High Dividend 50: Compass Diversified

Published on January 18th, 2023 by Samuel Smith

Compass Diversified (CODI) is an attractive dividend stock that is currently offering a dividend yield of nearly 5% alongside an attractive valuation and strong long-term growth prospects.

It is one of the high-yield stocks in our database.

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In this article, we will analyze the prospects of Compass Diversified.

Business Overview

Compass Diversified Holdings is a private equity firm that specializes in acquisition in the middle market. The middle market is loosely defined as businesses with owner earnings between $10 million and $500 million. Compass Diversified went public in 2006 and since that time, it has grown into a company that generates about $2.2 billion in annual revenue. The company purchases controlling stakes in small companies and holds them indefinitely. Compass Diversified Holdings has about ten different subsidiaries at most times, but there are regular changes in the portfolio.

Source: Investor Presentation

Compass Diversified Holdings reported its most recent quarterly earnings results in November. The company announced that its revenues totaled $600 million during the quarter, which was 22% more than the revenues that Compass Diversified generated during the previous year’s quarter. The company beat the top line estimate easily, by $50 million.

Compass Diversified was able to generate adjusted EBITDA of $98 million during the quarter, up 27% year over year. Compass Diversified Holdings’ non-GAAP earnings-per-share were $0.67, but profits are oftentimes not reflective of the company’s ability to generate cash flows. Compass Diversified usually generates cash flows that are higher than its reported net profits, which sometimes are even negative.

For 2022, Compass Diversified has increased its EBITDA guidance range to $460 million – $470 million, which is well above the $330 million of EBITDA generated in 2021. In the aftermath of transforming its company from a partnership to a C-Corporation for tax purposes (it now issues a 1099 tax form instead of a K-1 tax form), Compass Diversified cut its dividend by 31% this year, bringing the payout to $0.25 per quarter, or $1 per year.

Growth Prospects

Compass Diversified’s growth strategy is focused on generating $1 billion of EBITDA in 5-7 years from now. It has three primary growth drivers to achieve that goal.

Source: Investor Presentation

First, it plans to continue transforming and improving the businesses within its existing portfolio to drive increasing EBITDA organically. It aims to accomplish this by focusing on premium, highly differentiated brands, capitalizing on evolving economic factors and robust consumer demand, making strategic add-on acquisitions and high returning growth capital expenditures.

Second, it plans to continue acquiring new businesses that fit within its current platforms, with a continued focus on premium, highly differentiated brands where management sees opportunity for continued value-adding investments and the chance to drive substantial further EBITDA growth.

Finally, it is taking the beginning steps towards launching a more defensive healthcare vertical which it believes will provide it with a more balanced cash flow profile throughout the business cycle. Compass Diversified is particularly bullish on healthcare given that it enjoys advantageous demographic indicators, and the company already believes it has some compelling targets that are aligned with Compass Diversified’s acquisition profile. In the meantime, it has hired Kurt Roth to be its healthcare vertical lead. He brings 25 years of experience from the sector and is expected to provide the necessary expertise to drive strong value in this new vertical.

Competitive Advantages

Compass Diversified’s underlying subsidiaries primarily benefit from superior access to and cost of capital than most of their peers through their owner, Compass Diversified. Meanwhile, Compass Diversified benefits from its access to permanent capital that enables it to take a very long-term approach to its investments. This enables it to deploy capital patiently, withstand short-term market distortions, and act swiftly when some of its competitors are sidelined.

Additionally, its portfolio of diverse and uncorrelated assets and considerable scale gives it a lower overall cost of capital and increased risk-adjusted total returns. Finally, by aligning itself closely with shareholders, it has every incentive to deliver superior long-term total returns. In particular, management finances acquisitions at the parent company level and ties its incentive fees to the company’s returns on its investments. As a result, Compass Diversified bears the risk and the rewards alongside shareholders.

Dividend Analysis

Compass Diversified recently strengthened its dividend safety by announcing the sale of its Advanced Circuits business and used the proceeds from the sale to pay down debt on its revolving credit facility. This improves its leverage and liquidity profiles, positioning it to weather any economic downturn that may occur this year.

Furthermore, its dividend is well-covered by cash flows. Compass Diversified is expected to report $2.40 in cash flow per share in fiscal 2022, covering its $1.00 per share dividend by 2.4 times. When combined with the strong growth momentum in many of its underlying businesses and its expected expansion into the healthcare vertical, Compass Diversified should be able to pay out its dividend for many years to come provided that it does not overleverage itself for acquisitions.

That said, investors should keep in mind that Compass Diversified is very unlikely to grow its dividend moving forward given that it likes to use its retained cash flow to invest in new growth projects and acquisitions.

Final Thoughts

Compass Diversified is a compelling high yield dividend stock given its attractive portfolio of businesses, strong track record of generating attractive returns on investment, and its promising growth profile via a combination of organic growth and strategic acquisitions.

As a result, investors should not view it as a dividend growth stock, rather a dividend stock that also provides strong long-term cash flow and intrinsic value growth.

Overall, we view Compass Diversified as offering an attractive risk-reward profile that is likely to provide lucrative income and total returns to investors for many years to come.

If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them regularly: