Thomson Reuters (TRI): Paying Higher Dividends for 24 Consecutive Years

Thomson Reuters (TRI) has raised its dividend for 24 straight years and is arguably one of the safest sources of income in the market for investors living on dividends in retirement.

 

The company’s business benefits from selling mission-critical solutions and generates significant amounts of recurring revenue (86% of sales), which results in very predictable cash flow and a high Dividend Safety Score.

 

Thomson Reuters has also been improving its earnings profile through various transformational strategies and expects its adjusted EPS to grow at a double-digit rate this year.

 

Let’s take a closer look at this reliable dividend growth stock to see if its future remains bright and if its valuation is reasonable today.

 

Business Overview

Thomson Reuters was created when Thomson acquired Reuters (a 160-year-old global news and financial data service) for about $17 billion in early 2008.

 

Many of the company’s solutions were assembled through hundreds of acquisitions made over the years. However, the organization is now focusing on growing organically and transforming into more of an integrated enterprise.

 

Today, Thomson Reuters is the world’s leading source of news and information for professional markets, selling electronic content and services primarily on a subscription basis.

 

Its businesses provide solutions, software, and workflow tools which integrate its core data and information.

 

Approximately 86% of Thomson Reuters’s revenue is recurring and is derived from subscription or contractual arrangements, which most customers renew annually. About 93% of its revenue is from information delivered electronically or as software and services.

 

By geography, Thomson Reuters generated 62% of its 2016 sales from the Americas, 27% from Europe, the Middle East and Africa (EMEA), and 11% from Asia Pacific.

 

The company caters to the needs of various financial and risk, legal, tax and accounting, intellectual property and science and media markets in more than 100 countries.

 

Segments

In October 2016, Thomson Reuters sold its Intellectual Property & Science business in order to focus more on global trade news and regulation opportunities. The company’s business is now organized in three business units:

 

Financial & Risk (55% of 2016 revenue; 48% of operating profit): provides critical news, information and analytics, enables transactions and connects communities of trading, investment, financial and corporate professionals. It also provides regulatory and risk management solutions. The segment has witnessed higher growth from Elektron Data Platform and Risk products as desktop revenues have been declining.

 

Legal (31% of sales; 40% of operating profit): provides critical online and print information, know-how, decision tools, software and services that support legal, investigation, business, and government professionals around the world.

 

Tax & Accounting (14% of sales; 12% of operating profit): provides integrated tax compliance and accounting information, software and services to professionals in accounting firms, corporations, law firms and government.

 

Business Analysis

At a high level, one of the first things to like about Thomson Reuters’ business is that professionals will always need more the data and analysis it provides.

 

Knowing more about mission-critical topics (e.g. geopolitical risks, transformative technology, currency movements, regulatory changes, etc.) helps people make better informed decisions, adapt to change, solve tough problems, and create more successful outcomes.

 

Thomson Reuters helps its customers accomplish these timeless objectives with its vast array of electronic content. As long as knowledge is valued by key decision-makers, there will be a need for Thomson Reuter’s intelligence, technology and human expertise.

 

Over the course of many decades, Thomson Reuters has established a strong position of trust, and its news has a reputation for speed and integrity.

 

Many of Thomson Reuters’ customers use its solutions as a part of their workflows, which has led to strong customer retention. As a result, the company maintains #1 or #2 market share positions in most of the segments that it serves.

 

The company’s deep industry knowledge, proprietary databases, trusted reputation, and embeddedness in customers’ mission-critical workflows have all contributed to the company’s moat.

 

Replicating Thomson Reuters’ unique databases, enterprise solutions, tools, and platforms would be an extremely costly and time-consuming endeavor, especially when you consider that many of its solutions have been built up from hundreds of acquisitions over the years.

 

Thomson Reuters has even stated that it probably has more company data than any other corporation in the world.

 

Customer contracts serve as another barrier to entry, although the majority of them are up for renewal every year. Despite the relatively short contract arrangements, Thomson Reuters’ existing customers would need to be willing to take a chance on a lesser-known vendor to part ways with the firm.

 

Such a move could reasonably be deemed as “too risky” in many cases given the importance of customers’ workflows and their decision-making processes that have grown dependent on Thomson Reuters’ solutions.

 

As a result of customers’ reliance on its solutions, Thomson Reuters has generally enjoyed annual price increases in the low single-digit range, which provide a nice recurring lift to profits.

 

The company’s continuously improving breadth, content, and capabilities help justify the price hikes and further strengthen long-term customer retention rates, which have historically hovered near 90% in its Financial & Risk segment.

