Is R.R. Donnelley & Sons' 10.2% Dividend Yield Sustainable?

Oct.25.12 | About: R.R. Donnelley (RRD)

R.R. Donnelley & Sons Company (NASDAQ:RRD) provides business services like printing, business process outsourcing, logistics and pre-media services, to clients globally. It has an attractive dividend yield of 10.2%, which is sustainable over the short term. The stock is trading at a forward P/E of 5.4x with 34% of its float short and a short ratio of 22 days. If the free cash flow level falls below the forecast $500m, investors should expect a dividend cut.

The company pays an annual dividend of $1.04/share. The high dividend yield of 10.2% is mainly due to the 31% YTD decline in stock price. The company has maintained the same quarterly dividend of $0.26/share since 2003. The free cash flow yield is 21% at the moment, according to Reuters. The dividend coverage ratio (earnings per share/dividend per share) for 2012 and 2013 is 1.7x, considering the $1.84 EPS expected from RRD in both years. The cash dividend coverage ratio (free cash flow per share/dividend per share) is 2.6x, as the company expects free cash flows of $500 million for 2012. The company expects higher cash generation in 2H of the year because of the normal operating cycle of the company. Thus, the dividend seems to be sustainable at current earnings and cash flow expectations, though growth should not be expected.

The company has an interest coverage ratio (trailing twelve months) of 1.75x, which means that its earnings can just cover the interest obligations. The total debt to equity ratio as of the most recent quarter is 354%, with $343 million as current debt as of the last quarter. The company has been able to get debt/credit to repay the maturing debt e.g. notes maturing in January 2014 and as well as to repurchase senior notes maturing in April 2014 and May 2015. $258 million of April 2014 debt remained according to Q2 earning release, along with $299 million of the notes maturing in 2015. The only problem here might be the fact that the company is replacing debt with interest rates of 4.95% and 5.5%, with costlier debt at 8.25% interest rate.

The gross, operating and net profit margins in the last twelve months have all been below their 5-year averages due to economic conditions.

The company has beaten analyst estimates of earnings in the first two quarters of the year. The company guided to $10.4-10.5 billion in revenues for 2012, while analysts expect $10.37 billion. EPS guidance is $1.84-$1.92 as compared to analyst consensus estimates of $1.84. Last year, the EPS was $1.82.

Free cash flow trend in the future would be the key measure to follow in order to judge when the dividend would be cut. The graph below shows the free cash flow (TTM) over the last 5 years for RRD.

Click to enlarge

If the $500 million level is maintained, the dividends should be safe. Over the long run, there is plenty of risk that deterioration in cash generating abilities linked with declining top line from the company's business will result in a dividend cut. Prospects of the company depend on macro economic conditions as well. At the moment, the stock is fairly priced at 5.4x forward P/E and EPS expectations of $1.84 for 2013. Quad/Graphics, Inc. (NYSE:QUAD) has a forward P/E of 9x and also operates in the business services industry.

RRD is going to report Q3 results on 1st November. RRD would be a great investment for income investors once sales start increasing. Before that investors should be wary of future growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Retail Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.