Reasons to Buy.
"Nothing runs like a Deere" is the company"s apt slogan, and as far as industrial companies go, Deere has achieved almost unparalleled excellence over the years. They have an outstanding brand (and one of the most popular logos for hats, jackets, and so on, worn by people who have never seen a farm field!) and reputation in the agriculture industry, and we see the ag industry as strong and strategic far into the future. Farm incomes are on the rise, with a 3.5 percent growth projected for 2011. The company is making good progress in developing markets, particularly in Brazil and India.
Beyond its products, Deere has established an almost una.s.sailable brand leadership with its services and customer-centered innovations. Deere, more than others, puts its people in the field (literally) to figure out what agriculture professionals really need, and they work with their customers closely to sell their products through a solid dealer network, not unlike Caterpillar in the construction market.
Reasons for Caution.
The company is, and always will be, vulnerable to business cycles and particularly cycles in the farm sector. While agricultural commodities are once again on the rise, that can turn on a dime, and the company"s 1.55 beta reflects this long-term volatility. Recent public-sector belt tightening both at the federal and state level may hurt the farming business, as will any protracted rise in energy prices. Finally, many investors have noticed Deere"s excellent track record, and outside the 200809 downturn, the shares have tended to be relatively expensive related to fundamentals.
CONSERVATIVE GROWTH.
Dentsply International, Inc.
Ticker symbol: XRAY (NASDAQ) S&P rating: A Value Line financial strength rating: B++ Current yield: 0.6%.
Company Profile.
Dentsply is the largest dental products company in the world. The company designs, develops, manufactures, and markets a broad range of products for dentists, orthodontists, and dental laboratories, including dental prosthetics, precious metal dental alloys, dental ceramics, endodontic instruments and materials, pastes, sealants, scalers, and crown and bridge materials. They are the leading United States manufacturer and distributor of dental x-ray equipment, dental handpieces, intraoral cameras, dental x-ray film holders, film mounts, and bone subst.i.tute/grafting materials. Finally, they are also a leading worldwide manufacturer or distributor of dental injectable anesthetics, impression materials, orthodontic appliances, dental cutting instruments, and dental implants. In all, the company produces or resells over 120,000 SKUs, protected by more than 2,000 patents.
Dentsply has a presence in more than 120 countries, though its main operations take place in the United States, Canada, Germany, Switzerland, the United Kingdom, j.a.pan, and Italy. The company has an extensive sales network of over 2,100 sales representatives, distributors, and importers. Its products are manufactured in or distributed from facilities around the world and include well-established brand names such as Caulk, Cavitron, Ceramco, Dentsply, Detrey, Midwest, R&R Rinn, and Trubyte. International sales account for more than 60 percent of the total.
Financial Highlights, Fiscal Year 2010.
You would think dental care is a necessity largely unaffected by a recession, but that has proven not to be the case. Particularly since most dental insurance only provides partial coverage and many aren"t insured at all, people delay or postpone routine or reconstructive dental procedures to the extent possible. In FY2009 Dentsply"s net sales declined 1.5 percentthe first year-over-year decline in sales in over fifteen yearsalthough the shortfall was small enough that when precious metal content is removed from the calculation (precious metal costs are pa.s.sed through to customers without margin), sales were essentially flat. Gross margin fell 200 basis points (2 percent) because of unfavorable product mix and unfavorable currency movements.
During that year, the company put expense controls in place in response to the downturn in the economy and was able to shave 100 basis points off of SG&A. Additional savings were gained via headcount reduction and restructuring, and operating margins remained relatively strong at 21.2 percent, but in the end, earnings fell 2 percent, or $.04/share versus 2008. As bad years go, though, this was not all that bad.
The year 2010 was much the same story, with sales still off the 2008 pace and essentially flat earnings. The company continues to seek operational improvements but growth will really be driven by the economy making people more willing to pursue dental work. The base level of demand, meanwhile, remains secure.
Cash flow is ample, and the company has been repurchasing shares, reducing share counts from approximately 160 million in 2004 to an estimated 140 million in 2010.
Reasons to Buy.
