Nordson (NDSN) has the 14th longest dividend growth streak among U.S. public companies with 53 consecutive years of increases, but many investors have never heard of this member of the dividend kings list here.
However, Nordson is certainly a business that’s worth getting to know.
The company has sticky customer relationships, a large base of recurring revenue, extremely diversified end markets, low payout ratios, and excellent dividend growth prospects.
While Nordon’s dividend yield is far too low to consider the company for our list of the best high dividend stocks here, it is the type of business that can deliver exception long-term total returns for shareholders.
Let’s take a closer look at this dividend champion.
Business Overview
Nordson was founded in 1954 and manufactures products used for dispensing adhesives, coatings, sealants, biomaterials, and other materials; for fluid management; for test and inspection; and for UV curing and plasma surface treatment.
Approximately 40% of Nordson’s revenue is recurring in the form of parts and consumables (e.g. tips, connectors, cartridges, valves, tubing), with another 39% of sales from standard products and the remaining 21% of revenue from engineered systems.
By geography, Nordson derived 29% of its fiscal year 2016 revenue from the U.S., 28% from Europe, 29% from Asia Pacific, 7% from the Americas, and 7% from Japan. Emerging markets have driven organic growth, with revenues growing at a 12.6% annual growth rate over the last decade.
By end market, roughly 38% of Nordson’s sales are from consumer non-durables, 17% from consumer durables, 9% circuit board assembly, 9% electronic components, 8% medical, 6% industrial, 7% automotive, and 6% semiconductor.
The company serves virtually every end market including packaging, nonwovens, electronics, medical, appliances, energy, transportation, construction, and general product assembly.
Segments
Adhesives Dispensing Systems (49% of sales, 26.1% operating margin): products to melt, filter, pump, transport, dispense, and deposit adhesives, polymers and other materials in the manufacturing of a wide range of goods (e.g. food and beverage packaging, diapers, labeling, medical devices, cars, furniture, etc.).
Advanced Technology Systems (37% of sales, 23.6% operating margin): precision dispensing, fluid management, test, inspection, and surface treatment products for electronics, medical, and general industrial markets (e.g. smartphones, tablets, solar panels, LEDs, medical devices, semiconductor packaging, printed circuit boards).
Industrial Coating Systems (14% of sales, 17.2% operating margin): precision equipment and systems to apply and cure paints, sealants, coatings, cold materials, and other materials to a wide range of products (e.g. appliances, lawn equipment, automobile sealing, pipe coating, electronics, etc.).
Business Analysis
Nordson’s solutions help customers increase uptime, boost productivity (i.e. better product yields and faster line speeds), improve efficiency (i.e. reduce consumption of materials), and ultimately achieve a lower total cost of ownership.
The cost of Nordson’s solutions make up a small proportion of a manufacturer’s total factory and product cost but deliver a high return on investment through the efficiencies and reliability they provide.
For example, Nordson’s technology might help a manufacturer produce 10% more volume out of its existing capacity by enhancing production speed. Essentially, manufacturers are happy to pay a reputable company like Nordson to make sure their production lines are operating smoothly and cost effectively.
With roots tracing back over 100 years, Nordson has built up a sizable installed base with thousands of customers. Nordson’s solutions are literally installed and serviced at a customer’s manufacturing facility, which creates switching costs.
To replace Nordson with another vendor would require halting production and retooling each production line. Few vendors also have the global sales and service capabilities that Nordson had built up over the last 50+ years when it started expanding internationally (the company is in over 35 countries today).
Having a large installed base helps Nordson generate strong and consistent free cash flow and provides numerous opportunities for growth as customers’ needs change.
For example, a nonwoven customer might introduce a new type of diaper that more closely resembles clothing and requires different manufacturing techniques. As a result, they might need to order a new solution from Nordson, providing growth opportunities for the company. Nordson’s installed base also provides substantial recurring revenue in the form of parts and consumables.
