Trying to pick future dividend stars is tough, but it’s not impossible. They tend to be highly cash generative and operate within a defensive industry, which means the cash keeps flowing in both good times and bad.
However, the number of companies that manage to achieve and retain the title of ‘dividend champion’ in the long term is quite small. More often than not, managements get ahead of themselves and hike dividends too far too fast so companies often end up paying out more than they can afford, which always ends badly.
Morrisons (LSE: MRW) and BHP Billiton (LSE: BLT) both fell into this trap, but after a rethink by their respective managements, I believe these companies could now be future dividend stars.
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Future dividend stars
Both slipped up when it comes to dividends during the past few years. BHP was forced to slash its payout as commodity prices plunged in 2015 and profit margins collapsed. Management cut the payout from $1.24 per share in 2015, to $0.30 for 2016 as earnings per share fell from a high of $3.22 in 2012 to $0.23 in 2016.
As well as the company’s dividend, BHP’s management has also conducted a radical overhaul of the company’s capital spending since 2013. Indeed, over the last 10 years, BHP has pursued a growth-at-any-price strategy, which has only destroyed value for shareholders. Now management has adopted a more conservative strategy, seeking value over volume and this should mean the company’s payout is more sustainable in the long term.
Also, management has scrapped the company’s progressive dividend policy in favour of a more flexible approach, which gives the group scope to return more cash to shareholders in the boom times, and hold cash back when times are hard. This flexibility shouldn’t be underrated. By managing cash flows year-to-year, BHP is less likely to find itself in a position where it’s struggling to meet commitments to shareholders, grow the business and fund its debt. Put simply, this flexibility only makes BHP’s dividend more secure.
At the time of writing, shares in BHP offer a forward dividend yield of 3.9%.
Cash cow
Morrisons has been forced to take the same approach as BHP with regards to its dividend, but again, I believe this new strategy improves the firm’s dividend outlook.
It has cut its payout to 5.4p for the year ended 31 January, down from 15p three years ago. This dividend cut, combined with the group’s halt on capital spending, has transformed its financial position. Between 2012 and 2014 Morrisons borrowed an average of £670m per annum to meet its expenditure commitments. But in the past two years, borrowing has disappeared and the firm has paid down over £800m of debt.
As Morrisons’ financial position continues to improve, the company’s dividend payout will only become more secure. The shares currently support a dividend yield of 2.2% and the payout is covered twice by earnings per share.
