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Nordson: High Growth, But An Overvalued Dividend King


Updated on December 13th, 2019 by Bob Ciura

Nordson Corporation (NDSN) has a dividend track record that few companies can rival. The company has increased its cash dividend for 56 consecutive years, making it one of just 14 such entities in the entire market with a dividend increase streak of that length.

That puts Nordson among the elite Dividend Kings, a small group of stocks that have increased their payouts for at least 50 consecutive years. You can see the full list of all 27 Dividend Kings here.

 

Click here to download my Dividend Kings Excel Spreadsheet now. Keep reading this article to learn more.

Dividend Kings have the longest track records when it comes to rewarding shareholders with cash, and Nordson is no different. Nordson does not have a household name, and may not be well-known among investors. But the company certainly has a successful history of raising its dividend.

Nordson has been a high-growth company for many years. It experienced a slowdown last year, but we believe this is temporary. Nordson offers the potential for high dividend growth, making the stock appealing for long-term dividend growth investors.

Business Overview

Nordson was founded in 1954 in Amherst, Ohio, but the company can trace its roots much further back to 1909 as the U.S. Automatic Company. That enterprise specialized in making screw machine parts for the fledgling automotive industry but in the 1930’s, the company shifted to making more high-precision parts you’d probably associate with the Nordson of today.

Then in 1954, Nordson was started as a division of the US Automatic Company via the acquisition of patents covering the “hot airless” method of spraying paint and other coating materials. The rest, as they say, is history as Nordson has grown to $2B+ in annual revenue with its 7,500 employees all over the world.

Nordson engineers, manufactures and markets unique products used to dispense, apply and control adhesives, sealants, polymers, coatings and other fluids to test for quality as well as to treat and cure surfaces. The company’s products are found all over the world – sold primarily by a direct, global sales force – and offer custom solutions to their customers’ engineering problems. Nordson has built a reputation over the past five decades of quality and value with its wide range of solutions.

The company has a highly diverse customer base:

Source: Investor Presentation

Nordson is split into three business segments: Adhesive Dispensing Systems, Advanced Technology Systems and Industrial Coating Systems. Adhesive Dispensing Systems delivers proprietary precision dispensing and processing products for applications that reduce material consumption as well as increase line efficiency and enhance product durability. This segment primarily serves the consumer non-durable market, and accounted for 42% of sales last year.

Advanced Technology Systems serves the needs of electronics, medical and high-tech customers by integrating product technology found in the various stages of a production process such as dispensing of material, surface treatment, optical inspection and x-ray testing to ensure quality. This segment accounted for 46% of fiscal 2018 sales.

The Industrial Coating Systems segment provides standard and customized equipment used primarily for applying coatings, sealants, paint and other finishes as well as for curing and drying of dispensed material. Industrial Coating Systems primarily focuses on the consumer durable market. This segment represented 12% of company sales in fiscal 2018.

Nordson’s revenue mix is highly diversified as only ~30% of it comes from the U.S. The remainder is from a wide variety of global customers, offering Nordson not only a diverse customer base, but also diversity when it comes to the currencies it operates in. The U.S. is Nordson’s largest in terms of geographic presence but Asia-Pacific and Europe aren’t far behind; Nordson is a truly global company.

In terms of product type, Nordson generates approximately 47% of its sales from parts and consumables, which is a relatively attractive area of focus because much of this revenue is recurring in nature. Separately, Nordson generates 31% of sales from standard products, with 22% coming from engineered systems.

Growth Prospects

The company’s recently concluded fiscal year showed a difficult performance when compared with the prior year. For fiscal 2019, Nordson generated revenue of $2.2 billion, down 3% from fiscal 2018. This included a 1% decline in organic volume, acquisition-related growth of less than 1%, and a 2% negative impact from the effect of currency translation. Operating profit came to $483 million, while net income was $337 million for the year.

On a per-share basis, earnings came to $5.87 as adjusted to exclude certain one-time items. This marked a decline of 8% compared with the previous fiscal year. Company management cited the challenging global economic environment and lingering uncertainty, which negatively impacts the investment decisions being made by its customers.

