Nordson (NDSN): Dispensing Higher Dividends for 52 Straight Years

Nordson (NDSN) has the 14^th longest dividend growth streak among U.S. public companies with 52 consecutive years of increases, but many investors have never heard of this dividend king.

 

The company has sticky customer relationships, a large base of recurring revenue, extremely diversified end markets, low payout ratios, and even trades at about 15 times forward earnings. These are the types of businesses we like to own in our Top 20 Dividend Stocks portfolio.

 

Business Overview

NDSN 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. The company serves virtually every end market including packaging, nonwovens, electronics, medical, appliances, energy, transportation, construction, and general product assembly.

 

Approximately 42% of NDSN’s revenue is recurring in the form of parts and consumables (e.g. tips, connectors, cartridges, valves, tubing), with another 36% from sales of standard products and the remaining 22% from sales of engineered systems.

 

By geography, NDSN derived 31% of its fiscal year 2015 revenue from the U.S., 28% from Europe, 27% from Asia Pacific, 8% from the Americas, and 6% from Japan.

 

By end market, roughly 39% of NDSN’s sales are from consumer non-durables, 18% from consumer durables, 9% circuit board assembly, 8% electronic components, 8% medical, 7% industrial, 6% automotive, and 5% semiconductor.

 

Segments

Adhesives Dispensing (50% of sales, 23.4% 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 (35% of sales, 20.4% 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 (15% of sales, 16% 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

NDSN’s solutions help customers increase uptime, boost productivity (better product yields and faster line speeds), improve efficiency (reduce consumption of materials), and ultimately achieve a lower total cost of ownership.

 

The cost of NDSN’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, NDSN’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 NDSN to make sure their production lines are operating smoothly and cost effectively.

 

With roots tracing back over 100 years, NDSN has built up a sizable installed base with thousands of customers. NDSN’s solutions are literally installed and serviced at a customer’s manufacturing facility, creating switching costs. To replace NDSN with another vendor would require halting production and retooling each production line. Few vendors also have the global sales and service capabilities that NDSN 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 NDSN 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 NDSN, providing growth opportunities for the company. NDSN’s installed base also provides substantial recurring revenue in the form of parts and consumables.

 

NDSN is continuously investing in innovation to stay at the forefront of technological change for its customers. The company invests 2-3% of its sales in R&D each year and has nearly 1,800 global patents in addition to more than 100 years of application know-how.

 

Acquisitions have further strengthened NDSN’s business model. 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, NDSN has its own continuous improvement program called the Nordson Business System (NBS). 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. Most recently, NDSN believes it margin enhancement initiative can deliver a 200 basis point improvement in normalized operating margin by 2017. Whenever global GDP growth begins to improve, NDSN will be in excellent position to deliver strong profits.

 

Overall, NDSN’s sticky relationships with customers, diversified end markets, solid base of recurring revenue, 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 NDSN are temporary in nature. While the business has meaningful exposure to stable consumer non-durable end markets (39% of sales) and generates over 40% of its revenue from recurring parts and consumables sales, it is also exposed to cyclical markets such as electronics and automotive vehicles.

 

Some of these markets are experiencing temporary weakness, which is hurting NDSN’s volume growth. Furthermore, NDSN is being hurt by the stronger dollar because roughly 70% of its sales take place outside of the U.S.

 

These macroeconomic factors are suppressing the company’s growth and profitability, but we expect NDSN’s overall market to be much larger in 10 years than it is today.

 

What could impair NDSN’s long-term outlook? A fundamental change in the manufacturing processes used in the company’s largest end markets could reduce the need for the NDSN’s systems. If viable economic substitutes for adhesives are discovered or products advance to require much less adhesive, NDSN could experience lower demand.

 

However, we view this as 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.

 

New competition is also a risk, but NDSN’s long-standing customer relationships and massive installed base are difficult to overcome. For now, we maintain a favorable long-term outlook on the company’s moat.

 

Dividend Analysis

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. NDSN’s long-term dividend and fundamental data charts can all be seen by clicking here.

 

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

NDSN’s dividend Safety Score of 72 is very good and indicates that the company’s current dividend payment is extremely safe.

 

Over the last four quarters, NDSN’s dividend has consumed 27% of its earnings and 28% of its free cash flow, which provides plenty of wiggle room for the company to continue paying and growing the dividend.

 

Looking further back, we can see that NDSN’s payout ratios have remained below 30% each year over the last decade. A stable payout ratio means that the company’s dividend has grown in line with its earnings growth, which is a good thing.

 

 

While low payout ratios already provide a nice level of comfort, observing a company’s performance during the recession is also important. Despite NDSN’s large revenue base of parts and consumables (42% of sales) and exposure to consumer non-durables end markets (39% of sales), we can see that its sales declined by 27% during 2009. NDSN’s stock also returned -43% in 2008. The company’s cyclical markets are very sensitive to broader economic trends and can easily put off investing in more efficient manufacturing equipment when times get tough.

 

 

Despite NDSN’s sensitivity to the broader economy, it 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 $0.96, we can see that the company’s current dividend is well covered by NDSN’s free cash flow generation.

 

 

Looking at NDSN’s return on invested capital reveals the high quality level of the company’s operations. We can see that the business has generated double-digit returns every year since 2009. Companies with high returns on capital like NDSN are able to compound their earnings (and dividends) at a faster rate than other businesses.

 

 

If it weren’t for NDSN’s fantastic free cash flow generation, its balance sheet would be a concern. The company only has $50 million in cash on hand compared to over $1.1 billion of debt. However, its free cash flow easily covers its dividend and interest payments, leaving plenty left over for acquisitions. NDSN also has $200 million in

 

 

Overall, NDSN’s dividend is 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.

 

Dividend Growth Score

Our 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.

 

NDSN’s dividend Growth Score of 84 is excellent and suggests that the company can continue delivering very strong dividend growth. NDSN has increased its dividend for 52 consecutive years, which is the 14^th longest growth streak among U.S. public companies and puts NDSN on the list of dividend kings, which consists of companies that have raised their dividends for at least 50 consecutive years.

 

Over its last 10 fiscal years, NDSN’s dividend has compounded by 10.8% per year and accelerating to an 18% annual growth rate over the last five fiscal years. Going forward, we expect NDSN’s long-term dividend growth rate to be at least 10% per year, although growth could be somewhat lower over the next year due to macroeconomic headwinds.

 

 

Valuation

NDSN trades at 15x forward earnings and has a dividend yield of 1.7%, which is higher than its five year average dividend yield of 1%.

 

While currency headwinds and sluggish activity in many of NDSN’s cyclical end markets could persist for at least several more quarters, we don’t believe they impair the company’s long-term earnings power.

 

We still think this is a business with upper-single digit earnings growth potential given its relatively small revenue base ($1.7 billion), presence in 30+ countries, exposure to practically every end market, and constant stream of new products that further expand its addressable markets.

 

With the stock selling off over 20% during the past year, NDSN appears to be very reasonably priced and looks like it has at least 10% annual total return potential going forward.

 

Conclusion

NDSN is a boring business that doesn’t get much attention from investors. While it is dealing with several macroeconomic headwinds today, we believe NDSN will remain a powerhouse in the growing adhesives dispensing market for many years to come. NDSN’s large installed base, customer diversification, new product investments, and switching costs all serve as enduring competitive advantages and remind us of some of our favorite blue chip dividend stocks. With a very reasonable valuation multiple and potential for strong earnings growth over the next decade, NDSN is a dividend growth stock to watch closely.

 

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