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Introduction and Thesis

MSA Safety Incorporated (MSA) is now a Dividend King. The company raised the regular quarterly cash dividend 2.4% to $0.43 per share. The annual forward dividend is now $1.72 per share. This is the 50th consecutive annual increase, making the company a Dividend King. There are now 30 Dividend Kings out of about 4,300 publicly traded stocks in the U.S. For dividend growth investors, there is a lot to like here. The company is committed to the dividend and increases it slowly each year. This has the benefit of keeping the dividend sustainable in a cyclical industry. MSA also has market leading positions in several safety technologies. The company continues to grow through acquisitions and organically. Margins are also trending up. Overall, I like MSA Safety. But the stock is overvalued at this point and investors should wait for a better entry point. Hence, I am neutral on MSA Safety at the moment.

MSA SafetySource: MSA Safety Investor Presentation May 2020

Overview of MSA Safety

MSA Safety traces its history to 1914 and was founded after a mine accident in 1912. The company defines its mission as “That men and women may work in safety and that they, their families, and their communities may live in health throughout the world.” Although MSA traces its history to mine safety, it is now much more diversified. Today, it produces and sells safety products for firefighters, the oil and gas industry, the petrochemical industry, the construction industry, mining, utilities, and the military. The company has the No. 1 market position in self-contained breathing apparatus (SCBA), firefighter helmets and protective apparel, fixed gas and flame detection, and industrial head protection. It is also a market leader in portable gas detection and fall protection. Key brands include V-Gard, Cairns, and Gallet. Revenue in 2019 was approximately $1.4 billion.

MSA Safety RevenueSource: MSA Safety Investor Presentation May 2020

MSA Safety Revenue and Margins

MSA Safety has consistently grown its revenue and margins over the past decade. Revenue was $976.6 million in 2010 and it was $1,402 million in 2019. Revenue has grown both organically and through bolt on acquisitions.

MSA Safety Revenue and MarginsSource: TIKR.com

Safety has long-term secular growth trend drivers. There are regulatory considerations in the U.S. and other countries. In the U.S., the Occupational Safety and Health Administration or ‘OSHA’ promulgates workplace safety standards. The agency also issues fines. These represent avoidable costs for companies. Additionally, a lack of emphasis on safety in the workplace may lead to injuries and disabilities leading to costly claims. MSA states that for every $1 invested in injury prevention returns between $2 to $6. Next there is headline risk to companies with safety accidents. The combination of the aforesaid factors leads to long-term growth of safety equipment sales. Safety equipment is essentially mission critical for many industries.

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MSA Safety also acquires smaller companies to expand its technology and market leadership in core areas. The company has acquired Sierra Monitor [SMC] in 2019. The Globe Holding Company was acquired in 2017 to expand in protective clothing for firefighters, and Latchways Fall Protection was acquired in 2015. These bolt on acquisitions expand product offerings, grow revenue, and bring in new technology.

Lastly, MSA Safety invests about 4% of sales for R&D. The company spends to develop new intellectual property and new products that focus on technology features and comfort. These characteristics are likely important for most safety equipment. Hence, this investment serves as growth drivers in the context of higher pricing of new products.

The main story for MSA Safety and its bottom line is increasing margins. From the chart above, it is clear that the company has successfully raised gross margins attesting to its ability to control supplier inputs. Next, the company has more than doubled its operating margins in the past 10-years. This attests MSA Safety’s ability to manage labor costs, overhead, and SG&A expenses. Lastly, profit margins have also increased. Admittedly, the low margins 10-years ago were at the tail end of the Great Recession. But still, the company has focused on extracting costs and this has shown up in the bottom line.

MSA Safety Dividend and Dividend Safety

MSA Safety now pays a forward annual dividend of $1.72 per share. The dividend yield is not high though at approximately 1.4%. The dividend is, however, very safe from the perspective of earnings and cash flow.

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In 2019, MSA Safety earned $4.80 per share. The annual regular dividend was $1.64 per share. This gives a payout ratio of about 34%. Revenue will likely take a hit in 2020 due to COVID-19 and the downturn on the oil & gas industry. Consensus 2020 earnings per share is $4.35. The forward dividend is $1.72. This gives a payout ratio of 39.5%. If earnings and the dividend grow on average by 5% per year, then the payout ratio will stay near 40% for the next few years. This is a solid value and well below my threshold of 65%.

Operating cash flow was roughly $165 million in 2019. Capital expenditures were about $36.6 million. This gives free cash flow of $128.4 million. The dividend-to-FCF ratio was 28.5%. This is an excellent value and well below my criterion of 70%. Even if cash flow takes a 20% hit in 2020 due to COVID-19, the dividend-to-FCF ratio will still be below 40%. This is still a very conservative value.

MSA Safety also has a conservative balance sheet. At the end of Q1 2020, short-term debt and current portion of long-term debt was only $20 million. Long-term debt was $351.6 million. This is offset by $192.4 million in cash, equivalents, and short-term investments. The dividend is covered by cash on hand several times over. There is $235.7 million of senior revolving credit facility maturing in 2023, and $72.7 million of senior notes maturing in 2031. Clearly, debt is not much of an issue from the perspective of dividend safety.

MSA Safety Valuation

With the dividend seemingly secure in the near term, let’s take a look at MSA Safety’s valuation. The consensus 2020 earnings per share is now down to $4.35. Earnings estimates have dropped more than the stock price. At a stock price of $119.85, the earnings multiple is 26.9.

We will use 20.0 as the earnings multiple to determine a fair value of $87.00. This is about the trailing 10-year average multiple. Applying a sensitivity analysis using P/E ratios between 19.0 and 21.0, I obtain a fair value range from $82.65 to $91.35. The current stock price is ~131% to ~145% of my estimated fair value. The current stock price is ~$119.85, suggesting that the stock is very overvalued based on earnings.

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Estimated Current Valuation Based On P/E Ratio

P/E Ratio

19.0

20.0

21.0

Estimated Value

$82.65

$87.00

$91.35

% of Estimated Value at Current Stock Price

145%

138%

131%

Source: dividendpower.org Calculations

How does this compare to other valuation models? Morningstar is known to use a fairly conservative discounted cash low model and provides a fair value of $102.20. The Gordon Growth Model gives a fair value of $86, assuming a desired return of 8% and a dividend growth rate of 5%. An average of these three models is ~$91.73, suggesting that MSA Safety is very overvalued at the current price.

MSA Safety is a reasonably safe stock but it is somewhat cyclical due to its end markets. The trailing 5-year beta is ~1.07. The company is the market leader in several areas of the safety product market, which is its competitive advantage. Morningstar gives the stock a wide economic moat. Value Line gives the stock a safety score of ‘3’, financial strength rating of ‘B+’, a stock price stability of 75, and an earnings predictability of 80. These are OK scores.

Final Thoughts

MSA Safety is now a Dividend King. This will likely create some additional interest in the stock. However, the market is not really discounting the stock price based on the possible impact of COVID-19 on its end markets. The yield is still low relative to the broader market and some other Dividend Kings. However, the dividend is seemingly very safe. At the right price, MSA Safety is probably a good addition to most dividend growth portfolios. However, I am currently neutral on the stock.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.