it likely mean for the company’s future dividend growth prospects?

 

Basically, ABM management has realized that over the past decades it has acquired a lot of business units with poor moats, meaning they operated in rather commoditized businesses with little or no pricing power. Thus the three-phase Vision 2020 plan was launched in September of 2015.

 

Phase one (completed November 1st, 2016) consisted of a careful analysis of each business unit in terms of market size, growth potential, and capability of building a long-term competitive advantage or moat.

 

 

This review is why ABM has recently shut down or sold its security, retail, and government services businesses and had to take so many short-term writedowns.

 

However, management now believes ABM is far better positioned for profitable grow, thanks to its greater focus on faster growing and higher margin business segments.

 

 

Phase two of the turnaround involves improving operational results. Specifically, that means optimizing management’s best practices in each respective business unit, as well as finding the lowest possible cost supply chain.

 

Phase three involves maximizing investment to optimize growth, both organically and through ongoing M&A, especially into those business units that can achieve management’s goal of steadily improving margins and higher returns on shareholder capital.

 

For example, ABM’s most recent purchase, announced in July of 2017, was the $1.25 billion stock and cash acquisition of GCA Services Group. GCA specializes in maintenance, janitorial services, and grounds management of 3,200 K-12 schools, 80 colleges, and 1,000 commercial clients in 46 states, DC and Puerto Rico.

 

The deal is expected to be highly accretive to sales and earnings, thanks to the addition of $1.1 billion in annual revenue (21% increase in sales) and a 65% increase in Adjusted EBITDA, as well as $25 million in targeted long-term synergistic cost savings.

 

Overall, Vision 2020 appears to be on track and will likely result in a 100 basis point improvement (i.e. 20% gain) to Adjusted EBTIDA margin, which should greatly help the company’s long-term plan to accelerate cash return to shareholders and lead to faster long-term dividend growth.

 

 

Key Risks

ABM faces three key risks going forward.

 

The first is that its business model, while highly diversified across tens of thousands of clients, is rather cyclical, meaning that its growth and profitability ultimately depends on the health of the U.S. economy.

 

Over the past nine years U.S. economic growth has been steady, if slower than usual. However, if we are in the tail end of the current business cycle and the economy starts to slow, ABM could be forced to renegotiate contracts at less favorable terms than it currently enjoys.

 

The second risk is that most of ABM’s growth has historically come from large scale acquisitions in this highly fragmented industry. For example, the GCA acquisition represents 50% of the company’s current market cap, which exposes shareholders to significant risk.

 

Such large acquisitions pose a number of financial and operational risks which can quickly harm shareholder returns if the expected benefits don’t play out as expected.

 

Investors in ABM are counting on management continuing its strong long-term track record of disciplined and accretive acquisitions in the future.

 

Finally, as with all turnarounds, there is the risk that management will end up overpromising and under delivering when it comes to the kind of margin expansion that the company depends on to leverage its steady but slow sales growth into the kind of earnings increases that can fuel faster dividend growth in the coming years.

 

After all, a key reason for owning a dividend king is its steadily growing dividend. However, management’s latest guidance indicates that its current focus, when it comes to returning cash to shareholders, will be in the form of buybacks and not significantly greater dividends.

 

 

And while buybacks, if properly executed, can be an important factor in faster long-term dividend growth (they increase EPS and FCF per share and lower the dollar amount of dividends paid each year), keep in mind that because ABM often uses its shares as currency to make acquisitions, its share count has not been declining over the years.

 

 

This is because, as a relatively small company ($2.5 billion market cap), ABM usually doesn’t have sufficiently large cash reserves to acquire rivals without partially funding such deals with shares.

 

Which basically means that a good deal of the increased buyback spending in future years will merely go to offsetting its most recent dilution, which will limit how much ABM can put towards higher dividend payouts in the short-term.

 

ABM’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

ABM has a Dividend Safety Score of 95, indicating a highly secure and dependable payout. That’s what one would expect from a company that has been steadily raising its dividends since 1968.

 

Besides management’s proven commitment to the payout, there are two main reasons supporting the company’s excellent dividend safety.

