2 Dividend Stocks for a Global Megatrend

The best investment advice I ever received is to look for “megatrends” — trends that fundamentally change how we live. These trends often last decades and are usually the result of changing demographics or new technologies. Megatrends frequently present ground-floor opportunities for investors. Recognizing and investing in companies that benefit from a megatrend is one of the surest ways to lock in long-term returns.

A classic megatrend example is the Internet. The Internet was introduced only about 17 years ago, yet already 2.1 billion people, about one-third of the world’s population are Internet users — and this number is forecast to swell to 3.0 billion by 2015. Investors who recognized this trend early on and invested in Internet-enabled start-ups such as eBay (Nasdaq: EBAY) and Amazon (Nasdaq: AMZN) have earned huge returns.

America’s aging baby-boomer generation is another megatrend, and it’s partially responsible for spurring demand for health-care reform.

But there is an even bigger megatrend that is rarely discussed and has global repercussions. I’m referring to explosive growth in the world’s population, which is expected to nearly triple to 9 billion by 2050. This growth will result in global food shortages within 20 years, according to some estimates, unless farmers can greatly increase food production. It is estimated that food supplies must grow at least 70% in order to satisfy world hunger. And in case you haven’t noticed during a visit to the grocery store, demand is already driving up food prices. This is causing farmers to step-up investments in hybrid seeds, fertilizer, herbicides and other products that can help improve crop yields.

Last week, I discussed two fertilizer companies — Terra Nitrogen (NYSE: TNH) and CVR Partners (NYSE: UAN) — that benefit from food-demand megatrends. Seed and herbicide companies should also benefit. The two stocks I profile below are especially attractive, based on their dominant market shares, rising cash flow and above-average yields.  

1. Dow Chemical Co. (NYSE: DOW)
Yield: 4%

Global chemicals conglomerate Dow Chemical is also a leader in agriculture. The Dow AgroSciences division generates $5 billion in annual sales from hybrid seeds, herbicides and pesticides, and other products related to crop production. This business contributes 10% of Dow’s consolidated revenue and 16% of overall income. In the first six months of 2011, Dow Agrosciences increased sales 19% year-over-year to $3.1 billion and boosted EBITDA within the division by 20% year-over-year to $693 million. Growth was driven by expanded demand for herbicides and a 40% increase in new product sales.

Dow AgroSciences expects new products to add $800 million to sales in the next two years. The business is experiencing huge demand for its SmartStax hybrid seed, which is more resistant to insect damage. Next year, Dow will launch Enlist, a herbicide that kills “superweeds,” which have become resistant to Roundup, the best-selling herbicide sold by rival agricultural seed giant Monsanto (NYSE: MON). Dow thinks Enlist can capture market share from Roundup, which is used on 72% of U.S. corn acreage and 94% of soybean acreage, according to the Food and Drug Administration reports. 

Dow has crushed earnings estimates for three quarters in a row, and analysts forecast 44% earnings growth this year and 18% growth next year. Despite a strong outlook, Dow stock has been hurt by the European debt crisis and weak stock market, so it has plummeted 30% this year. Dow shares currently trade at just 11 times earnings and near the five-year historic price-to-earnings (P/E) low of 10.4.

Dow raised dividends 67% in June to a $1.00 yearly rate per share. The shares now yield 4.3%. Payout is modest at just 32% of earnings, and Dow has a stellar track record, showing 400 consecutive quarters of dividend payments. Long-term debt is somewhat high at $18.5 billion and 42% of capitalization, but Dow has already paid down $4 billion of debt this year and is well on its way to achieving its 2012 target of 40% debt-to-capitalization. Also, with cash flow exceeding $4 billion a year, Dow can easily handle its $1.5 billion in annual interest expense payments and $1 billion in dividend payments. 

2. DuPont (NYSE: DD)
Yield: 4%

DuPont is another worldwide chemical company that has multiple lines of business, but agriculture is by far its largest, accounting for 29% of overall sales of $31.5 billion and operating profits of $3 billion last year. DuPont sells hybrid seeds, herbicides, fungicides and insecticides under the Pioneer Hi-Bred brand name. Pioneer is the No. 1-selling seed in North America, accounting for 36% of all corn and soybean acreage planted.
During the first half of 2011, DuPont’s agriculture business delivered 15% year-over-year growth in sales to $6.5 billion as a result of both volume growth and price gains. The Agriculture division’s operating income improved 16%, to $1.9 billion, in the first six months of 2011. As a result of strong performances from the agriculture and chemical businesses, management has raised full-year 2011 earnings guidance, and analysts look for DuPont to deliver 21% growth this year and 13% growth next year.

DuPont pays a $1.64 annual dividend and yields 4.1%. This company’s payout is higher than Dow’s, at 46% of earnings, but the balance sheet is stronger, with $12.5 billion in long-term accounting for just 26% of capitalization. DuPont generated cash flow of $4.6 billion last year and paid out $1.5 billion of dividends, so the company has ample capacity for dividend growth. DuPont has not raised the dividend since 2007, so an increase appears overdue.

DuPont shares have also been impacted by the global selloff, and are down 17% for the year. The company is bargain-priced right now at a five-year P/E low of 11.5.

Risks to consider: Dow and DuPont are global companies that generate the majority of sales overseas. As a result, both are affected by the European business slowdown and changes in the value of the dollar against the euro.

Action to take–> My top pick is DuPont, because the company derives nearly one-third of revenue from its agriculture business and has greater exposure to the food-demand megatrend. Income investors may find Dow more attractive, however, because of its better yield and superior track-record for dividend growth.