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3 Industrial Stocks To Build Your Dividend Growth Portfolio

As many industries operate through unique economic cycles, there are always a few industrials for sale.

I often have the feeling we forget about industrials. There is nothing sexy about them. There is often minimal stimuli to create hype on the stock market. Even worse, this sector is not seen as a source for high dividend yields. As many industries operate through unique economic cycles, there are always a few industrials for sale.

Here are three industrials that should be on your watch list for whenever the next cycle hit their stock price.

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A. O. Smith Corporation (AOS) Business Model

A. O. Smith Corporation is a provider of water heating and water treatment solutions. The Company operates through two segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe, and India. Both segments manufacture and market a range of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The North America segment also manufactures expansion tanks, commercial solar water heating systems, swimming pool and spa heaters, related products, and parts. The Company's Lochinvar brand is a residential and commercial boiler brands in the United States. It sells its Aquasana branded products directly to consumers through e-commerce as well as on-line retailers. The Company’s water softener branded products and problem well water solutions include Hague, WaterBoss, Water-Right, WaterCare, and Evolve.

Source: AOS investors presentation

Source: AOS investors presentation

Investment Thesis

Besides being a leader in its market, AOS shows several growth vectors. The company has used its strong North American position to expand through emerging markets where water heaters & boilers have a growing demand. AOS also sells reverse osmosis water treatment products. As technology evolves, reverse osmosis seems like the most efficient and preferred way to treat heavy metals in water. China, India, and other water treatment segments represent 36% of sales and are their fastest growing opportunities. AOS is also seeing additional growth from stimulus checks and renovation incentives in North America. The housing market is healthy, and demand should remain robust with low interest rates. Finally, we like how AOS keeps growing while paying down its long-term debt (from $450M in 2017 to $106M in 2021).

Potential Risks

Some headwinds are coming. The rise of raw material costs (such as steel) is affecting AOS’s profitability. Margins are thin in the “Rest of World” segment, showing roughly a 10% difference from North American margins. This has been a recurrent problem in recent years, and AOS’s earnings might not grow as fast as they have historically. While sales are now back in growth mode in Asia, we saw how tariffs could hurt AOS’ business. Finally, while AOS enjoys strong momentum since the second half of 2020, the stock price may now look pricey. Your investment in AOS could be subject to short-term fluctuations.

Dividend Growth Perspective

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AOS has increased its dividend for the past 14 consecutive years (since 2006). It shows great dividend growth but a low yield. The company is clearly focusing on R&D and growing its markets. With a payout ratio under 40%, the money is not going to shareholders currently. Management thinks it can offer stronger share value appreciation than simply paying out a generous yield. After reviewing its growth vectors, I tend to agree. Nonetheless, AOS has increased its dividend by 8% for Q3 2020. You can count on this company even during difficult times.

Apogee (APOG) Business Model

Apogee Enterprises, Inc. is engaged in designing and developing architectural building products and services. The Company operates through four segments: Architectural Framing Systems, Architectural Glass, Architectural Services and Large-Scale Optical Technologies (LSO). The Architectural Framing Systems segment designs, engineers, fabricates and finishes the aluminum frames used in aluminum and glass window, curtainwall, storefront, and entrance systems and comprises of skin and entrances of commercial, institutional, and multi-family residential buildings. The Architectural Glass segment fabricates coated glass used in window and wall systems. The Architectural Services segment provides full-service installation of the walls of glass, windows, and other curtainwall products. The LSO segment manufactures glasses and acrylics products primarily for framing and display applications. Under the Tru Vue brand, products are sold primarily in North America.

Source: APOG website

Source: APOG website

Investment Thesis

Apogee is one rare small cap with a market capitalization of $1B showing a steady dividend payment history going all the way back to 1985. While the company didn’t always increase its dividend through this period, it has never cut the dividend. Apogee has built a strong reputation and provides its customers with high-quality products. The company operates in a highly fragmented market and shows a solid balance sheet. This could lead to potential M&A in the future. So far, the COVID-19 has affected the APOG margins, but its backlog for 2021 remains robust.