While the company’s EPS declined last year, its long-term growth should remain intact. The company already expects to return to growth in the upcoming year, albeit at a low rate. For fiscal 2020, Nordson expects organic sales volume to increase 1%-3%. Operating margin and EBITDA margin are expected to remain roughly flat with fiscal 2019. Diluted earnings-per-share are expected to grow 2%-6% for fiscal 2020. While this would represent a slowdown from the stronger growth rates generated in years past, the upcoming year is still expected to bring EPS growth, which is impressive in a challenging business environment.

There are many levers for Nordson’s long-term growth. Nordson is a serial acquirer and has been basically from the beginning when it was started with the acquisition of patents covering the hot airless method of spraying. Nordson’s track record when it comes to acquisitions is a good one as it looks for companies that give it some sort of competitive advantage it does not already possess with high percentages of recurring revenue and expense synergies.

Growth-by-acquisition is a difficult thing at which to succeed but Nordson has proven the ability to do so over the long term. This is a key differentiator for Nordson and should not be overlooked by investors. While Nordson’s growth may be a bit lumpy – beholden to acquisition rates as well as companies’ willingness to spend their capex budgets on Nordson’s products – this company’s long term track record of growth bodes well for the future. Nordson has generated strong growth for many years, consisting of both internal initiatives as well as acquisitions.

Source: Investor Presentation

The combination of acquisitions, organic growth and focus on continuous improvement drives not only top line expansion but margin gains as well. Organic revenue growth is driven by continually introducing new products and technology. This steady stream of new ideas turns into new products and drives organic revenue growth.

Nordson’s innovative prowess is on full display in its core Advanced Technology Systems segment, which generated annualized sales growth above 15% from fiscal 2014-2018. Going forward, the company sees the potential for long-term growth of 2x-3x the global GDP growth rate in this business.

Source: Investor Presentation

In addition to that, Nordson’s focus on emerging markets has helped it grow and will continue to do so in the future. The company’s emerging markets have produced low double-digit revenue growth on average in the past ten years, outpacing Nordson’s core markets of the U.S. and Europe. The growing middle classes of these emerging markets should allow Nordson to continue to see impressive rates of organic revenue growth as well as opening up the opportunity for continued, targeted acquisitions in those markets.

Nordson, through its decades of strong growth, also has a large installed customer base. That is tremendously valuable when it comes to upgrade and replacement cycles as its customers offer Nordson recurring revenue on a regular basis and even more when it is time to upgrade. This virtuous cycle is how Nordson makes its living and it is very good at it; this should not be overlooked as an avenue for steady, continuous growth moving forward and as Nordson grows, so does its installed customer base.

Finally, Nordson has been in the process of improving its efficiency through what it calls the Nordson Business System. Basically, this is a set of tools and best practices Nordson has collected over the years that is rooted in Lean Six Sigma principles and is applied throughout the company in all business units. Nordson closely monitors and measures results against benchmarks and this focus on efficiency is a growth driver via margins.

Competitive Advantages & Recession Performance

Nordson’s competitive advantages are varied and when combined, they paint a pretty rosy picture of the company’s position. First, Nordson has an impressive global infrastructure that puts it in a place of not only having a diverse customer base, but diverse groups of talent as well.

In addition to that, its facilities are where the customers are in the world, meaning it can react more quickly to product needs and get them to market more quickly. This also affords Nordson an advantage when service is needed as it has people near its customers wherever they are. This is the sort of thing that drives long term relationships that are Nordson’s bread and butter.

That brings us to our next point, which is Nordson’s R&D and patents. Nordson only spends about 3% of its revenue on R&D but it makes the most of it, filing for dozens of patents each year. In addition to that, it buys patents and businesses with critical products it can use to supplement its existing lines.

Third, Nordson’s large installed customer base means that not only does it have a large amount of recurring revenue, but it makes it that much more challenging for competitors to take customers away. Switching costs are high for the kinds of things Nordson sells and thus, the incumbent in any given space has a huge advantage. Nordson’s installed base has many advantages and is a primary reason why the company has remained so successful.

Finally, Nordson’s geographic diversification works for the reasons I’ve mentioned in addition to providing a long and diverse mix of customers. Further, Nordson earns the vast majority of its revenue outside of the US, meaning it derives revenue mostly in non-dollar terms. That provides additional risk and exposure to currency markets but Nordson has certainly made it work.

