As we had previously outlined as to why net cash on the balance sheet represents dry powder for the dividend growth investor in the case of Chevron (CVX) here, let's evaluate the investment merits of ConocoPhillips (COP) and its dividend under the Valuentum Dividend Cushion framework.
Evaluating ConocoPhillip's Dividend
(click to enlarge)
Source: Valuentum Securities
ConocoPhillips' dividend yield is excellent, offering a 4.1% 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 ConocoPhillips fits the bill thus far. But before proceeding, please note that we are still forecasting the firm to continue to grow its dividend, albeit modestly (see image above, bottom right). These future growth forecasts are embedded in our analysis that follows.
Still, we think the safety of ConocoPhillips' dividend is very 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 via the forward-looking Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand (on its balance sheet) plus its expected future free cash flows (cash flow from operations less capital expenditures) 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 of 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 ConocoPhillips', this score is 0.2, revealing that on its current path the firm may not be able to cover its future dividends with net cash on hand and future free cash flow.
Now on to the potential growth of ConocoPhillips' dividend. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. In ConocoPhillips' case, there's not much cushion at all. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. To do so, 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 ConocoPhillips. We have the firm rated as having very poor growth potential, and our future forecasts for low-single-digit expansion are consistent with that.
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 ConocoPhillips' case, we currently think the shares are fairly valued, so the risk of capital loss medium. If we thought the shares were undervalued, the risk of capital loss would be low.
Though ConocoPhillips has a nice track record of paying out dividends, its dividend safety isn't as strong as it once was (as a result of its large net debt position, which is a component of our Dividend Cushion score). For why the Dividend Cushion score is important, please click here. All things considered, we're not huge fans (anymore) of the potential growth and safety of ConocoPhillips' dividend. We think there are better places to look, and Chevron is one of them.
The glossary below shows how we rate a company's dividend in each key area:
Additional disclosure: CVX is included in our Dividend Growth portfolio.