We feel that the base level of demand is solid, and any economic recovery will bring healthy earnings and cash flow growth to a relatively leaner and meaner Dentsply. We feel that the chickens will come home to roost from a couple of years of relative dental neglect: sugar and bacteria simply didn"t get the memo to hold back on tooth decay during the recession. Demographics, at least in the domestic market, continue to work in the company"s favor. Older people tend to spend more on dental care, and every office visit, whether it be for a simple cleaning or full endodontic repair, uses Dentsply consumables. A larger percentage of the population are retaining their natural teeth, and are doing so far longer than they used to, and natural teeth require relatively more dental care.
Trends in the global economy also favor Dentsply. As per capita and discretionary incomes rise in the emerging nations of the Pacific Rim, Latin America, and Eastern Europe, improved health care, and dental care in particular, become a priority. Dental care spending in India and China is growing far faster than in the mature U.S. market.
The company is nearly debt-free and has cash to support both share repurchase and acquisitions, should opportunities arise.
Reasons for Caution.
Dentistry in North America and Western Europe has changed focus over the years from treating pain, infections, and poor overall dental health toward a practice with an increased emphasis on preventive care and cosmetic dentistry. Cosmetic dentistry includes many high-value procedures, but cosmetic procedures are elective in nature and are often not covered under insurance programs. In general, dental insurance coverage is on the decline. These factors lead to reduced and deferred dental care, which will hurt the top line at least short term.
GROWTH AND INCOME.
Dominion Resources, Inc.
Ticker symbol: D (NYSE) S&P rating: A- Value Line financial strength rating: B++ Current yield: 4.3%.
Company Profile.
Dominion is one of the nation"s largest producers and distributors of energy, with 27,000 megawatts of power generation, 6,000 miles of electric transmission lines, 12,000 miles of natural gas transmission, gathering, and storage pipeline, and 1.3 trillion cubic feet equivalent of natural gas reserves. Included in these a.s.sets is the nation"s largest underground natural gas storage system with about 942 billion cubic feet of storage capacity serving retail energy customers in twelve states. Dominion"s strategy is to be a leading provider of electricity, natural gas, and related services to customers in the energy-intensive Midwest, Mid-Atlantic, and Northeast regions of the United States, a potential market of 50 million homes and businesses where 40 percent of the nation"s energy is consumed.
As of 2010, Dominion operates in three reporting segments: Dominion Generation (44 percent of revenue, 59 percent of profits) includes the generation operations of Dominion"s merchant fleet and regulated electric utility, as well as energy marketing and price risk management activities for its generation a.s.sets. Their utility generation operations primarily serve the supply requirements for the Dominion Virginia Power segment"s utility customers. Their generation mix is diversified and includes coal, nuclear, gas, oil, and renewables. DG produced 60 percent of the company"s earnings in 2009.
Dominion Energy (30 percent of revenue, 24 percent of profits) includes Dominion"s Ohio regulated natural gas distribution company, regulated gas transmission pipeline, and storage operations, regulated liquefied natural gas (LNG) operations, and Appalachian natural gas Exploration & Production (E&P) business. Dominion Energy also includes producer services, which aggregates natural gas supply, engages in natural gas trading and marketing activities and natural gas supply management, and provides price risk management services to Dominion affiliates.
The gas transmission pipeline and storage business serves gas distribution businesses and other customers in the Northeast, Mid-Atlantic, and Midwest.
Dominion Virginia Power (26 percent of revenue, 18 percent of profits) is responsible for all regulated electric distribution and electric transmission operations in Virginia and North Carolina. It is also responsible for Dominion Retail and all customer service, as well as its non-regulated retail energy marketing operations. DVP"s electric transmission and distribution operations serve residential, commercial, industrial, and governmental customers in Virginia and northeastern North Carolina.
The company"s utility revenue breakdown (2009) was 45 percent residential, 33 percent commercial, 8 percent industrial, and 14 percent other. The generation mix was 33 percent coal, 32 percent nuclear, 25 percent purchased, 9 percent gas, and 1 percent oil.
Financial Highlights, Fiscal Year 2010.
Dominion"s net revenue continued to decline slightly with the 2010 divest.i.ture of its gas exploration and distribution operations. Earnings came in at $2.89 per share versus an acquisition-adjusted $2.64 per share on revenues of $15.2 billion. For 2011, the company forecast a dip in earnings to about $3.15 per share for the year.
