Alcoa (AA) is no dividend champion and it certainly doesn't have a noteworthy dividend yield today. But the company's 2016 split into an upstream company and a "value-add" company could change a lot on the dividend front. Will it be a good change for dividend investors?
The dividends after the split
Alcoa's plan is to break out its upstream assets, the ones that make aluminum, from its value-add business, which makes things out of aluminum and other metals. The profile of each will be very different.
Alcoa's big break up plan. Image source: Alcoa.
For example, the value-add business is really focused on growth markets like aerospace and automotive, where aluminum is gaining market share by displacing steel. It's also reasonable to expect more acquisitions after the split, just like the ones that helped build the Value Add business to what it is today. The thing is, growth businesses don't usually focus on returning capital to shareholders via dividends. They focus on reinvesting in the business to spur growth.
That doesn't mean the stand-alone value-add business won't pay a dividend. In fact, since institutional investors, like insurance companies, often won't buy a stock if it doesn't pay some sort of dividend, it's highly likely that there will be at least a token payout. However, I would expect more than that. And as the company grows, the dividend is likely to be increased along the way. That suggests a low yield, but a potentially high-growth distribution.
The upstream business, on the other hand, is going to be in a vastly different position. It will be a commodity business with, at best, a slow growth profile. As it stands, Alcoa is telling investors that the upstream business will focus on "prudent return of capital to shareholders." That's telegraphing that it will pay a dividend, but that it will have to balance what it can pay in good times against what it can afford in bad times.
In other words, upstream is likely to have a higher dividend yield than the value-add business. However, it's unlikely to be a fast-growing distribution. That will probably remain true even if commodity markets take off, since most companies frown on committing to a dividend they can't maintain -- a fact that Alcoa is hinting at strongly with the word "prudent."
Alcoa's value-add business, by the numbers. Image source: Alcoa.
A recent example of just such a low growth/high growth split up is Hewlett-Packard. The company broke into HP Inc (HPQ 1.55%) with a 4% or so yield and Hewlett-Packard Enterprise Co (HPE 0.59%) with an around 1.5% yield. HP basically kept things like the slow-but-stable printer business and Hewlett-Packard Enterprise got the company's enterprise operations that will, hopefully, provide higher growth. Alcoa's split, though in a different industry completely, is similar.
Is this good or bad?
All of this is definitely good news for dividend investors. Alcoa as it is today offers a miserly yield of around 1.3%. The dividend has been stuck at $0.12 a year for more than five years. Basically, Alcoa isn't much of a dividend story right now. But those five-plus years coincided with the efforts to refocus Alcoa's business -- the very moves that paved the way for 2016's split. Essentially, Alcoa got stronger.
And while the break-up will be the culmination of that effort, it will also be a new day for each company: A time when they can establish new dividend benchmarks and expectations based not on a combined company reworking itself, but their separate business models, financial strengths, and growth prospects.
That means dividend investors will be able to put their money to work in the way that makes the most sense to them. For example, an investor looking for a mix of capital appreciation and income would likely be best served with the value-add business. Someone focused on income alone will probably prefer the upstream company. Both companies, meanwhile, will give you exposure to a key metal and its increasingly important role in society. That's a clear win for dividend investors across the spectrum.
