Air Products And Chemicals: This Dividend Champion's Dividend Is Risky

| About: Air Products (APD)

Dividend growth investors sometimes place too much emphasis on what has happened in the past. And many times investors find comfort when their holdings reach the designation of Dividend Champion, or a firm that has raised its dividend for 25 consecutive years. Is this a valid view? And most importantly, is it valid for Dividend Champion Air Products and Chemicals (NYSE:APD)? Let's take a look.

Air Products and Chemical's Investment Considerations

Air Products and Chemical's Return on Invested Capital

Air Products and Chemical's Dividend

Air Products and Chemicals' dividend yield is above average, offering roughly a 3% annual payout at recent price levels. We prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. So Air Products and Chemicals just meets our criteria.

However, and this may be shocking to some, we think the safety of Air Products and Chemicals' dividend is poor (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.

That has led us to develop the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple reasons: 1) the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and 2) the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future.

For Air Products and Chemicals, this score is 0.5, revealing that on its current path the firm won't be able to cover its future dividends with net cash on hand and future free cash flow. Other Dividend Champions such as Procter & Gamble (NYSE:PG) and McDonald's (MCD) have Dividend Cushion scores comfortably above 1. We also use our dividend cushion as a key decision component in choosing companies for addition to the portfolio of our Dividend Growth Newsletter (please see our links on the left sidebar for more information).

Now on to the potential growth of Air Products and Chemicals' dividend. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. As such, we evaluate the company's historical dividend track record. If there have been no dividend cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is not the case for Air Products and Chemicals. The firm's Dividend Cushion, which is weighed down by its capital structure (debt position) and size of its future dividend payments is below parity. This could spell trouble, despite some of its steady-eddy contracts with customers.

And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Air Products and Chemicals' case, we currently think the shares are fairly valued, so the risk of capital loss is medium. If we thought the shares were undervalued, the risk of capital loss would be low. All things considered, we don't see the potential growth and safety of Air Products and Chemicals' dividend. This company may not be a Dividend Champion forever.

Disclosure: I 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.