Source: TaxCredits.net via Flickr.
When it comes to your retirement perhaps no factor is more involved with helping you reach your goals than dividend payments.
On the surface dividend payments may not seem like much (2% here and 3% there), but when reinvested they can make all the difference when it comes to retiring early and/or comfortably. Of course, not all dividends are created equally, meaning investors have to be able to dig beyond the surface of a company's yield to get the full story on whether a dividend payment is sustainable or even worth the paper it's printed on.
With that in mind, today we're going to take a closer look at iron ore miner Cliffs Natural Resources (CLF 0.27%) and conduct a dividend payout ratio analysis to determine whether or not its current dividend is sustainable or at risk for a cut.
A dividend payout ratio analysis of Cliffs Natural Resources
The dividend payout ratio is one of the most important tools investors have to work with in order to establish the sustainability of a dividend payment. Simply, this payout ratio is the percentage of profits a company is paying out to shareholders in the form of a dividend. An exceptionally low number (think less than 20%) means a company could probably boost its dividend and may not be doing all it can for investors. On the other hand, an exceptionally high number (perhaps 80% and above) could be a red flag as profits may not be enough to support paying out the current dividend. Even if that doesn't prove the case it could mean little in the way of dividend growth for some time to come.
Source: Cliffs Natural Resources.
In the case of Cliffs Natural Resources, according to data provided by S&P Capital IQ, its dividend payout ratio is a whopping 182%, as its forward annual dividend is $0.60 ($0.15 per quarter) and S&P Capital IQ reports the company has earned $0.32 in earnings per share over the trailing 12-month period. But, are things really this unsustainable for Cliffs Natural Resources? Let's have a closer look.
One thing you'll quickly note about Cliffs' earnings per share, or EPS, which helps yield this payout ratio of 182% is that there's a marked difference between its GAAP profits and its non-GAAP profits. S&P Capital IQ's estimates involve Cliffs' GAAP profits, which totaled $0.32 over the previous four quarters, while its non-GAAP profits are equal to $0.73 in EPS over that same time frame, leading to a dividend payout ratio of 82%.
"Why the big difference in EPS between these two accounting methods?" you ask? The reason is that non-GAAP EPS excludes non-recurring and one-time costs and benefits that might skew investors' perceptions of a company. For instance, a miner like Cliffs Natural Resources may write down assets, make acquisitions which come with added costs, or restructure its business. All of these factors can lead to higher costs for a few quarters, but they aren't necessarily indicative of how good or poorly its iron ore business is performing. GAAP EPS, on the other hand, includes all costs and benefits, recurring or not, into one easy number that can be uniformly compared across sectors. In this instance, Cliffs' EPS has been weighed down by these non-recurring costs.
Source: Cliffs Natural Resources.
Additionally, just last week Cliffs announced that it would be taking a $6 billion non-cash write down, primarily related to the purchase of Consolidated Thompson Iron Mines in Quebec, Canada. As iron ore demand and prices have fallen, so has the value of unearthed iron ore. In other words, expect this GAAP vs. non-GAAP difference to widen even further in the coming months.
What's Cliffs' true dividend payout ratio? The answer is that it likely falls right in between the 82% based on non-GAAP EPS and the 182% from GAAP EPS. The reasoning is that GAAP EPS tends to understate earnings as it fails to account for the non-recurring nature of some charges. On the flipside, non-GAAP has a tendency to overstate earnings, since you can't completely turn a blind eye to these charges.
Is Cliffs Natural Resources dividend sustainable?
Now that you have a better understanding of what Cliffs' true dividend payout ratio is, let's return to our original question and determine whether or not this payout remains sustainable, keeping in mind that Cliffs already slashed its dividend by 76% in February 2013 in order to reduce its outgoing cash and pay down its debt.
Iron Ore Spot Price (Any Origin) data by YCharts
Personally I don't believe Cliffs' current dividend payout is sustainable given the collapse in iron ore prices and weakness in iron ore demand from China. Overall, iron ore prices have been hammered over the past three years, falling from a peak of $187 per dry metric ton in Feb. 2011 to just $82 per dry metric ton as of September 2014.
Though Cliffs has dramatically reduced its costs, the company simply cannot turn a profit with iron ore spot prices below $100 to $105 per DMT, at least in my personal opinion. However, it would appear that Wall Street agrees with me, as forecasts are calling for the company to continue losing money through 2016. With Cliffs expected to dip into the red for many quarters to come it's only logical that its dividend will be chopped even further, or perhaps even eliminated in its entirety.
What could change this outlook? A quick rebound in iron ore prices and rapid growth in China would certainly help, but the catalyst to deliver such a move isn't apparent at the moment. Based on the data we have now on iron ore demand and pricing, Cliffs' shareholders could be in for a reality check sooner rather than later when it comes to the company's current 6.6% yield.
