This Overlooked Dividend Aristocrat Has Potential for 20% Annual Total Returns

This stock has paid increasing dividends for 43 consecutive years... And still has amazing 20%+ annual total return potential.
By Ben Reynolds ,

When investors think of Dividend Aristocrats, they often think of 'the best of the best' blue-chip dividend payers.

After all, Dividend Aristocrats are stocks that have paid increasing dividends for 25+ years in a row.

Many of them are household names; companies like:

  • Coca-Cola
  • Wal-Mart
  • ExxonMobil
  • Colgate-Palmolive
  • Johnson & Johnson

Who hasn't heard of these well-established blue chip stocks?

But the overlooked Dividend Aristocrat with 20%-plus annual total return potential tha I'm going to talk about isn't a "household name" stock, and that's okay.

In fact, that probably has something to do with why it's such a great value today.

The Dividend Aristocrat I'm talking about is W.W. Grainger (GWW) - Get Report.

GWW

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The Facts About W.W. Grainger

W.W. Grainger has paid increasing dividends for an amazing 43 consecutive years.

The company has accomplished this phenomenal growth by slowly consolidating the North American maintenance, repair, and operations industry (MRO).

W.W. Grainger has a network of 713 stores and 34 distribution centers. The majority of those are in the United States and Canada. W.W. Grainger's large supply chain gives it a scale based competitive advantage over its competitors. W.W. Grainger is the largest player in the North American MRO market.

In addition, W.W. Grainger runs a thriving e-commerce business. It owns the following:

W.W. Grainger's Growth Story

W.W. Grainger has a straightforward growth plan: Acquire smaller MRO companies in North America through bolt-on acquisitions in order to consolidate the MRO industry.

The company has a long growth runway. W.W. Grainger is the industry leader in North America, yet it controls just 6% if the United States MRO market and 8% of the Canadian MRO market. W.W. Grainger has many decades of growth ahead comparing its relatively small size to the size of the total MRO market.

And the company's growth story goes beyond North America. W.W. Grainger is rapidly expanding its international e-commerce operations. One country W.W. Grainger has had tremendous success in this area is Japan.

Japan's small geographic size and dense population make it a prime candidate for W.W. Grainger to quickly build and scale e-commerce operations in the country. W.W. Grainger is expecting sales of $500 million from MonatoRO in fiscal 2015. The company expects to double sales from MonatoRO to $1 billion in just five years. This is not profitable growth. MonatoRO has a ROIC (return on invested capital) of around 40%.

W.W. Grainger's European e-commerce operations are also performing exceptionally well. European sales are expected to grow from a very small base currently to about $200 million a year by 2020.

In addition, W.W. Grainger has large growth plans for its United States e-commerce operations. Sales are expected to more-than-triple to $1 billion by 2020.

20%-Plus Total Return Calculations

W.W. Grainger has compounded its earnings-per-share at 15% a year over the last decade. The company is not new to rapid growth. Expect the company to generate even greater total returns over the next three years.

Total returns will come from the following sources:

  • Dividends of ~2% a year
  • Share repurchases of ~7.5% a year
  • Revenue growth of 7% to 12% a year
  • Margin improvements of 0% to 4.0% a year

Adding up the sources above, investors in W.W. Grainger should expect total returns of 16.5% to 25.5% a year over the next three years.

W.W. Grainger currently has a 2.2% dividend yield. The company has paid increasing dividends for 43 consecutive years in a row. It is probable dividend payments will continue to rise for W.W. Grainger over the next three years.

Share repurchases will be one of W.W. Grainger's biggest growth drivers over the next three years. The company has repurchased around 3% of its shares outstanding on average each year over the last decade. The company is planning to use $3 billion to repurchase shares over the next three years. This comes to ~7.5% of shares outstanding each year over the next three years at current prices.

On top of massive share repurchases and a reasonable dividend, W.W. Grainger is projecting revenue growth of 7% to 12% a year. This growth will come from expanding e-commerce operations, organic growth, and bolt-on acquisitions.

Finally, margin expansion could result in even greater returns. W.W. Grainger's net profit margin has grown at nearly 4.0% a year over the last decade. The company should continue to see margins expand as it grows larger and realizes more economies of scale in its operations.

Final Thoughts

No investment is completely risk free. W.W. Grainger is no exception.

The company struggled in its latest quarter on sales weakness resulting from fewer purchases from oil and gas companies. Low oil prices and layoffs were the cause of lower purchases, not a long-term shift in the MRO market.

Additionally, Amazon's new business service is targeting business customers. This will likely have a noticeable impact on companies like Staples. It could impact W.W. Grainger as well over the long run if Amazon decides to focus on the MRO market.

The two "bear outcomes" above could reduce growth for W.W. Grainger. Much of this fear is already baked into the price. W.W. Grainger is currently trading for a price-to-earnings ratio of 17.5. This is far too low given the company's amazing total return potential over the next three years.

W.W. Grainger is a buy at current prices. The company is a favorite of The 8 Rules of Dividend Investing thanks to its reasonable valuation and excellent total return potential.

This article is commentary by an independent contributor. At the time of publication, the author held positions in GWW, WMT, and XOM

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