 

First, management likes to be conservative with its payout ratios, resulting in large safety buffers during times of economic distress or in years when large unexpected one-time costs occur. That’s what happened in 2016 when the writedown on its government service business sale, and self insurance reserve adjustment resulted in large decreases in EPS and FCF, respectively.

 

 

The second major protective factor is ABM’s strong balance sheet. While ABM is a relatively small company (it doesn’t have a credit rating), management is disciplined to not overextend the company with debt, despite occasionally borrowing heavily to make acquisitions.

 

 

For example, the company’s cash reserves are high enough to fund 18 months of the dividend, and its current ratio (short-term assets/short-term liabilities) is nicely above one, indicating no difficulty servicing its short-term debts or paying its suppliers.

 

And when we look at ABM’s credit metrics relative to its peers, we similarly see the company is on sound financial footing.

 

 

For example, ABM’s leverage ratio (Debt/EBITDA) is about half the industry average, while its debt/capital ratio is also much lower. Combined with a strong interest coverage ratio, this gives the company plenty of flexibility when it comes to growth without having to divert cash flow from its slowly rising dividend.

 

In fact, management recently said it’s planning to use more low cost debt to make acquisitions in the future but will limit its long-term leverage ratio to 2.5 or less.

 

This will still be far less than most of its peers but will also allow ABM to fund future growth while relying less on stock based deals, thus making it easier to grow the dividend in the future.

 

ABM’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

ABM’s Dividend Growth Score of 46 indicates that ABM’s long-term dividend growth prospects are about equal to the S&P 500’s. That’s not surprising given that ABM’s half century of consistent dividend growth has never been particularly quick.

 

 

Note especially that in recent years, as management has been working its turnaround strategy, ABM’s dividend growth has been much slower than its long-term average and pretty disappointing given the company’s low yield of 1.5%.

 

Going forward ABM should be able to continue growing slowly but surely, with sales expected to rise around 5% to 6% a year, which combined with steadily improving margins and potentially faster buybacks, should make annual earnings per share growth of 6% to 8% possible.

 

Since the current payout ratios are well balanced between strong dividend security and steady growth potential (while still providing excess cash to grow the company), investors should expect long-term dividend growth to closely track bottom line increases as well, suggesting mid to upper single-digit growth.

 

Of course, that’s over the long-term and assuming the turnaround is successful. In the short-term ABM’s dividend increases are likely to continue their recent tepid pace, as management’s priorities are with executing on Vision 2020 and prioritizing share buybacks over large dividend increases.

 

Valuation

Over the past year ABM shares have outperformed the S&P 500 by about 5%, which has caused the stock’s current valuation to look stretched today.

 

For example, ABM’s forward P/E ratio of 23.2 is not only much higher than the S&P 500’s 17.6, but it’s also significantly greater than both the industry median of 21.9 and the company’s long-term historical value of 19.9.

 

Meanwhile, ABM’s very low dividend yield of 1.5% is not just below the S&P 500’s 1.9%, but also the industry median of 2.2% and the company’s own 2.3% median yield over the past 13 years.

 

Essentially, ABM appears to be overvalued compared to its long-term history using P/E ratios and dividend yield.

 

If its valuation multiples were more reasonable (a stock price of $38 per share would put ABM’s P/E ratio in line with its long-term average), the stock has potential to deliver decent annual total returns between 7.5% and 9.5% (1.5% dividend yield plus 6% to 8% annual earnings growth), assuming management’s turnaround efforts are successful.

 

Conclusion

ABM is one of the few small cap dividend kings. While its long track record of steady, conservative, and disciplined dividend growth is impressive, income investors need to be aware that this isn’t, nor will it ever be, a fast-growing company.

 

Which means that, with a very low current dividend yield, this stock isn’t suitable for those looking to fund retirement with dividends, nor is it especially attractive for those seeking strong (i.e. double-digit) annual dividend growth.

 

When combined with the fact that ABM’s business doesn’t seem to possess many significant competitive advantages and its valuation looks elevated, ABM is not a dividend growth stock that I am very interested in following today.