Published September 19th, 2016 by Eli Inkrot
Founded in 1961, Lancaster Colony Corporation (LANC) was formed as the result of several glass and housewares manufacturing companies coming together.
By 1963 the company started doling out a regular quarterly dividend, which is a tradition that has carried on every since. This makes the company one of just 18 Dividend Kings – stocks with 50+ consecutive years of dividend increases. You can see all 18 Dividend Kings here.
Eight years after Lancaster was formed was pivotal time for the company. In 1969 the company went public and also bought a specialty foods business: the T. Marzetti Company.
Given the profitable and growing last half century, it seems that this has been a fine decision. The company went from selling someone a plate once a decade, to selling them something to put on that plate every other week.
Here’s a look at the company’s current collection of brands:
Source: Lancaster Colony, Our Company
Lancaster certainly doesn’t carry the internationally acclaimed powerhouse brands like a PepsiCo (PEP) or Kraft-Heinz (KHC). However, there are a lot of steady and profitable names carried under the Lancaster umbrella. You might be familiar with the company’s New York Texas Toast offering, salad dressings and toppings, rolls or bread products. Personally, I know the company via the Olive Garden-branded salad dressing that the T. Marzetti Company puts out.
On August 18th of 2016, Lancaster reported fourth quarter and fiscal year results. For the fourth quarter ending June 30th 2016, improvements were seen across the board. Sales were up 2.4%, operating income was up 20% (as a result of a lower cost of sales), net income was up 19.7% and earnings-per-share were up 20.4% as compared to the previous fiscal year-end quarter.
Comparing fiscal year 2016 to 2015, sales nearly touched $1.2 billion – up 7.8%. Operating income hit $184 million – up 19.2% for the year-over-year period. Net income was up 19.7%, coming in at over $121 million. And earnings-per-share came in at $4.44 as compared to $3.72 in the previous year.
It would be fair to suggest that the company had a pretty solid year. With regard to the upcoming year, Chairman and CEO John B. Gerlach Jr. had a bit more subdued expectations. For 2017 guidance, Gerlach indicated that the retail side ought to be strong – lead by expansions in the salad dressings (including the Olive Garden offering) and new innovations like Siracha Ranch favored veggie dips and “Bake & Break” garlic bread.
However, only “flat to modest” gains are forecast on the foodservice side as cost reductions wane and commodity input costs could act as a future headwind. Moreover, innovative product offerings can create new sales growth, but these will accompanied by increased expenses in the way of greater marketing and promotion investments.
Just prior to the earnings announcement, Lancaster also voted to continue its $0.50 quarterly dividend – up 8.7% as compared to the previous mark in the prior year. Lancaster is astute in detailing that it is one of only 15 companies that increased its cash dividend for each of the last 53 consecutive years. Moreover, this $0.50 quarterly dividend excludes the $5 special dividend that investors received earlier in the fiscal year.
Competitive Advantage & Recession Performance
While Lancaster’s product lines might not be the blockbuster names that you’d ordinarily think about dominating the grocery isles, this certainly does not mean that the company does not carry clout. Indeed, the company’s competitive advantage is easy to explain: “Lancaster has the number one position in its six primary categories and saw share growth in all but two.” Moreover, Lancaster supplies everyday and limited offerings to 20 of the top 30 national restaurant chains.
Here’s a look at how the company fared leading up to, during and after the Great Recession:
- 2006 earnings-per-share = $2.26
- 2007 earnings-per-share = $2.05
- 2008 earnings-per-share = $1.64
- 2009 earnings-per-share = $3.18
- 2010 earnings-per-share = $4.07
It turns out when things get tough, Texas Toast isn’t exactly a necessity. Earnings of $2.26 per share in 2006 turned into “just” $1.64 by fiscal year 2008 – a decline of over 27%. Yet three notes should be made.
For one thing, it wasn’t as if profits went from positive to negative. Instead, the company went from earning roughly $75 million to $50 million. Next, the dividend continued to grow through this time and was still well covered – reaching almost 70% of earnings during the recession, but easily abating thereafter.
Finally, you can see the “snap back” effect very plainly. Once times were good again, the demand and profitability of the firm easily ramped up – hitting new records along the way. Lancaster has now earned north of $95 million in profits every year since 2010.
Here’s a look at Lancaster’s record of earnings and dividend growth over the past decade:
- Earnings-per-share have grown at an average compound rate of 7.0% per annum
- Dividends per share have growth at an average compound rate of 7.4% per annum
Note the close connection of earnings and dividend growth. In 2006 Lancaster was paying out 45% or thereabouts of its profits in the form of cash dividends. Given what we know above, you’d anticipate only slight growth in the payout ratio. Indeed, last year Lancaster still paid out just under half of its profits as cash dividends.
It depends on where you look, but analysts are presently anticipating intermediate-term growth for the company in the 3% to 8% range. As a personal preference, I’d rather be overly cautious instead of needing excellent performance to justify an investment thesis. Despite the robust growth this year, something in the mid-single digits as a baseline expectation may be a more prudent anticipation.
Valuation & Total Return
Thus far we’ve outlined an exceptional business. This wasn’t mentioned above, but in addition to strong operating history, enduring profitability, reasonable growth and a 50+ year dividend increase streak, Lancaster also has an excellent balance sheet – with cash and equivalents effectively covering all of the liabilities (both short and long-term).
Yet there is one hitch: valuation.
Investors have recognized the excellence and priced it accordingly. From 2006 through 2015, the company put together 6% to 7% earnings growth but investors saw share price appreciation of over 11%. This was a direct result of the earnings multiple jumping from around 17 back in 2006 all the way up to 29 by the end of 2015.
As I write this shares of Lancaster trade hands around $131. As compare to the recently reported earnings-per-share of $4.44, this equates to an earnings multiple of nearly 30. Just to give you some context, the company’s average P/E ratio over the past two decades has been closer to 18 and around 20 during the last decade. Only recently has something well above 20 been the norm.
This could have important implications for today’s investor. For instance, if Lancaster was able to grow both its earnings and dividends by say 6% annually, this would translate to an expectation of receiving ~$11 in cash payouts and a future earnings-per-share number near $6. If shares were to trade at say 22 times earnings in the future, investors would expect annual returns of just 1.6% per annum.
Granted something much better (or worse) could happen, but the idea is that today’s valuation is much higher than what has historically been reasonable.
In short, Lancaster is one of those “behind the scenes” companies that you probably don’t think about too often. When I found out about the Olive Garden dressing, I had to go check for myself, sure enough: “Distributed Exclusively For Olive Garden by T. Marzetti Co.” There’s a storied record of profitability, sustainability and dividend increases inherent in the company’s culture. Moreover, you have a solid financial standing to boot.
The problem comes in the way of valuation. Your starting dividend yield sits at just 1.5% and future business results could very well be stymied by an overextended valuation. Should shares later trade at say 20 or 25 times earnings, shareholder growth is sure to trail business results. This can still work out alright (if growth hits 10% per year or if the price-to-earnings ratio remains lofty for instance) but in my view it’s also a reason for caution. As a result of its high valuation, the company does not rank particularly well using The 8 Rules of Dividend Investing.