Some dividends have staying power. Companies delivering enduring dividends tend to back such often-rising payouts with robust business and financial achievement.
Fragile dividends, meanwhile, arise because of weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.
How to tell the difference
Under the spotlight today, two FTSE 100 firms: AstraZeneca (LSE: AZN) the pharmaceutical supplier and BP (LSE: BP) the oil giant.
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These firms operate in different sectors, but they both have a reasonable dividend yield. At the recent share price of 4320p, AstraZeneca’s forward yield for 2016 is 4.3%. At 332p, BP’s is 7.8%.
Let’s run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.
-
Dividend record
Both firms maintained dividend payments over the past five-year trading period:
|
Ordinary dividends |
2011 |
2012 |
2013 |
2014 |
2015 |
|
AstraZeneca (cents) |
280 |
280 |
280 |
280 |
280 (e) |
|
BP (cents) |
29 |
34 |
37 |
39.5 |
40 (e) |
AstraZeneca’s dividend has been flat, but BP looks set to move its payment forward by 38% if 2015’s fourth quarter payment keeps up the established pattern. However, there is some doubt about whether the dividend is sustainable, due to the continuing low price of oil.
Both firms managed to maintain payments over the last few years. So, for their dividend records, I’m scoring AstraZeneca 2/5 and BP 4/5.
-
Dividend cover
AstraZeneca expects its 2016 adjusted earnings to cover its dividend around 1.4 times. BP expects cover from earnings of just 0.9 times, which makes on-going dividend payments look vulnerable.
Both firms are running thin cover from adjusted earnings. I’m more comfortable with cover of around two times earnings. Of course, cash pays dividends, so it’s worth digging deeper into how well, or poorly, companies cover their dividend payouts with free cash flow.
On dividend cover from earnings, I’m scoring AstraZeneca 2/5 and BP 1/5.
-
Cash flow
Dividend cover from earnings means little if cash flow doesn’t support profits.
Here are the firms’ recent records on cash flow compared to profits:
|
AstraZeneca |
2010 |
2011 |
2012 |
2013 |
2014 |
|
Operating profit ($m) |
11,494 |
12,795 |
8,148 |
3,712 |
2,137 |
|
Net cash from operations ($m) |
10,680 |
7,821 |
6,948 |
7,400 |
7,058 |
|
BP |
|
|
|
|
|
|
Operating profit ($m) |
(9,140) |
33,001 |
14,157 |
27,803 |
2,197 |
|
Net cash from operations ($m) |
13,616 |
22,154 |
20,479 |
21,100 |
32,754 |
Generally, both businesses see there cash flow support profits well. I’m scoring both firms 4/5 for cash flow.
-
Level of gross debt
Interest payments on borrowed money compete with dividend payments for incoming cash flow. That’s why big debts are undesirable in dividend-led investments.
At the last count, BP’s borrowings were around 1.75 times the size of its net cash from operations, which seems manageable. AstraZeneca’s is even better at about 1.5 times its last-reported net cash from operations figure.
My attitude to debt in mature companies is quite harsh — I’m old-fashioned and believe they are better off without it — so, for their debt positions, BP gets 2/5 and AstraZeneca scores 3/5
-
Degree of cyclicality
AstraZeneca’s share price moved from around 3,000p at the beginning of 2011 to 4,320p or so today, handing investors a 44% capital gain over the period to add to income from dividends.
BP slipped from around 500p at the start of 2011 to around 332p today, erasing investor dividend gains, and then some.
Those share-price movements act as a clue to the degree of cyclicality inherent in each sector. At one end of the cyclicality scale, we have BP, a business joined at the hip with macro-cycles and with little control over its own selling prices as the price of oil dances up and down to the tune of supply and demand.
At the other end of the cyclicality scale sits AstraZeneca, a firm well placed in a consumable market with high barriers to entry, and a structural trend locked on a course of rising demand. Patent expiry issues move in cycles, but they are cycles the firm may control by keeping up investment in research and development.
Of the two firms, in terms of cyclicality AstraZeneca best supports a long-term dividend-led investment strategy. I’m scoring BP 1/5 and AstraZeneca 4/5.
Putting it all together
Here are the final scores for these firms:
|
|
AstraZeneca |
BP |
|
Dividend record |
2 |
4 |
|
Dividend cover |
2 |
1 |
|
Cash flow |
4 |
4 |
|
Level of gross debt |
3 |
2 |
|
Degree of cyclicality |
4 |
1 |
|
Total score out of 25 |
15 |
12 |
Neither firm is perfect but I’m inclined to put greater weight on some factors over others. For example, BP’s finances look reasonable after a period of relative prosperity, which boosts some of the scores. The current year’s results are not in yet, though, and the persistent low price of oil will surely affect the firm’s dividend outlook from here. Looking at BP’s share-price performance the effects of cyclicality are difficult to predict.
AstraZeneca’s operations, though, seem far more stable. The dynamics of the pharmaceutical sector gives AstraZeneca a fair chance of restoring its profitability from here, which could work well for a long-term, dividend-led investment in the firm over the coming years.