Nordson is continuously investing in innovation to stay at the forefront of technological change for its customers as well. The company invests 2-3% of its sales in R&D each year and has over 2,800 current as well as pending global patents in addition to more than 100 years of application know-how.
Acquisitions have been an important part of the company’s success as well, boosting Nordson’s growth by 3.7% annually over the last decade.
Since January 2017 alone, Nordson has acquired businesses like Ace Production, Inter Select, Plas-Pak Industries and Vention to strengthen its Advanced Technology Systems segment and add a greater mix of less cyclical end markets. Acquisitions added 6% top line growth in the second quarter of this fiscal year, highlighting their importance.
The company acquires businesses that provide new technologies, sales channels, adjacent markets, and sources of recurring revenue to help it maintain the broadest suite of dispensing, test & inspection, and surface treatment technologies in its markets.
Like many other high-quality industrial businesses, Nordson has its own continuous improvement program called the Nordson Business System (NBS) to keep the company efficient.
Rooted in Lean Six Sigma methodologies, NBS seeks to deliver on a set of key performance indicators around things such as growth, price effectiveness, cost reduction, productivity, and more to meet the company’s goals.
This type of organizational discipline can be especially effective during periods of slower growth because it can help cushion profits and create stronger operating leverage whenever growth recovers.
Nordson believes its margin enhancement initiative can deliver a 200 basis point improvement in normalized operating margin by 2017. The company has already made good progress in fiscal 2016 and should continue doing so in 2017 utilizing the NBS program.
Looking further out, Nordson’s 2017-22 Strategic Plan entails accelerating organic and inorganic growth, optimizing existing businesses and expanding organizational capability.
The company believes that it can grow organically at a rate of 2x global GDP growth, so Nordson should be in an excellent position to deliver strong earnings growth whenever global GDP growth begins to improve.
Overall, Nordson’s sticky relationships with customers, diversified end markets, solid base of recurring revenue, strategic acquisitions, global service capabilities, concentration in a slow-changing market, and commitment to innovation and operational excellence form the foundation of a strong economic moat.
Key Risks
The primary risks faced by Nordson are largely temporary in nature. While the business has meaningful exposure to stable consumer non-durable end markets (38% of sales) and generates 40% of its revenue from recurring parts and consumables sales, it is also exposed to cyclical markets such as electronics and automotive vehicles.
A slowdown in any of these end markets could directly affect Nordson’s profitability because demand for its products is sensitive to the general economic conditions of the industries and global macroeconomic factors.
Sluggish global growth could impose challenges for Nordson as seen in the recent past, and currency fluctuations can also affect reported sales and earnings growth over the short-term, which occurred in 2015.
What could potentially impair Nordson’s long-term outlook? A fundamental change in the manufacturing processes used in the company’s largest end markets could reduce the need for Nordson’s systems. If viable economic substitutes for adhesives are discovered or products advance to require much less adhesive, Nordson could experience lower demand.
However, this seems like a very low probability event. Adhesives have been in use for hundreds of years and are seeing even more applications for them emerge because they are increasingly lighter and stronger in weight than bolts, screws, and other fasteners.
In fact, adhesive manufacturer H.B. Fuller (FUL) is one of the more interesting long-term dividend growth stocks in the market. You can read our full thesis on the company here.
New competition is also a risk, but Nordson’s long-standing customer relationships and massive installed base are difficult to overcome. For now, the company’s moat appears to have a favorable long-term outlook.
Nordson’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.
Nordson’s Dividend Safety Score of 92 indicates that its dividend payment is one of the safest in the market. The company’s safe dividend starts with management’s conservative approach to Nordson’s payout ratio.
Over the last four quarters, Nordson’s dividend has consumed 23% of its earnings and 22% of its free cash flow, which provides plenty of wiggle room for the company to continue paying and growing the dividend even if economic conditions unexpectedly deteriorate.
Looking further back, we can see that Nordson’s payout ratios have remained nicely below 30% each year over the last decade. A stable payout ratio indicates that the company’s dividend has grown in line with its earnings growth, which is a good thing.
