In the search for income, much emphasis is being placed on companies that not only managed to maintain dividends throughout the downturn, but haven’t even missed a payout for 15+ years—the Tescos (TSCO) of the world. Companies that cut their dividends in the aftermath of the financial crisis received a lot of negative publicity. But there are a good number of companies that have since restored their strength and are now offering an improving dividend outlook. Rexam (REX) is one such example—a UK stock that our analyst believes could be worth a look if you’re hunting yield.
Rexam's Dividend History
Rexam is typically recognised as a manufacturer of drinks cans, but the diversified firm’s business also includes plastic packaging used by healthcare companies. The firm made an ill-timed and expensive acquisition in the plastics sector in 2007 that stretched the company's balance sheet ahead of the financial crisis, Morningstar analyst Todd Wenning explains. Since then it has been selling off pieces of its plastics business—a move that Wenning welcomes, while maintaining its healthcare packaging business—an area that Wenning describes as “unexciting” but “steady” in terms of cash flow generation. Rexam’s main line of business, its can manufacturing, remains a steady business that proved its durability during the downturn.
Having learned some M&A lessons the hard way—the firm not only had to cut its dividend but also initiated a large rights issue to raise capital—Rexam is once again focusing on its dividend policy and conservatively aims to cover its payout two to two-and-a-half times with earnings. “We think it can easily raise its dividend payout at 6%-8% over the next few years,” Wenning says.
Potential Growth Drivers
So what’s going to fuel this dividend growth? Wenning sees the firm’s position as sole provider of specialist cans for Red Bull as one near-term driver, and its fresh focus on India—where its competitors don’t seem to be showing much interest—as a potential longer-term growth driver. “It’s got a really solid specialist can business,” says Wenning, highlighting the slim cans that Rexam makes for the energy drink. “We think that’s a nice business for them and one that can continue,” he adds.
Another point in favour of Rexam is its geographical exposure and aspirations. Wenning is upbeat on the firm’s decision to largely steer clear of China, a country in which its competitors are pouring cash but where Wenning believes the demand outlook is uncertain, and to instead focus on India. With other industry players focusing on China, Rexam is one of the first global players in India. Furthermore, its experience of entering emerging markets—the firm was one of the first global firms to supply cans in Brazil, where it developed a very strong foothold—provides a solid foundation for entering India, Wenning believes. India is, he concedes, a much tougher market than Brazil, but overall Wenning says Rexam is wise to focus its efforts there rather than China.
Potential Risks
So what of the risks? Rexam has a decent sized business in Russia, where there is currently a strong push to curb alcoholism, which could curb the demand for alcohol beverage cans. “It’s unclear at this point how much of an effect that will have on Rexam,” Wenning says.
Rosy Dividend Outlook
All things considered, Wenning believes Rexam has the opportunity to return its dividend payout to pre-financial crisis, pre-rights issue levels over the next five years. “They got burned,” he says, “but they’ve done a really nice job of improving return on capital employed and that helps assuage analyst concerns.” Once the market starts to notice some of these positives, Wenning expects to see a notable increase in investor interest.
Is this a good time to look at the stock? “We think the company is currently a tad undervalued,” Wenning says. He recently upgraded his fair value estimate to 470p based on improvements made in 2011 and a stronger profit margin outlook. “We think Rexam’s strategy is heading in the right direction,” he concludes.
Read Wenning's research report on Rexam here. Not a Premium member? Gain instant access to Morningstar Research and other Premium featues with a free 14-day trial of Premium.
