Streetwise

Lauren Rudd

Sunday, March 27, 2011

On The Wings of a Dover

Sorry, but the recent announcement by Citigroup that it is reinstating its dividend and undertaking a reverse stock split only reasserts my opinion of how poorly that bank is managed.

Citigroup plans to resume paying a quarterly dividend of a penny a share after it uses a reverse stock split to reduce the number of shares outstanding to 2.9 billion from 29 billion by means of a 1-for-10 reverse stock split. The dividend payout will total about $116 million a year, or approximately one percent of Citi’s 2010 net income. The bank also reiterated that it anticipates returning even more capital to its shareholders starting in 2012. This is not the time to start depleting capital to pay dividends.

Does anyone remember what happened three years ago? Citigroup was only able to extricate itself from Federal government ownership and assistance this past December. Furthermore, reverse splits have traditionally been the last resort of companies trying to make their shares look more attractive, or to try to meet exchanges' minimum share price requirements.

A reverse split makes no economic sense. It is a psychological move and while it might instill some confidence in Grandma, it certainly is not going to create a shred more confidence among analysts. Rather it is just another example of Wall Street arrogance.

However, the Street’s antics should not be an impediment to your investment strategy. More importantly, do not become distracted by those who sermonize on the idea of economic Armageddon as a result of recent world events. Instead, direct your efforts towards locating investment opportunities that enhance your wealth and immunize your portfolio against the Street’s transient activities.

For example, you might want to consider the Dover Corporation (DOV), an industrial manufacturing company. When I last wrote about the company a year ago, my earnings forecast for FY 2010 was $2.55 per share. My 12-month target price on the shares back then was $53. So how well did the company perform in 2010?

Revenues for 2010 came in at $7.1 billion, up 24 percent over the prior year. That revenue gain consisted of 20 percent organic growth and 4 percent from acquisitions. Earnings from continuing operations came in at $707.9 million or $3.74 per share.

If you exclude the impact of tax benefits, the year’s earnings from continuing operations were $3.47 per share. Meanwhile the shares recently closed at $64.33, well above my target price and thereby producing a one-year capital gain of 39 percent.

Furthermore, during its 2010 fiscal year Dover was able to generate free cash flow of $767 million, representing 11 percent of revenue, which in turn funded the company’s re-investment program, its acquisition program and its 55th consecutive annual dividend increase.

In its guidance going forward, Dover expects full year 2011 revenue growth of between 9 and 11 percent, which breaks down into organic revenue growth of 6 to 8 percent plus growth from acquisitions of 3 percent. Based on that revenue assumption, the company stated that it is expecting earnings from continuing operations of between $4.05 and $4.25 per share.

A discounted earnings model yields an intrinsic value of $80 per share, while the more conservative free cash flow to the firm model suggests an intrinsic value of $68 per share, using an 11 percent growth rate. Regular readers know that as a general rule intrinsic values that are so close to the current share price, in this case $64.33, would rule out the shares from further consideration.

However, my earnings estimate for FY 2011 is $4.28 per share, and $4.78 for FY 2012, representing an earnings growth rate of about 12 percent. Therefore, I am willing to break a few eggs in order to make an omelet.