- Healthy free cash flow and EPS growth trends create room for higher dividend growth.
- With conservative assumptions, BMY can sustain a 5% dividend growth in foreseeable future.
- Current share valuation reasonably reflects the higher dividend growth potential.
The dividend of Bristol-Myers Squibb (NYSE:BMY) has only grown by a 3% CAGR since 2010. In my view, there is a good chance that the dividend growth may accelerate to about 5% per annum in the near term. In this article, I will provide readers some perspective on the company's future cash flow and dividend trends and explain how I arrived at my opinion.
I first performed free cash flow projections from 2014 to 2016 to gauge BMY's capacity for dividend growth. My analysis was based on consensus revenue estimates which predict the top line to rise by just 2% CAGR from $15.5B in 2014 to $16.1B in 2016. I noted that BMY's operating cash flow margin tended quite steadily in the past 5 years except in 2012. To be fair, I assumed a 22.5% cash margin for 2014, which is consistent with its 5-year historical average after excluding both high and low ends. Based on current consensus view that BMY's EBITDA margin may expand by about 250 bps from 2014 to 2016, I assumed a 200 bps expansion for the cash margin such that it will reach 24.5% by 2016. In this case, operating cash flow was projected to grow by 6.4% CAGR from $3.5B in 2014 to $4.0B in 2016. As a note, my estimate is more conservative than sell side. For example, Citigroup predicts the operating cash flow to reach $4.9B by 2016. For capex, I assumed the spending to increase by 14% over the forecast period from $500M in 2014 to $650M in 2016, which is also above consensus estimate in a range from $400M to $500M in the forecast period. Based on these conservative assumptions, free cash flow was projected to grow by 5.1% CAGR from $3.0B in 2014 to $3.3B in 2016 (see chart below).
As BMY is expected to pay out an annual dividend of $1.44 in fiscal 2014, the company will likely spend $2.4B on dividend payment in the year based on my share count estimate (discussed later). This would result in a free cash flow dividend payout ratio of 79%, which is slightly above 77% in 2013. To maintain a steady free cash flow payout level, BMY can grow its annual dividend spending by about 5% per year as I have projected a similar free cash flow CAGR. In this scenario, BMY would have about $500M-$700M excess free cash flow each year that can be spent on share buybacks and other corporate purposes (see chart above).
Assuming 90% of the excess free cash flow will be spent on share repurchase, total buyback value would be $1.6B from 2014 to 2016. However, given BMY's notable equity issuance in the past few years, I assumed no change in share count over the forecast period for conservatism. As such, dividend per share will grow at the same rate of annual dividend spending. It was projected to grow by 5.0% CAGR from $1.44 per share in 2014 to $1.59 in 2016. Compared with consensus EPS estimates, my dividend projections imply that earnings dividend payout ratio will decline from 81% in 2014 to 78% in 2016 as EPS is expected to grow at higher CAGR of 7% over the forecast period (see chart below).
There are few reasons making me believe my dividend forecast is within a sustainable level. Firstly, both the free cash flow and earnings dividend payout ratios trend steadily in the forecast period. Secondly, BMY has a consensus long-term EPS growth estimate of 11.9%, which is considerably above my EPS growth forecast. Thirdly, I have used a few conservative assumptions in the analysis while the sell side generally predicts a double digit operating cash flow growth from 2014 to 2016. Lastly, even with my predicted 5% dividend growth, the earnings payout ratio will drop to 78% by 2016, which is significantly below the payout ratios of 118% and 92% in 2012 and 2013, respectively.
Based on current annualized dividend of $1.44 and 8% cost of equity, Gordon Growth Dividend Discount Model suggest that current share price of ~$50 has priced in a dividend growth rate that is close to 5% (see chart below).
In conclusion, owing to favorable free cash flow and earnings trends in next few years, BMY has room to accelerate its dividend growth without boosting the payout level. Income investors can consider building positions as share valuation remains reasonable from a dividend growth perspective.
All charts are created by the author, and historical data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.