Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.
Let's examine how Huntsman
1. Yield
First and foremost, dividend investors like a large yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.
Huntsman yields 4.3%, which is fairly high and tops the 2.9% industry median, but it isn't necessarily cause for alarm.
2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company pays out in dividends to the amount it generates. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford.
Huntsman is both earnings and free cash flow negative, so it doesn't have a payout ratio. For the payout ratio to be in the realm of "safe," you'd want to see profits of at least $0.50 per share. Sales are currently depressed, but analysts expect revenue to bounce back and Huntsman to return to those earnings levels by 2011.
3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.
Let's examine how Huntsman stacks up to its peers:
|
Company |
Interest Coverage Ratio |
Debt-to-Equity Ratio |
|---|---|---|
|
Huntsman |
1.3 |
235% |
|
Dow Chemical |
1.5 |
105% |
|
DuPont |
9.9 |
116% |
|
Ashland |
3.1 |
39% |
|
Median Diversified Chemicals |
6.2 |
96% |
Source: Capital IQ, a division of Standard & Poor's. Medians are of medium- and large-cap U.S. industry components.
Among the major U.S. diversified chemical manufacturers, Huntsman actually has the highest debt-to-equity ratio (DuPont is a distant second) and the lowest interest coverage ratio (followed by Dow.) It's tempting to think that the interest coverage ratio may be depressed along with operating earnings, but when you look back at recent years of higher operating earnings (2005-2007), the ratio remained below two then as well.
4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.
Huntsman's earnings have shrunk over the few years, while its dividend has remained at a steady $0.40 per share.
The Foolish bottom line
Huntsman exhibits several dividend warnings signs -- in particular, its negative earnings and free cash flow and debt burden. However, its dividend may not turn out to be a huge financial burden if it can restore the levels of earnings and free cash flow it enjoyed in recent years.