 

Thanks to Thomson Reuters’ recurring revenue, relatively fixed cost base, economies of scale, decent pricing power, healthy customer retention, and business diversification (no customer is greater than 2% of revenues), the company has been a consistent free cash flow generator over the years:

 

 

Despite its strengths, the company has faced headwinds resulting from its acquisition spree, which saw the firm acquire close to 300 companies from 2003 through 2013 (most notably its $17 billion merger with Reuters in April 2008).

 

These deals brought a growing mass of unrelated businesses, and soft customer growth trends following the financial crisis caused further challenges The Reuters acquisition in particular was challenging as it caused a number of cultural issues, disappointing product launches, high employee turnover, and organizational complexities.

 

As a result, Thomson Reuters put together a turnaround plan in late 2013 to restore organic growth, simplify operations, capture true economies of scale, rely less on acquisitions, and improve profitability.

 

Thomson Reuters essentially acknowledged that its acquisition strategy resulted in a complicated infrastructure, an overgrown portfolio of products rather than an integrated enterprise, and a big company that wasn’t taking advantage of its scale.

 

The management team has now slowed down on acquisitions (16 acquisitions during 2014-2016 vs. 97 between 2011 and 2013). It also sold off its Intellectual Property & Science segment (close to 10% of sales) to focus more on its core businesses.

 

As a result, Thomson Reuters has successfully registered its second consecutive year of organic growth in 2016 while improving its margins.

 

 

The company’s new strategy focuses on an enterprise approach rather than a portfolio approach and drives attractive returns while maintaining a strong capital structure.

 

This enables organic revenue growth, which achieves savings from simplifying processes and reinvesting in growing businesses. Thomson Reuters is also targeting a return on invested capital above cost of capital for the first time since 2007.

 

 

Thomson Reuters has engaged in various simplification and productivity initiatives that have strengthened its core. The company founded Enterprise Technology & Operations (ET&O) at the beginning of 2016, unifying more than 10 functions into a single Enterprise team, for example.

 

The company has also retired 110 legacy applications, closed a number of data centers, reduced its workforce by 25% since 2012, and consolidated 62 office locations to 230 locations from 520 in 2012. Thomson Reuters is simplifying its product portfolio as well by reducing the number of products by roughly 70% in the Financial & Risk segment alone.

 

These transformational programs are designed to drive growth, improved retention, and efficiencies by accelerating organic growth and productivity gains.

 

 

As Thomson Reuters continues simplifying and unifying its products while divesting non-core businesses, it hopes to show a meaningfully improved organic growth rate this year and beyond.

 

As seen below, the firm is looking to generate 60% of its sales from “Growth” segments, such as Risk, Elektron Data Platform, Legal Software & Services and Global Tax, in 2017, up from just 48% in 2012.

 

The company expects to see its growth profile gradually improve as well as it allocates capital into faster-growing adjacent markets outside of its financial and legal research businesses.

 

Source: Thomson Reuters Investor Presentation

 

By relying more on organic growth rather than M&A, the company is also holding onto more cash to return to shareholders in the form of repurchases and dividends.

 

For example, Thomson Reuters completed 16 acquisitions between 2014 and 2016 for a cost of $316 million, which is significantly less than the 97 acquisitions made during 2011-2013 for a cost of $3.8 billion.

 

 

Through a combination of cost efficiency gains and incremental revenue growth (recall that Thomson Reuters’ cost base is largely fixed), the firm should be poised for stronger earnings growth in the years ahead.

 

Key Risks

Although Thomson Reuters has considerably reduced its number of acquisitions and is showing good progress on its 2017 plan, the company still faces a handful of risks.

 

Many of Thomson Reuters’ markets are increasingly tech-driven, for example. Data is becoming cheaper, information is more accessible than ever before, and low technology costs (e.g. the cloud) have resulted in thousands of fin-tech startups trying to disrupt the old incumbents like Thomson, Bloomberg, and LexisNexis.

 

These trends, which encourage more competition and innovation, will likely only intensify in the coming years.

 

Additionally, some of Thomson Reuter’s larger markets (e.g. banks, law firms) are struggling to grow headcounts due to heightened regulatory scrutiny and challenging economic conditions.

 

Market saturation could lead to intensified competition and pricing pressures, making it all the more important for Thomson Reuters to stay ahead of customers’ evolving needs to maintain its strong market share and profitability.

 

The company still appears to have a large advantage as the incumbent, but smaller players will always be much faster-moving and quicker to adapt new, potentially disruptive technologies to further unlock the flow of valuable information.

 

If competitors begin eroding Thomson Reuters’ moat, it seems reasonable to expect a company as large as Thomson to struggle with generating profitable organic sales growth. As of today, however, the business appears to be performing well overall.

 

Thomson Reuters has delivered positive organic revenue growth for two consecutive years, for example, and the company’s Financial business has continued recording revenue growth over the past year.

