A debt-free balance sheet is often a statement of financial strength. Although leverage has certain benefits and is, in fact, advisable and appropriate for some industries, operating without debt materially increases a company’s financial flexibility. For example, in lean times, such as a recession, a balance sheet sans debt can allow a company to continue operations without interruption. This is a margin of safety that a highly-leveraged company may not have.
Investors using dividend income to pay living expenses should find such stocks of particular interest. Indeed, if a company, industry, or the entire economy should fall on hard times, a debt-free balance sheet increases the chances that a company will maintain its distribution unaltered. Thus, an investor’s “paycheck” won’t take a hit at the same time that the value of his or her portfolio is declining.
Indeed, such dividend payments can allow the investor to ride out the bad times and the likely corresponding share-price decline. Although capital preservation is clearly important, sometimes the best way to conserve capital is to sit tight with a good company regardless of what the emotionally-driven stock market is doing. Dividend distributions supported by a strong financial structure make that easier to do.
To find such companies, we used the online screening tools of The Value Line Investment Survey to identify companies, such as Tractor Supply Company (TSCO) and SEI Investments Company (SEIC) that feature a dividend but carry no debt. Clearly, the screen could be altered to meet the needs of investors looking for a particular level of dividend payments or made more lenient for those who believe a little bit of debt is a good thing.
Tractor Supply Company
Tractor Supply Company is the predominant operator of retail farm and ranch stores in the United States. It operates under the Tractor Supply Company and Del’s Farm Supply banners and is three times larger than its five nearest competitors combined. Its niche merchandise selection consists of 16,000 to 19,500 unique products per store, with approximately one quarter of sales being derived from high-margined private label merchandise. Its customer base consists mostly of homeowners with above average incomes and little debt, including recreational farmers and ranchers, as well as those who enjoy the rural, “out here” lifestyle. Product offerings include horse, pet, and small animal products necessary for their health, care, growth, and containment; hardware, truck, towing, and tool products; seasonal items including lawn and garden goods and power equipment, maintenance products and work/recreational clothing and footwear. As of March 31, 2012 the company operated 1,117 retail farm and ranch stores in 44 states, the majority of which were located in the Eastern, Midwestern, and Southeastern United States.
The company is in strong financial condition with zero long-term debt and only $1.3 million in capital lease obligations. This, combined with solid free cash flow, should support its aggressive store-expansion initiative. Management recently upped its footprint target from 1,800 to 2,100 locations, reflecting expected square footage growth of 8% per annum. Not only is there opportunity to breach new markets out West, but its relatively strong East Coast presence could very well double over the long term. Also, management recently raised the dividend payment by 67%, and the stock was recently yielding a more respectable 1%.
The company is very engaged with its customer base, which provides useful information for targeted advertisements. This strategy, along with its focus on consumable, useable, and edible products (CUE), contributed to an 11.5% same-store sales gain in the first quarter. We expect top-line growth to slow considerably in the current period, since the company won’t have the benefit of unseasonably warm winter weather pulling forward sales. Still a 6% comp would be quite healthy, in our view. Elsewhere, the operating margin is expected to expand moderately in the coming years thanks to price optimization, increased penetration of lucrative private label merchandise, and improved product sourcing and inventory management. In sum, although hardly inexpensive, we view Tractor Supply shares as a solid growth play.
SEI Investments Company
SEI provides investment processing, management, and operations solutions that help corporations and financial institutions, advisors, and ultra-high-net-worth families create and manage wealth. It provides investment processing/operations outsourcing solutions for banks and portfolio managers and investment management programs for affluent individual investors. As of December 31, 2011, SEI managed or administered $404 billion in mutual fund and pooled or separately-managed assets including $172 billion in assets under management and $232 billion in client assets under administration.
Recently, shares of SEIC have come under pressure, with the stock falling 9% since early march compared to a 3% decline in the Dow Jones Industrial Average. Part of that underperformance can be attributed to the moderate decline in earnings during the first quarter. Expenses have been high as the Global Wealth Platform (GWP) continues to be built out. GWP can increase efficiency, reduce errors, provide access to real-time information, and give trading and transaction info on 102 stock exchanges in 46 countries. Management expects development costs to moderate and thinks the $14 million this business made in 2011 will more than triple by 2015.
The future looks bright for SEI. Not only is the demand environment improving, but Value Line analyst Kathryn Drew thinks that “with a strong cash position and no debt, SEI will likely be able to continue to generate new service offerings, thereby further strengthening its market position”. Although not overly exciting, the stock’s yield was recently hovering around 1%.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.