Although analyzing historical trends is important, we think assessing what may happen in the future is even more important. That is why we created a forward-looking assessment of dividend safety through our innovative, predictive dividend-cut indicator, the Valuentum Dividend Cushion™ for the financial advisor. In this article, let's use this framework to evaluate the investment merits of Anadarko (NYSE:APC), as well as its dividend.
Return on Invested Capital
Anadarko's dividend yield is below average, offering a paltry 0.5% 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.
Yet, even with this paltry yield, we think the safety of Anadarko's 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. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges (read: hiccups in operations), which makes earnings a less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter or year. As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.
That has led us to develop the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows 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 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 Anadarko, this score is -3.7, revealing that on its current path the firm may not have the capacity to pay out its expected future dividends, though flexibility remains.
Now on to the potential growth of Anadarko's dividend. As we mentioned above, we think the larger the "cushion," the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. As such, 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 Anadarko. We rate the firm's future potential dividend growth as very poor. The company's cash flow profile and capital structure just aren't conducive to a high dividend payer.
And 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 Anadarko's case, we 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.
All things considered, we think there are much better dividend risk/reward profiles out there. Importantly, we'd be very skeptical of any meaningful dividend increases at the company. They may not be sustainable.