This High-Yield Dividend Is Still Safe Despite the Coronavirus

Speaking on the company' second-quarter earnings call, Emerson Electric Company (EMR +6.11%) CEO David Farr left investors in no doubt as to the depth of his commitment to maintaining Emerson's status as a Dividend Aristocrat. The company has increased its dividend for the last 63 years, and despite some very difficult end markets, Emerson's near 4% dividend yield looks secure. Let's take a look at why the stock is a decent option for income seeking investors.

Why Emerson Electric's dividend is safe

In a departure from the usual refrain in the current earnings season, Farr decided to give earnings guidance, and what he said should have reassured investors. He also outlined the commendable efforts made by Emerson in teaming up with its process automation rival Honeywell International in order to facilitate the production of N95 face masks.

The key points to Emerson's guidance are shown below. Even though the current economic slowdown has caused a significant downgrade to sales and earnings expectations, the dividend remains well covered by earnings and free cash flow.

Image source: Getty Images.

Furthermore, Farr spoke directly to investors when he said: "as long as I'm here, our dividend will not be cut and we will maintain our dividend payments and history. We have the financial flexibility and capabilities to do that going forward." 

Data source: Emerson Electric presentations. 

A strong financial position

CFO Frank Dellaquila reiterated the strength of Emerson's financial position when he forecast the company would end 2020 with a debt-to-earnings before interest, taxation, depreciation and amortization (EBITDA) multiple of just 1.9. For reference, a multiple of 2.5 times EBITDA or lower is seen as suitable for investment-grade debt. Moreover, the company has $3.5 billion in undrawn bank facility until April 2023.

In addition, management's updated guidance still calls for $950 million in share repurchases, so there's definitely room for financial flexibility. Incidentally, share buybacks make perfect sense in the current environment. Emerson's guidance implies it will generate 6.8% of its current market cap in FCF in 2020, so using that FCF to buy back stock that it's paying a near 4% yield on is a good idea. That said, Farr also made it clear he's on the lookout for acquisitions and Emerson's financial strength puts it in a position to do so.

All told, based on management's projections, the dividend looks safe and Emerson appears well placed to deal with a very difficult year.

Will Emerson Electric hit its guidance?

Given the uncertainty in the economy right now, it makes sense for investors to question what the risk to Emerson's earnings outlook is. The chart below includes the midpoint of the guidance ranges for Emerson's upcoming third and fourth quarters.

Data source: Emerson Electric presentations. YOY = year over year.

Frankly, it's impossible for anyone to know exactly how global growth will pan out in the next couple of years -- not least because we don't know what the extent of the policy responses to the COVID-19 pandemic will be. Moreover, Emerson is a company with significant exposure to energy prices -- around 20% of its total revenue (and 31% of its automation solutions segment) is currently coming from upstream oil and gas and pipelines and terminals.

The other segment, commercial and residential solutions, is a collection of industrial businesses comprising heating and air conditioning solutions, industrial tools, and refrigeration solutions. It's a set of businesses that usually go up and down with the economy at large. 

That said, Emerson's guidance looks like it's based on some conservative assumptions. For example, the price of oil is expected to stabilize at "$20 to $30 range per barrel" according to Director of Investor Relations Pete Lilly. Moreover, Farr cautioned that a recovery was going to take time -- a viewpoint consistent with his guidance for a sales upturn to be delayed until the second half of Emerson Electric's 2020.

Furthermore, the sharp drop in sales in the third and fourth quarters of 2020 will make for much easier comparisons in the second half of the year.  

The bottom line

All told, Emerson Electric is probably a stock to avoid if you think the price of oil will enter a multi-year decline. On the other hand, its dividend looks safe, so if you are confident the economy will avoid a protracted recession and the oil markets will stabilize in the $20 to $30 range, this may be a stock to consider.

In addition, the company's sound financial position and reasonable-looking guidance -- which implies a deeper, but shorter downturn than the industrial recession of 2015 to 2016 -- means it's a good option for dividend-seeking investors.