How Safe Is Cardinal Health's Dividend?

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About: Cardinal Health Inc. (CAH)
by: Sure Dividend
Summary

Cardinal Health has one of the highest dividend yields among the Dividend Aristocrats Index.

Because of this, as well as industry-specific headwinds facing drug distribution companies, some investors have questioned the safety of Cardinal Health's current dividend payment.

In this article, we perform a deep dive on the company's dividend safety by looking at earnings, free cash flow, recession resiliency, and debt (including an interest rate stress test).

Cardinal Health (CAH) has one of the highest dividend yields among the Dividend Aristocrats Index and, more broadly, relative to its peers in the healthcare sector.

Separately, the company is facing a few industry-specific headwinds, including a price war among drug distribution companies as well as the potential entry of Amazon (NASDAQ:AMZN) into the pharmaceutical distribution space.

These factors and the firm's high yield have led some investors to question the safety of Cardinal Health's current dividend payment.

In this article, we perform a deep dive into Cardinal Health's current dividend safety. If you prefer learning through videos, you can watch a video analysis on the topic below:

Business Overview

To begin, let's talk about Cardinal Health's business model. Cardinal Health is one of the "Big 3" drug distribution companies, along with McKesson (NYSE:MCK) and AmerisourceBergen (ABC). Cardinal Health serves over 24,000 United States pharmacies and more than 85% of the country's hospitals. The company has operations in over 60 countries with approximately 50,000 employees.

Cardinal Health is a well-known dividend stock because of its compelling track record of dividend growth. With 32 years of consecutive dividend increases, Cardinal Health is a member of the Dividend Aristocrats Index, a group of elite dividend stocks with more than 25 years of consecutive dividend increases.

Looking ahead, Cardinal Health high dividend yield, combined with several industry-specific factors, including the price war among drug distributors and the potential entry of Amazon into the pharmaceutical space, has led many investors to question the safety of its future dividend payments. For the remainder of this article, we will discuss the company's current dividend safety from four perspectives:

  1. its dividend safety in the context of its current earnings
  2. its dividend safety in the context of its current free cash flow
  3. its dividend safety in the context of its recession performance
  4. its dividend safety in the context of its current debt load

Cardinal Health's Dividend Safety Relative to Earnings

First, let's discuss Cardinal Health's dividend safety in the context of the company's current earnings.

When Cardinal Health reported first-quarter financial results on November 8th, the company provided financial guidance for the full fiscal year. Cardinal Health expects to generate adjusted earnings per share between $4.90 and $5.15 for the twelve-month reporting period.

For context, Cardinal Health currently pays a quarterly dividend of $0.476 per share. This implies a payout ratio of just 38% for fiscal 2019.

Using earnings, Cardinal Health's dividend appears very safe for the foreseeable future.

Cardinal Health's Dividend Safety Relative to Free Cash Flow

Many analysts believe that comparing a company's dividend payments to its free cash flow is a better method for assessing dividend safety. Accordingly, we will now compare Cardinal Health's current dividend payment to its free cash flow.

In the first quarter of fiscal 2019, Cardinal Health generated $365 million of cash flow from operating activities and spent $58 million on capital expenditures for free cash flow of $307 million. The company spent $150 million on common share dividends during the same time period for a free cash flow payout ratio of 49%.

Looking out over a longer time horizon, our conclusion is the same. In fiscal 2018, Cardinal Health generated $2.8 billion of cash from operating activities and spent just $384 million on capital expenditures for free cash flow of $2.4 billion. During the same time period, Cardinal Health spent just $581 million on common share dividends for a payout ratio of 24%.

Using free cash flow, Cardinal Health's dividend safety is just as robust as when we used earnings. The company's dividend appears safe for the foreseeable future.

Cardinal Health's Dividend Safety Relative to Recession Performance

Companies do not cut their dividends in the good times. Instead, dividends are reduced when companies experience financial difficulties. Accordingly, this section will analyze Cardinal Health's current dividend safety in the context of the company's historical recession performance.

We believe that the best way to measure a company's recession resiliency is by measuring its earnings per share performance during the financial crisis that occurred between 2007 and 2009. Cardinal Health's performance during this time period is shown here:

  • 2007 adjusted earnings per share: $3.41
  • 2008 adjusted earnings per share: $3.80
  • 2009 adjusted earnings per share: $2.26
  • 2010 adjusted earnings per share: $2.22
  • 2011 adjusted earnings per share: $2.67
  • 2012 adjusted earnings per share: $3.06

While the company's performance appears horrific, it's important to keep in mind that Cardinal Health's financial results around 2009 and 2010 are materially impacted by its spinoff of CareFusion Corporation, which was completed on September 1, 2009. Despite this spinoff, the company's segment revenues, segment earnings and per-share dividends continued to grow during this time.

With this in mind, we believe that Cardinal Health is a very recession-resistant business, and its dividend safety is unlikely to be impacted by short-term economic contractions.

Cardinal Health's Dividend Safety Relative to Its Current Debt Load

The last angle that we will use to assess Cardinal Health's current dividend safety is by looking at the company's current debt level. More specifically, we will see how much the company's weighted average interest rate will need to increase before the company's free cash flow will no longer cover its dividend payment.

In fiscal 2018, Cardinal Health generated $329 million of interest expense and had $9.0 billion of total debt for a weighted average interest rate of 3.7%.

The following image shows how changes to Cardinal Health's weighted average interest rate would impact the company's dividend coverage, as measured by free cash flow.

CAH Interest Rate Stress Test Source: Sure Dividend Calculations

As the image shows, Cardinal Health weighted average interest rate would need to rise to above the 25% level before its dividend would no longer be covered by free cash flow. Accordingly, we believe that Cardinal Health debt level is unlikely to impact the safety of its dividend moving forward.

Final Thoughts

Cardinal Health's high dividend yield combined with the price war that is currently underway among drug distributors as well as the potential entry of Amazon into the pharmaceutical distribution arena has led some investors to question the safety of the firm's current dividend payment.

In this article, we examined Cardinal Health's dividend safety relative to its earnings, free cash flow, recession performance, and debt levels. The company's dividend appears very safe in the context of its current fundamentals.

Disclosure: I am/we are long CAH. 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.