Flowers Foods’ Cash Flow Increases The Safety Of Its Dividend Yield

Recap from March’s Picks

On a price return basis, the Safest Dividend Yields Model Portfolio (+2.0%) underperformed the S&P 500 (+5.8%) by 3.8% from March 19, 2021 through April 20, 2021. On a total return basis, the Model Portfolio (+2.3%) underperformed the S&P 500 (+5.8%) by 3.5% over the same time. The best performing large cap stock was up 10% and the best performing small cap stock was up 50%. Overall, 7 out of the 18 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from March 19, 2021 through April 20, 2021.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Featured Stock for April: Flowers Foods

Flowers Foods Inc. (FLO) is the featured stock in April’s Safest Dividend Yields Model Portfolio.

Flowers Foods has grown revenue by 5% compounded annually and net operating profit after tax (NOPAT) by 18% compounded annually over the past two decades. Flowers Food’s NOPAT margin increased from 5% in 2016 to 7% in 2020 while its return on invested capital (ROIC) improved from 7% to 9% over the same time.

The firm’s economic earnings, or the true cash flows of the business, more than doubled from $101 million in 2016 to $204 million in 2020.

Figure 1: Flower Foods’ Revenue & NOPAT Since 2016

Cash Flow Supports Dividend Payments

Flowers Foods has increased its dividend for 18 consecutive years. More recently, the firm increased its dividend payment from $0.57/share in 2015 to $0.79/share in 2020, or 7% compounded annually. The current quarterly dividend, when annualized provides a 3.3% dividend yield.

Since 2015, Flowers Foods’ cumulative FCF easily covers its annual dividend payments. Over the past six years, Flowers Foods generated $1 billion (20% of current market cap) in FCF while paying $870 million in dividends, per Figure 2.

Figure 2: Flowers Foods’ FCF vs. Dividends Since 2015

Companies with strong FCF provide higher quality dividend yields because I know the firm has the cash to support its dividend. On the other hand, dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.

FLO Is Undervalued

At its current price of $24/share, FLO has a price-to-economic book value (PEBV) ratio of 0.5. This ratio means the market expects Flowers Foods’ NOPAT to permanently decline by 50%. This expectation seems overly pessimistic given that Flowers Foods has grown NOPAT by 7% compounded annually over the past five years and 18% compounded annually over the past two decades.

Even if Flowers Foods’ NOPAT margin falls to 5% (twenty-year average, vs. 7% in 2020) and the firm grows revenue by just 2% compounded annually over the next decade, the stock is worth $39/share today – a 63% upside. In this scenario, Flowers Foods’ NOPAT falls by 1% compounded annually over the next ten years. See the math behind this reverse DCF scenario.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Flowers Foods’ 10-K:

Income Statement: I made $277 million in adjustments with a net effect of removing $137 million in non-operating expenses (3% of revenue). See all adjustments made to Flowers Foods’ income statement here.

Balance Sheet: I made $338 million in adjustments to calculate invested capital with a net increase of $124 million. The most notable adjustment was $182 million (6% of reported net assets) in asset write-downs. See all adjustments to Flowers Foods’ balance sheet here.

Valuation: I made $1.6 billion of adjustments with a net effect of decreasing shareholder value by $1.4 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $128 million in net deferred tax liabilities. This adjustment represents 3% of Flowers Foods’ market value. See all adjustments to Flower Foods’ valuation here.

Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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