Source: Simply Safe Dividends
While low payout ratios already provide a nice level of comfort, observing a company’s performance during the recession is also important. Despite Nordson’s large revenue base of parts and consumables (40% of sales) and exposure to consumer non-durables end markets (38% of sales), its sales declined by 27% during 2009.
Nordson’s stock also returned -43% in 2008m, underperforming the S&P 500 Index. The company’s cyclical markets are very sensitive to broader economic trends and can cause many of Nordon’s customers to put off investing in more efficient manufacturing equipment when times get tough.
Fortunately, as economic conditions have continued improving, the company’s sales have bounced back and even registered record organic growth of 13% in fiscal year 2016.
Despite Nordson’s sensitivity to the broader economy, the company easily generates free cash flow in every business environment. Its free cash flow per share even increased in 2009 despite its drop in sales.
With an annual dividend payout of $1.08 per share, the company’s current dividend is well covered by Nordson’s free cash flow generation.
Looking at Nordson’s return on invested capital reveals the high quality level of the company’s operations. The business has generated double-digit returns every year since 2009, which usually indicates the presence of a moat.
Companies with high returns on capital like Nordson are able to compound their earnings (and dividends) at a faster rate than other businesses.
If it weren’t for Nordson’s fantastic free cash flow generation, its balance sheet could be a concern. The company only has $88 million in cash on hand compared to over $1.7 billion of debt.
However, its free cash flow easily covers its dividend and interest payments, leaving plenty left over for acquisitions. Nordson also generated $272 million in free cash flow or 100% of net income during the last fiscal year, reflecting the strong cash conversion of its business model.
Overall, Nordson’s dividend appears to be extremely safe. The company has low payout ratios, generates a lot of free cash flow, earns high returns on capital, operates in a stable industry, and has proven its commitment to the dividend with over 50 straight years of dividend growth.
Nordson’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.
Nordson’s Dividend Growth Score of 99 is excellent and suggests that the company can continue delivering very strong dividend growth over the coming years.
Nordson has increased its dividend for 53 straight years, consistently rewarding shareholders with double-digit annual dividend growth over the last decade.
Going forward, Nordson’s long-term dividend growth rate will likely continue to be near 10% per year, reflecting the company’s strong earnings growth profile and low payout ratios.
Valuation
NDSN trades at a forward P/E ratio of 23, which is a premium to both the S&P 500’s multiple of 17.6 and the industrials sector’s forward P/E ratio of 18.
From a dividend yield perspective, NDSN’s current yield of 0.9% is slightly lower than its five-year average dividend yield of 1%.
In other words, investors are clearly recognizing the strength of Nordson’s business and its long-term growth opportunities in the stock’s current price.
According to the IMF, global GDP is expected to grow by around 3.5% over the next five years. While you can never read too much into economic forecasts, Nordson’s organic sales growth would register at around 7% per year, according to management’s expectations of a growth rate that double’s global GDP.
When combined with ongoing margin improvements, share buybacks, and the continued launch of new products to expand its addressable market, Nordson has good potential to record double-digit annual earnings growth.
As a result, NDSN’s stock has potential to deliver annual total returns between 10% and 13% (0.9% dividend yield plus 10% to 12% annual earnings growth) going forward, likely continuing its impressive track record of outperforming most of its peers.
Source: Nordson Corp
Conclusion
Nordson is a boring business that doesn’t get much attention from investors, but the company seems likely to remain a powerhouse in the growing adhesives dispensing market for many years to come.
Nordson’s large installed base, customer diversification, new product investments, and switching costs all serve as enduring competitive advantages. The stock’s valuation multiple doesn’t look cheap and its yield is far too low for investors living off dividends in retirement, but it reflects Nordson’s high quality businesses and multiple growth opportunities across all of its segments.
Investors might be best off waiting for a 10% pullback to around $110 per share to get the stock at a somewhat more comfortable valuation multiple, but Nordson is a dividend growth stock worth watching given its potential for strong earnings growth over the next decade.
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