Nordson’s many competitive advantages allow it to hold up fairly well in recessionary environments; the company’s earnings-per-share during and after the Great Recession are below:

Earnings were volatile during the recession, but on the whole, Nordson performed very well. There aren’t many companies with EPS figures that look like this during and after the Great Recession and in particular, ones that manufacture for a living. Keep in mind that a lot of Nordson’s products require capex from its customers so when things like the Great Recession happen, those budgets tend to get slashed.

However, Nordson also sells things that are absolutely vital to many businesses and thus, when the smoke clears, those orders tend to materialize. Indeed, as the global recovery began to gain steam in 2010, Nordson’s revenue was up 27%; its recession-resistance is surprisingly good.

Valuation & Expected Returns

We expect Nordson to generate earnings-per-share of $6.10 for fiscal 2020. As a result, the stock trades for a forward price-to-earnings ratio of 26.7. The stock does not look particularly cheap, since it has held an average price-to-earnings ratio of just under 18 over the past 10 years.

We expect 6% annual EPS growth over the next five years, and the stock has a 0.9% dividend yield. Both of these items will add positively to shareholder returns. However, overvaluation could erode shareholder returns moving forward.

Nordson’s strong free cash flow and disciplined approach to acquisitions mean that the dividend is very well covered. It also happens to grow quickly. Nordson has raised its dividend every year for more than 50 years. The company has a current annual dividend of $1.52 per share. With projected EPS of approximately $6.10 at the midpoint of 2020 guidance, Nordson has an expected payout ratio of 25% for the upcoming year. A low payout ratio means investors can be reasonably confident the dividend will continue to grow for many years.

The only problem with the dividend is that the yield is less than 1%, which does not make the stock very attractive for income investors looking for high yields.

Nordson’s approach to spending its cash is a bit different from other companies in that, depending upon the year, it may buy back lots of stock, make acquisitions, pay down debt or any number of other things. Since 2012, Nordson has spent its cash in different ways from one year to the next, including more than half of it over this time frame on acquisitions. There have been years of high levels of buybacks and years with none.

Source: Investor Presentation

The ability to allocate capital in so many ways is actually a testament to the strength of the business model. The company is in the enviable position of having a self-funding business which generates excess cash flow, that can later be used for acquisitions, debt reduction, or shareholder cash returns.

All of this is to say that this management team has performed very well in the past by making opportunistic decisions in terms of how to spend its cash. Top line growth has been strong apart from a blip during the Great Recession and it has been able to maintain strong operating margins. Again, Nordson’s results can be lumpy but over time, it is tremendously successful in terms of producing growth over the long term.

Shareholder returns could reach nearly 7% annually from earnings growth and dividends. However, if the stock valuation declines toward its 10-year average, it will eat into those returns. Assuming the stock valuation falls back to a price-to-earnings ratio of 18, Nordson is currently overvalued by a significant amount. If it takes five years to reach this level, a declining valuation could reduce shareholder returns by ~7.5% annually.

As a result, if earnings growth and dividends provide 7% annual returns, but a declining valuation reduces those returns by 7.5% per year, total returns are likely to be negative in the amount of ~0.5% annually moving forward. This is not a satisfactory rate of return, and in fact makes Nordson stock a sell in our view.

Final Thoughts

Nordson is a high-quality business that is simply too expensive for investors right now. This is a common occurrence these days, with the S&P 500 Index sitting at a record high. It is becoming much harder to find reasonably valued dividend stocks with high yields and growth potential. While Nordson certainly has long-term growth potential, the stock appears to be considerably overvalued, with a low dividend yield as well.

Nordson isn’t a strong stock for high income. That is a bit strange to say given that it is a very rare Dividend King but the payout’s size simply isn’t the priority for management. The priority is growing the business and this company has done that exceedingly well, producing sector-leading total returns for shareholders. The dividend will continue to rise because Nordson has made it clear over the past 56 years that is something it intends to continue.

Nordson is a class leader in sectors where its high level of expertise and large installed base make it difficult for competitors to supplant. It is also recession-resistant and the management team has proven adept at managing its capital. However, Nordson is a classic example of a great company, not-so-great stock. Investors should wait for a significant decline before buying shares of this Dividend King.

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