Dividend Kings In Focus Part 12: Nordson Sure Dividend

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Dividend Kings In Focus Part 12: Nordson


Updated on October 1st, 2020 by Aristofanis Papadatos

Nordson Corporation (NDSN) has a dividend track record that few companies can rival. The company has increased its cash dividend for 57 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 30 Dividend Kings here.

Additionally, we created a list of all 30 Dividend Kings along with important financial metrics such as P/E ratios and current dividend yields. You can access your copy of the Dividend Kings sheet by clicking on the link below:

 

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 43% 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 45% of last year’s sales.

The Industrial Coating Systems segment provides powder coating, spray painting, and food & beverage can production solutions. The segment is the company’s smallest. It accounted for 12% of last year’s sales.

Nordson’s revenue mix is highly diversified as only ~35% 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 currencies. 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.

Source: Investor Presentation

In terms of product type, Nordson generates approximately 54% 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 23% of sales from standard products, with 23% coming from engineered systems.

On June 1st 2020, Nordson announced the acquisition of Fluortek, a precision plastic extrusion manufacturer in the medical device industry. The expertise of Fluortek is complementary to the component offering of Nordson for minimally invasive therapies. It is also suitable for Nordson, which has prioritized growth in its Medical business.

Just like all the other industrial manufacturers, Nordson is currently facing a headwind due to the coronavirus crisis. In its fiscal third quarter, the company posted a 4% decrease in its revenue. The decrease in organic sales was uniform across its two segments, but its division of Advanced Technology Solutions was assisted by the recent acquisition of Fluortek and thus posted just a 2% decrease in sales.

Gross margin shrank from 54.0% in the prior year’s quarter to 52.0% due to the takeover of Fluortek and production inefficiencies caused by the pandemic. The adjusted earnings per share fell 12%, from $1.61 to $1.42, but exceeded the analysts’ consensus by $0.08. While a decrease in revenues and earnings is never welcome, Nordson exhibited remarkable resilience amid the pandemic, particularly given the nature of its business. Industrial manufacturers are very sensitive to the underlying economic growth and thus they are highly vulnerable to the downturn caused by the pandemic.

Moreover, management has observed improving trends in the business lately and thus it expects a modest improvement in revenues and earnings in the fourth quarter compared to the third quarter. It also views the current headwinds as temporary and expects to return soon to the consistent historical gross margin of the company, which is around 55%.

Growth Prospects

Nordson has more than doubled its revenue and has grown its earnings per share at an 11.3% average annual rate over the last decade.

The company stumbled last year, with a 3% decrease in revenues and a 1% decrease in earnings per share. Management attributed the lackluster performance to the challenging global economic environment and lingering uncertainty, which negatively impacted the investment decisions made by its customers.

The absence of revenue and earnings growth has remained in place this year due to the pandemic. However, the company has actually exhibited remarkable resilience amid the severe recession caused by the coronavirus. While most companies have seen their earnings collapse, Nordson is poised to report a 5% decrease in its annual earnings per share this year. We view this performance as a great positive.

Moreover, we believe that the long-term growth prospects of Nordson should remain intact. 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 the company looks for takeover targets 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 endeavor for long-term success but Nordson has proven its 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 of 13% between 2015 and 2019. 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, Nordson’s focus on emerging markets has been a significant growth driver and will continue to contribute to growth 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. This is essentially 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.

Nordson has managed to grow its EBITDA margin at a 6.6% average annual rate over the last five years.

Source: Investor Presentation

Thanks to all the above growth drivers and the somewhat low comparison base formed this year due to the pandemic, we expect Nordson to grow its earnings per share at an 8.0% average annual rate over the next five years.

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, its facilities are where its customers are in the world, and hence Nordson can react more quickly to product needs. 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, which 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, it buys patents and businesses with critical products it can use to supplement its existing lines. Its recent acquisition of Fluortek is just an example.

Moreover, Nordson’s large installed customer base means that not only does it have a large amount of recurring revenue, but it is also 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 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 many products of Nordson require capital expenses from its customers, whose budgets tend to be slashed during recessions.

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 grew 27%; its recession-resistance is surprisingly good.

Nordson has proved its resilience to recessions once gain in the ongoing downturn, which has been caused by the pandemic. The company is on track to report a modest 5% decrease in its earnings per share this year and expects to return to growth mode next year. It is thus one of the extremely few industrial companies that have been hardly affected by the coronavirus crisis.

Valuation & Expected Returns

We expect Nordson to generate earnings-per-share of $5.60 this year. As a result, the stock is trading at a forward price-to-earnings ratio of 34.3. This is by far the richest valuation level of the stock in more than 10 years.

On the one hand, a rich valuation is somewhat justified this year, as the results of this year are lower than the long-term potential of the company. On the other hand, the stock has an exceptionally rich valuation right now, which raises a red flag for its expected future returns.

We consider a price-to-earnings ratio of 19.0 to be fair for Nordson. If the stock reaches our fair valuation level over the next five years, it will incur an 11.1% annualized drag in its returns due to the contraction of its earnings multiple.

We also expect 8% annual EPS growth over the next five years while the stock is also offering a 0.9% dividend yield. Both of these items will add positively to shareholder returns. However, they are not sufficient to offset the overvaluation of the stock. Overall, the stock is likely to offer a -2.2% average annual return over the next five years.

The stock may remain richly valued for a considerable period and hence it can offer greater than our expected returns. However, it is not a prudent investing strategy to rely on a sustained rich valuation of a stock. We thus advise investors to sell the stock at its current price and wait for a meaningful correction before repurchasing it.

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 just raised its quarterly dividend from $0.38 to $0.39 and thus it is now offering an annual dividend of $1.56 per share. With projected EPS of approximately $5.60, Nordson has an expected payout ratio of 28% this year. A low payout ratio means that investors can be reasonably confident that the dividend will continue to grow for many years, particularly given the strong balance sheet of the company.

The only problem with the low payout ratio 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, which can be used later 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 Nordson has been able to maintain strong operating margins. Overall, Nordson’s results can be lumpy but the company is tremendously successful in generating growth over the long term.

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 near 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. This is somewhat surprising, given that it is a very rare Dividend King, but the low payout ratio shows that a generous dividend is not a 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 rise for many more years because Nordson has made it clear over the past 57 years that it intends to continue for the future.

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 its 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 of the stock price of this Dividend King before buying its shares.

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