Earlier this week, I put forth the Argentine oil and gas company YPF S.A. (YPF) as a high-yielding energy stock that could be a dividend play that is worthy of additional research. A short discussion ensued in the comments to that article regarding whether that company’s dividend (currently at 9.7%) is sustainable. I wanted to take a closer look at this question.
According to Yahoo Finance, YPF had trailing twelve month earnings of $3.31 per share and pays a dividend of $3.35 per share. That gives the company a dividend payout ratio of 101% which at first glance does not appear to be sustainable. It is important to look beyond this though as the dividend payout ratio is not always the best way to judge the sustainability of a company’s dividend. This is because a company’s net income can be reduced by various accounting numbers that do not represent actual cash outflows for the business.
We can get a better idea of the sustainability of a company’s dividend by looking at the statement of cash flows. The statement of cash flows shows us the actual amount of cash that comes into a business from all sources and how that cash is used.
The figure on the statement of cash flows that we are most interested in is the cash flow from operations, also known as the operating cash flow. Investopedia defines operating cash flow as “the cash generated from the operations of a company.” Essentially, a company’s operating cash flow tells us how much cash a company generates through its regular business operations. The operating cash flow is after all expenses. It also excludes things such as cash coming into the company through borrowings and things such as asset sales. Thus, the operating cash flow is the best number to use to determine the level of dividends that a company’s operations can sustain.
This chart shows YPF’s operating cash flows for the past three full fiscal years:
This chart shows the total amount of money that left the company in dividend payments to shareholders during each of these three years:
These numbers show us that YPF is generating substantially more cash than the company pays out in dividends. This does not tell the whole story about whether or not the dividend is sustainable. This is because a company has to fund things other than dividend payments to shareholders.
A more common measurement of dividend sustainability is the company’s free cash flow. Free cash flow is defined by Investopedia as “the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.” Free cash flow thus represents the amount of cash that a company has available to distribute to stock and bond investors after paying all of its expenses. Free cash flow is calculated by subtracting capital expenditures from operating cash flow. Like operating cash flow, free cash flow excludes money that comes into the company through borrowing as well as cash inflows from asset sales.
This chart shows YPF’s capital expenditures and free cash flows for each of the past three fiscal years:
As we can see, YPF only generated enough free cash flow to cover their dividend in one of the last three years. The company had two other sources of cash during these years that made up the difference. Of the two, the positive cash flows from issuance of debt is by far the more concerning as it shows that YPF is partly funding its operations by borrowing money while continuing to pay out a monster of a dividend. The does not necessarily indicate a problem, so long as the company can keep rolling over its debt, but it could be a potential red flag.
What is more worrying though is that these increases in debt do not appear to be productive. Borrowing money to make investments that grow the business can make sense as the increase in cash flows can cover the interest on the new debt. That does not appear to be the case here. YPF’s debt has surged significantly in recent years along with the resulting interest payments. However, the impact on their net income and operating cash flow has been minimal at best.
The majority of the increase in YPF’s debt is short-term as opposed to long-term. We can see this by looking at the company’s balance sheet. Having large amounts of short-term debt is a strategy that works well in today’s low interest-rate environment. At some time in the future though, interest rates will inevitably increase. This will drive up YPF’s interest costs. When this happens, YPF may have to cut its dividend to cover their interest costs.