Banco Santander: Is The 7% Dividend Sustainable?

| About: Banco Santander (SAN)

With investors still struggling to generate income in their portfolios thanks to the government's easy money policy, some are turning to equity dividends to fill in the gaps. Utilities and financials are often popular choices for income where a 3-4% dividend yield is not uncommon. But take a look at Banco Santander's (SAN) current 7.3% yield and your snap reaction might be that it's a little too good to be true.

Banco Santander is one of the largest banks in the Eurozone and does most of its business in Europe and Latin America. Like many financial companies, Santander saw its stock price maintain a steady upward trajectory until the global financial crisis and weakness in the European economy began to take its toll. Since Santander derives most of its revenue and earnings from the retail sector it was hit particularly hard as millions of dollars of mortgage loans went bad. As the Eurozone housing market begins to recover Santander could be positioned to rebound nicely.

With regard to the dividend, part of the reason that we see such a significant yield is due to the stock price decline. The stock hit a high of $22 around the beginning of 2008 but thanks to the mortgage crisis it dropped all the way to its current level of around $9 per share. During that time, Santander has largely been maintaining or raising its dividend, pushing the yield up to its current level.

In assessing the sustainability of the current dividend, it's worth noting that a dividend cut is not unprecedented for Santander. As the mortgage market started melting down, Santander cut its dividend from $0.36 per share down to $0.15 in order to preserve cash for ongoing operations. But is a similar situation ahead for the bank?

Looking at the numbers would suggest that the answer is yes. 2013 earnings are expected to come in somewhere around $0.60 per share. When compared to the current annual dividend payout of $0.64 per share you could conclude that the dividend cannot be maintained with current earnings. But that may not be the case.

Somewhere between 80-90% of Santander shareholders elect to receive scrip dividends instead of cash dividends. This means that most shareholders are issued more shares of Santander stock instead of cash. The primary advantage to shareholders is that a scrip dividend will not be subject to the 21% Spanish withholding tax that applies to cash dividends. The primary advantage to Santander is that it allows the company to maintain its cash position and it's this advantage that allows the company to pay out a dividend that exceeds what it's able to earn.

There is a downside to this strategy however. Issuing a scrip dividend dilutes the ownership share of all shareholders making everybody's stake worth incrementally less over time. As shares drop in value due to the scrip Santander needs something to replace the lost value of diluted shares and it's currently counting on future growth to fill in that gap.

From a fundamental standpoint, things look good. Santander's stock has a price/book ratio of about 1.0 which is on par with the banking industry. Its price/earnings ratio of 15 is slightly below the banking sector and the market in general. When you put that next to an estimated 33% annual earnings growth over the next five years, the stock begins to look like a value.


The current dividend yield is based on a $0.64 annual dividend and a share price of roughly $9. If the stock price begins to rise we can expect the yield to drop a bit but the more important issue is whether or not the quarterly payout is sustainable.

If Santander falls short of growth estimates or if the European economy begins to regress once again I think the dividend yield is at risk. Current earnings don't keep up with current dividend payouts but with so many shareholders opting for scrip dividends I don't see why the dividend payout is not sustainable if the company can deliver on growth estimates. If Santander can deliver, the dividend should be on solid ground.

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.