 

The Legal business has also seen its revenues grow (albeit modestly) despite declining U.S. print and transaction sales. Macro conditions have been strengthening, but the firm’s initiatives have been driving some of the improvement in profitability and productivity.

 

Thomson Reuters’ 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.

 

Thomson Reuter’s Dividend Safety Score of 89 suggests that its dividend is very safe.

 

The company’s dividend is first supported by the firm’s payout ratio. As you can see below, the company’s free cash flow payout ratio has increased over the last decade from about 35% in 2006 to 50-60% more recently.

 

The firm’s payout ratio is expected to be around 60% this year, which is in line with recent years. Given the steadiness of Thomson Reuters’ cash flow, this is a very reasonable payout ratio.

 

 

Looking at a company’s performance during the financial crisis can also be helpful when evaluating the safety of its dividend payment. If earnings are highly cyclical, the company has greater risk of needing to freeze or cut its dividend if conditions unexpectedly deteriorate.

 

Thomson Reuters’ reported results are skewed higher because of its acquisition of Reuters, which closed in April 2008.

 

Adjusting for the acquisition and currency headwinds, the company’s sales rose in 2008 and edged down by just 1% in 2009 despite meaningful weakness across many of its financial services customers. The company’s stock also outperformed the S&P 500 by 12% in 2008.

 

Since a high proportion of Thomson Reuters’ revenues are recurring, its revenue patterns are generally more stable compared to other business models that primarily involve one-time product sales.

 

In other words, the company’s sales are typically slower to decline when conditions worsen, but they are also slower to return to growth when the economy improves. I like these types of stable business models that consistently generate cash.

 

 

Thomson Reuters has also maintained an attractive margin profile over the last decade. Steady sales and high margins are often the sign of an economic moat.

 

With plenty of recurring revenue, an ability to push through modest price increases, improved profitability from its transformation program, and a gradually expanding platform of products, Thomson Reuters is consistently profitable.

 

 

Looking at the balance sheet, Thomson Reuters’ stable business model allows it to responsibly maintain more debt than most types of companies.

 

In fact, S&P has issued the company an investment-grade credit rating (BBB+) with a stable outlook.

 

 

Thomson Reuters’ average debt maturity is also 8 years and spread out nicely, which provides plenty of flexibility for the company to meet its obligations.

 

Source: Thomson Reuters Earning Presentation

 

All things considered, Thomson Reuters’ dividend payment appears to be quite safe. The company has a relatively high debt load, but its reasonable payout ratio, high recurring revenue, impressive dividend growth track record, and consistent cash flow all provide nice protection.

 

Thomson Reuters’ 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.

 

Thomson Reuters’ Dividend Growth Score is 29, suggesting that the company’s dividend growth potential is below average.

 

The company’s low score reflects its very low sales growth rate, indebted balance sheet, and management’s preference for small dividend increases in recent years.

 

As seen below, the company’s dividend has grown between 1% and 2% annually over the last five years.

 

 

Given the company’s target dividend payout ratio of 40% to 50% of its annual free cash flow, I wouldn’t be surprised to see 1-3% annual growth continue until business growth accelerates.

 

While Thomson Reuters’ dividend growth rate is far from remarkable, it has been consistent. The company has paid out dividends consistently for over 30 years and increased its dividend for 24 consecutive years.

 

Thomson Reuters is not eligible to join the S&P Dividend Aristocrats Index because it’s not a member of the S&P 500, but it has been a reliable dividend grower.

 

Valuation

TRI trades at a forward P/E ratio of 18.5, a slight premium to the S&P 500’s forward P/E ratio of 17.8, and offers a dividend yield of 2.9%, which is about in line with its long-term average yield.

 

For a company with substantial recurring revenue, strong free cash flow generation, and stable business trends, it’s not a big surprise to see its stock trade at a premium valuation multiple.

 

While the company expects its adjusted earnings per share to grow by 13.5% in 2017, it seems unlikely that this business could generate more than mid-single-digit earnings growth over the long-term.

 

As a result, TRI’s stock appears to offer annual total return potential of 7% to 10% (2.9% dividend yield plus 4% to 6% annual earnings growth).

 

Conclusion

Thomson Reuters shares many characteristics with some of the best high dividend stocks in the market. The company has a long history of strong profitability and dependable dividend increases, almost all of its revenue is recurring, and management is taking actions to make the company more competitive.

 

While Thomson Reuters’ dividend growth rate has been fairly low over the last five years, management’s transformation plan appears to be improving the company’s organic growth, which could translate to faster payout growth over the coming years.

 

The stock doesn’t look like a bargain today, but it seems like a reasonable long-term hold as the company continues gaining organic growth traction.