Alcoa (AA) is one of the world's largest and most important aluminum and specialty parts makers. CEO Klaus Kleinfeld likes to call these two broad divisions Alcoa's "value engines." They are about to go their separate ways, however, and that should have a big impact on the company's (or companies') dividend. But will the dividend be raised in 2016?
Not a dividend play today
Alcoa isn't much of a dividend play today. The payout has been stuck at $0.12 annually for more than five years. That leaves the company with a yield of just 1.3% or so. No dividend growth, below market yield: That's not much of a story to dig your teeth into. But things are about to change.
That's because Alcoa is breaking the company up into an upstream business, which will make aluminum, and a value-add business, which makes things like jet engine parts with aluminum and other metals. This is the culmination of years of work building up the value-add business and trimming down, but strengthening, the upstream business.
Both companies will be large and important in their niches. But, more important to dividend investors, both will have more freedom to make dividend decisions than exists today because the transition period will be over.
Up, down, or sideways
The value-add business will be focused on growth. That's likely to mean a relatively low dividend, if for no other reason than many institutional investors, like insurance companies, won't buy a stock unless it pays a dividend. But growth companies often have low dividends and higher dividend growth rates. So, value-add's dividend might start small, but it could be enticing to growth and income types. I wouldn't be surprised to see value-add come to market with a yield roughly in line with Alcoa's current yield.
The upstream business, which is supposed to keep the Alcoa name, will be in a completely different position. This company will be in a slow-growth business with significant capital needs. However, at this point, Alcoa is saying that upstream will focus on "prudent return of capital to shareholders." That means dividends.
And they're likely to be higher than those paid by the value-add company. But "prudence" means you should expect slow growth, at best, as the company balances often volatile commodity markets against its ability to pay a consistent distribution. And don't look for double digits, either. Other commodity players have such high yields because of the difficult market environment. Upstream will be starting fresh, so it will probably gear toward a more realistic mid-single digits number.
Higher and lower: it's normal
This isn't an odd breakdown at all. Hewlett-Packard just broke into HP Inc (HPQ -0.38%) with a 4% or so yield and Hewlett-Packard Enterprise Co (HPE 0.17%) with a yield around 1.5%. HP Inc kept the slow but stable -- and more capital-intensive -- businesses like printers. Hewlett-Packard Enterprise got the company's enterprise operations that are expected to provide higher, asset-light growth. Sure, HP (pre-split) and Alcoa operate in different industries, but their breakups are similar.
In fact, I wouldn't be surprised to see the dividend yields come out similarly at the end of the day, too. And, along the way, that will mean a dividend hike for any investors who hold on throughout the split. So will Alcoa raise its dividend in 2016? It depends on how you look at it, but, ultimately, the answer is likely to be yes.