Valhi, Inc.: When Will We Get Dividend Growth?

About: Valhi, Inc. (VHI)
by: Individual Trader

Stock selling at just three times earnings.

Can recent earnings growth be sustained, though?

We look at the generous dividend and its future viability.

Valhi, Inc. (VHI) is a pretty diversified company as it deals with chemicals, components products, and real estate management services on an international scale. The stock at present has a very interesting valuation. Selling at just 3 times earnings, Valhi is bound to attract some value investors here.

Apart from earnings, though, one can buy plenty of the company's sales and cash flow at its present share price of $2.33. For example, Valhi's present sales multiple is 0.4, and cash flow multiple is 4.8. These numbers look very attractive on the surface compared to both the averages in this industry as well as Valhi's historic averages.

Furthermore, the company pays out a forward dividend of $0.08, which equates to a dividend yield of almost 3.6% (well above the industry average of 3.1%). Many value investors are income-orientated and with good reason. There is no point buying a "cheap stock" if the dividend in question is not viable. Why? Because a cut to the dividend invariably affects the stock price in an adverse fashion. Suffice it to say, dividend research is critical when researching any potential value play.

So, from this standpoint, let's delve into the important aspects of the firm's dividend, which include its history, growth, whether profit is currently covering the annual payout, and how viable the dividend looks going forward. Let's dig in.

Many times, high-yield stocks pay out a large dividend for a reason. With respect to Valhi, there has been very little growth in the share price since its lows of 2009. One of our core strategies when researching a dividend stock is check how the firm's key financial metrics have been trending over the past 10 years. We echo Warren Buffett's sentiments here when he says..

it is better to buy a wonderful company at a fair price than a fair company at a wonderful price

Now, revenues and earnings are actually up over the past decade for example, but the dividend has remained at an annual payout of $0.08 since 2015. The reason being is that Valhi's net earnings have been very jumpy over that period. In fact, in 5 out of the past 10 years, Valhi has reported negative earnings. This obviously has put pressure on the generation of free cash flow, which has resulted in the no-growth environment the dividend currently finds itself in.

Just a few points about the importance of dividend growth. For a start, dividend growth protects against inflation. It does not make sense to be invested in a dividend stock (for income) if one can get a better yield from a fixed income investment for example. Furthermore, dividend growth is usually a sign of confidence by management that earnings are or will improve usually as a result of improving fundamentals.

Nevertheless, from an affordability standpoint, the dividend does not look to be in any distress at present. The payout ratio when calculated off net profit comes in an ultra-low 10%, whereas the free cash flow ratio comes in at 26%. Again, though, investors need to take these percentages with a pinch of salt as this key metric has been very erratic, for example, over the past decade. Suffice it to say, the current payout ratio of 10% should not be used a proxy to believe the dividend is viable over the long term.

With respect to predicting the viability of the dividend going forward, we look at the interest coverage ratio and the liabilities to equity ratio. At present, the interest coverage ratio comes in at 4.23. The trend here is encouraging as this key ratio has been rising since more or less since the dividend was frozen a few years ago. With respect to the balance sheet, Valhi reported $989 million in shareholder equity in its annual report in 2018. The total amount of liabilities it reported on the 31st of December 2018 came to $1.72 billion. This gives us a liabilities to equity ratio of 1.73. Again, this key metric seems to be trending in the right direction, which is encouraging for the future viability of that dividend.

To sum up, Valhi's dividend looks in pretty good shape in that earnings can easily afford it at present. Furthermore, if future earnings were to disappoint, the balance sheet does not look to be heavily overextended at present. The issue here, though, is growth and the track-record of the firm's key financials. Can stability be brought to the equation is the key question. Will review when the company next announces earnings in May.

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.