CA: Strong Dividend, But Now's Not The Time

| About: CA Inc. (CA)

Summary

CA’s stock has been the beneficiary of a strong earnings report but still sports a 3% dividend yield.

No indication of significant dividend increases in the near term following a negligible 2% increase.

Dividend investors seeking to invest in CA should wait until a pullback to maximize their dividend yield.

Analysis

Recent Good Run. CA Inc. (NASDAQ:CA), one of the world's largest developers of systems software, has had a good run in 2016, with its stock rising by over 16% for the year. CA, which was a formerly known as Computer Associates, is a New York-based maker of mainframe, distributed computing and cloud computing software for Fortune Global 500 companies.

The reason for the stock's run-up is fairly simple: it reported earnings of 60 cents per share in the 4th quarter of its Fiscal 2016 (i.e. for the 12 months ending in March 2016) - 3 cents better than the consensus estimate of 57 cents per share. While its revenue growth was flat, CA was able to capture operating efficiencies that enabled it to increase its EBITDA margin from 34.4% to 37.26% in the 4th quarter.

Dividend Analysis. CA's current dividend yield is a solid 3.09%, which is among the highest in its peer group. This means that investors who purchase $10,000 worth of CA shares can expect passive income of $309 per year.

Following its strong fiscal 4th quarter, CA raised its dividend slightly from 25-cents per share to 25.5-cents per share. This represented the first increase in CA's dividend since 2012, when it raised its dividend fro 5-cents per share to 25-cents.

While CA's management has stated that it wishes to maintain flexibility, we anticipate that CA will continue to pay at least a 25-cent dividend going forward given its solid financial footing.

To begin with, CA has a respectable working capital ratio of 1.23x - more than enough to cover its near-term operating requirements. Meanwhile, its gearing is fairly low at just 36 cents of financial debt for every dollar of equity, which is lower than the industry average of 60 cents. What these two metrics tells investors is that operating and debt-servicing costs are unlikely to impede CA's ability to pay a dividend.

What's more, CA only has only around $47 million left out of its authorized stock repurchase plan of $750 million to implement. Rich Beckert, CA's Chief Financial Officer has indicated that it intends to complete its repurchases over the course of Fiscal 2017 (i.e. April 2016 to March 2017). That works out to less than $12 million per quarter. Once this is completed, there will be fewer cash outlays to 'compete' with CA's dividend payment.

Moreover, CA has among the healthiest operating margins in the industry with an operating margin of 29% over the last twelve months compared to just 6% for its industry as a whole. Indeed, the reason that CA was able to beat expectations was because of its improved operating margin.

Outlook. Of course, considering CA's recent success, Investors may pose the legitimate question of whether CA will raise its dividend further.

Our answer is: 'don't hold your breath.' As we mentioned earlier, CA has kept its dividend largely unchanged since 2012 - the latest 'increase' was an almost-negligible 2%. What's more, CA's scope to increase earnings by reducing its operating leverage is limited - investors can't expect CA to raise its operating margin indefinitely, especially since it is already 34% higher than the industry average.

Most importantly, CA's revenues are not rising - as solid as its 4th quarter fiscal 2016 results were, CA's revenues actually fell by 6%, marking the second straight year of revenue attrition. In the same period, CA's total new product and capacity sales dipped by around 10%, suggesting that it continues to operate in a challenging sales environment. As such, it's not surprising that CA's revenues are forecasted to rise by only 4.5% in the current year - less than half the 9.6% revenue growth estimate for its industry.

Considering the foregoing, we argue that while CA has capacity to keep its dividend at around its current level, we do not feel confident that CA will have the scope to raise its dividend by a significant amount.

Conclusion

How might dividend investors play CA stock? With a dividend that is unlikely to rise significantly soon, the best way for investors to maximize their dividend yield on CA is to wait for a 10 to 15% pullback before getting into the stock.

To wit: CA is pricey right now: among its closest competitors like HP (NYSE:HPQ), Oracle (NASDAQ:ORCL) and IBM (NYSE:IBM), it carries both the highest Price-Earnings and Price-Earnings-to-Growth ratios. At the same time, worldwide IT spending is actually forecasted to fall slightly in 2016 before rising by just under 3% a year through 2020 - so CA is unlikely to see a huge boost to its revenues in the years ahead.

In such an environment, it's difficult to see CA's stock rising by much further. Indeed, CA is already trading above the median target for its stock, which is $32 per share. It is also within striking distance of its 52-week high and not that far off from $36 per share, which is the top-end analysts' forecasts. This being the case, we just don't see much more headroom for the stock and anticipate that it is more likely for the stock to pull back by 15% than it is to rise by another 10%.

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Disclosure: I/we 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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.