Richelieu Hardware has earned record profits for years. The manufacturing stock is expected to earn record profits this year and next. This has sent the stock up, which gives it upwards share price momentum. The trouble is, the shares now look too costly and yield little.
We regularly review manufacturing stock Richelieu Hardware (TSX—RCH). Since we published our July 7 issue, its shares have risen by 16.2 per cent. This gives them upwards share price momentum. But the shares are costly.
Richelieu has earned record profits for years. It’s expected to earn record profits again this year and next. The company is what’s known as a ‘dividend aristocrat’ after having raised its dividend for more than five consecutive years.
Are you conservative or aggressive?
For conservative investors, we’ve now downgraded Richelieu to a hold for long-term share price gains and small, but growing, dividends. Aggressive investors, however, might continue buying the company in order to profit from the positive momentum and earnings per share growth.
In the nine months to September 30, Richelieu earned $47.7 million, or 81 cents a share. This was up by 9.5 per cent from $43.6 million, or 74 cents a share, a year earlier.
In the first nine months, Richelieu’s sales increased in all of its markets. Sales to manufacturers went up by 9.7 per cent, to $586 million. The company’s sales growth from pre-existing operations was 3.8 per cent while acquisitions accounted for the other 5.9 per cent. Richelieu’s sales to hardware retailers and renovation superstores jumped by 14.9 per cent, to $106 million.
Richelieu’s sales rose across the board
In the first nine months, Richelieu’s Canadian sales climbed by 11.2 per cent, to $461 million. Sales growth from pre-existing operations came to 5.8 per cent. Acquisitions contributed 5.4 per cent to the sales growth. In the US, the company’s sales rose by 10 per cent, to US$176 million, or C$231 million. Sales growth from pre-existing operations was 5.5 per cent and, from acquisitions, 4.5 per cent. Sales south of the border continued to account for just over a third of Richelieu’s sales.
There are other things that we like about Richelieu. One is that it has no net debt. That is, the company’s cash of $26.9 million significantly exceeds its total debt of only $4.5 million. We also expect its growing cash flow to keep its balance sheet healthy.
In the first nine months, Richelieu’s cash flow advanced by 11.7 per cent, to $57.7 million. This confirms its higher earnings. What’s more, the company’s cash flow easily exceeded its needs: capital investment of $9.4 million, business acquisitions of $30.2 million, and dividend payments of $10.1 million. Richelieu used its excess cash flow wisely. It repaid debt of $1.1 million and completed net share buybacks of $1.7 million (new shares issued for $2.4 million less shares repurchased for cancellation of $4.1 million).
Growth through capital investment and acquisitions
Richelieu’s capital investment exceeded its total amortization of $8.5 million. Excess capital investment is a hallmark of growing, successful, companies. Richelieu complements its capital investment with acquisitions. In the third quarter, for instance, it acquired a Cincinnati, Ohio-based specialty product distribution center that supplies kitchen cabinets and furniture manufacturers as well as woodworkers. The company will merge this center with an existing center in Cincinnati. We expect Richelieu to continue to make acquisitions to fuel its expansion.
Richelieu now pays yearly dividends of 22.58 cents a share. This is up by 6.4 per cent from annual dividends of 21.32 cents a share last year. This yields only a small 0.64 per cent. Even so, the growing dividend is positive.
President and chief executive officer Richard Lord said: “We will continue to pursue our sales and sustained profitability growth targets and expect to close the fiscal year ending November 30, 2017, with good results and an impeccable balance sheet.”
Indeed, in 2017 Richelieu’s earnings are expected to climb by 9.3 per cent, to a record $1.17 a share. The trouble is, the shares are costly. Based on this estimate, the shares trade at an excessive P/E (Price-to-Earnings) ratio of 30 times.
In fiscal 2018 (which began on December 1), Richelieu’s earnings growth is expected to accelerate by 13.7 per cent, to a record $1.33 a share. Based on this estimate, the shares trade at a better—but still excessive—P/E ratio of 26.4 times.
The consensus recommendation of two analysts is ‘Buy’. We’re less sanguine. On the positive side, the shares have upwards price momentum. This could carry them up further. And Richelieu has earned record-high profits year after year. On the negative side, the shares look overpriced. Aggressive investors might buy for further share price gains. But conservative investors can find better value among other buy-rated stocks. They should hold.
This is an edited version of an article that was originally published for subscribers in the November 24, 2017, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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