In late 2010, the company not only raised its dividend 7.7 percent, from $1.83 to $1.97 per share, but it also announced a change in dividend policy, whereby 6065 percent of net earnings would be paid to shareholders, up from the previous 55 percent.
In early 2011, Duke Energy announced a $13.7 billion acquisition bid for Progress Energy to create what would be the country"s largest regulated public utility. Both companies operate as virtual neighbors to Dominion, and it was rumored that Dominion had started this round of mergers with its own quest for Progress or even possibly Duke. This situation bears watching as an indicator of whether authorities support another round of mergers and consolidations in the industry.
Reasons to Buy.
Dominion has exited the natural gas exploration and production business, having sold off its remaining a.s.sets in early 2010 (the divest.i.ture began in 2006). The company felt that the business, although profitable, was too volatile and far from the core business. This was viewed as a negative among the traditional utility and large inst.i.tutional investors. In the meantime, the company"s core businesses are healthy and located in areas of solid recovery and growth potential, particularly in the Eastern Seaboard areas. The acquisition winds are blowing, and the effects on Dominion bear watching.
Reasons for Caution.
The year 2011 looks to be one of higher energy prices, and naturally, Dominion is exposed to such price increases. That said, the company has enough nuclear capacity in its portfolio to diversify away from some of this risk. And that said in turn, those who avoid nuclear energy should probably avoid this issue.
INCOME.
Duke Energy.
Ticker symbol: DUK (NYSE) S&P rating: A- Value Line financial strength rating: A Current yield: 5.4%.
Company Profile.
Duke Energy Corporation is a utility provider and operator working primarily in the Southeast and Midwest but with operations outside those areas. The company has three segments: U.S. Franchised Electric and Gas, Commercial Power, and International Energy. The company was reformed into a new company in 2007 after spinning off most of its gas business into a new company called Spectra Energy.
The Franchised Electric and Gas segment generates, transmits, distributes, and sells electricity in central and western North Carolina, western South Carolina, southwestern Ohio, Indiana, and northern Kentucky including the Greater Cincinnati area; and transports and sells natural gas in southwestern Ohio and northern Kentucky. This segment supplies electric service to approximately 4 million residential, commercial, and industrial customers with approximately 151,600 miles of distribution lines and a 20,900-mile transmission system. The company is relatively heavily invested in nuclear power, with some 35 percent of its power provided this way (55 percent coal, 10 percent other).
The Commercial Power segment offers onsite energy solutions and utility services for large customers. This segment owns, operates, and manages power plants; and handles all procurement and services around these plants; it also develops customized energy solutions for these customers.
The International Energy segment operates and manages power generation facilities and sells and markets electric power and natural gas outside the United States. This segment provides services and consulting for retail distributors, electric utilities, independent power producers, marketers, and industrial and commercial companies. It also develops, owns, and operates a fiber optic communications network, primarily in the Southeast United States, serving wireless, local, and long-distance communications companies, as well as Internet service providers, and other businesses and organizations. The company was founded in 1916 and is based in Charlotte, North Carolina.
In early 2011, Duke announced a $13.7 billion takeover of Progress Energy, which operates in adjacent markets and would make the combined company the largest public utility in the United States. Aside from direct impacts on the company and its operations, the acquisition is viewed as a referendum on public regulator acceptance of a new round of "mega" mergers in the utility industry.
Financial Highlights, Fiscal Year 2010.
The 2007 spinoff makes long-term comparisons difficult. The year 2010 saw a moderate earnings increase to $1.40 per share from $1.13 a year before, due to an unusually hot summer, but 2011 earnings were forecast to stay in the $1.30$1.40 range. The company continues to bring new generating capacity online in its most vibrant markets in the Carolinas. The company continues to generate cash flow almost double reported earnings.
Reasons to Buy.
Duke has always been a well-managed utility operating in solid markets with a growing customer base. The North Carolina customer base is diverse and especially attractive as more companies and individuals move there to enjoy lower costs of living and costs of doing business. The company should also stand to benefit, perhaps more than its peers, from an economic recovery.
We actually like its nuclear exposure as we do think nuclear power will return to the electricity generating stage in a bigger way. Duke will have the advantage of experience and existing infrastructure. Because it"s a relatively new concern in its current form, and perhaps because of its nuclear exposure, the dividend is about 1 percent higher than the average for similar companies. That said, it is well covered by current cash flows.