Potential Risks

You won’t be surprised if we tell you the APOG business model is highly cyclical. If no new buildings are being built, APOG won’t sell much framing and glass. When you look at the APOG revenue trends over the past 2 years, you can see the business was slowing down before COVID-19. This strong recession could slowdown APOG in the coming years. In the meantime, additional health measures and delays have affected the company’s margins. The pandemic raises another key question: will there be a growing need for large buildings in the future?

Dividend Growth Perspective

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Apogee has successfully increased its dividend yearly since 2011. APOG shows a high-single digit dividend growth rate over that period. Their latest dividend increase (7%) was in line with our expectations. The company has been paying a dividend for a long time, but prudent management has paused its growth policy during the recessions of 2000 and 2008. APOG Dividend Safety Score was recently upgraded from 3 to 4 following their most recent dividend increase.

Cummins (CMI) Business Model

Cummins Inc. designs, manufactures, distributes and services diesel and natural gas, electric and hybrid powertrains and powertrain-related components. The Company's segments include Engine, Distribution, Components, Power Systems and New Power. The Engine segment manufactures and markets a range of diesel and natural gas-powered engines under the Cummins brand name, as well as certain customer brand names, for the heavy and medium-duty truck. The Distribution segment consists of sales and support of a range of products and services, including power generation systems, horsepower engines, and in-shop and field-based repair services. The Components segment supplies products, including aftertreatment systems, turbochargers, filtration products, electronics and fuel systems. The Power Systems segment consists of businesses, including Power generation, Industrial and Generator technologies. New Power segment designs, manufactures, sells and supports hydrogen production solutions.

Source: CMI Q2 presentation

Source: CMI Q2 presentation

Investment Thesis

Cummins has taken over 100 years to build its solid reputation in the engine manufacturing industry. Today, CMI’s brand is known for its reliability and longevity. The company offers advanced engines and continues to invest in R&D to improve fuel efficiency. CMI benefits from economies of scale where its R&D results can be spread across a wide variety of products. CMI is well positioned to benefit from the transition from classic engines to cleaner technologies such as hybrid motors. The company has successfully gone through the pandemic and has recently (May 2021) raised their guidance for the current fiscal year. It looks like the pandemic may have given a second breath to the transportation industry.

Potential Risks

We have previously discussed how economic cycles can shift rapidly. Cummins will follow the highly cyclical transportation industry. The market greatly overreacted in 2020 leaving CMI close to $100/share before going “all-in” a few months after. You can appreciate how fast the stock goes up and down after each quarterly earnings report. The enthusiasm toward greener trucks compensates for temporarily sluggish sales. With 58% of its sales coming from Canada and the U.S., CMI’s future is closely linked to both countries’ economies. In the hope of getting better results, some of CMI’s customers started their own “in house” engine programs. This could hurt Cummins’ growth potential. Finally, we see a big interest in the electrification of commercial powertrains. CMI’s classic diesel engine will suffer in sales revenues as electric engines gain market share.

Dividend Growth Perspective

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CMI has been on a positive streak since 2010. Despite declining revenues and earnings in 2020, management approved a 3% dividend increase. Although management has been more than generous with its payout raises in the past, the current economic situation may call for smaller increases going forward.

FINAL THOUGHT

As you can see, the industrial sector includes many different companies. You could easily add the three companies discussed in this article and still show diversification in your portfolio. Each company would react differently to market events, offering you better protection against market fluctuations.

Cheers,

Mike Heroux, Passionate Investor & founder of Dividend Stocks Rock

P.S. Are you concerned by the current state of the market? I recently hosted a free webinar on What To Buy In This Overvalued Market? Know What to Buy, Know When to Sell. Watch the replay here!

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**Please do your own due-diligence before investing in any stocks we discuss in this article**

I may hold shares of companies discussed in this article.

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