The ability to calculate the reliability of dividends is absolutely crucial for investors, not only for evaluating the income generated from your portfolio, but also to avoid a share-price collapse from stocks where payouts are slashed.
There are a variety of ways to judge future dividends, and today I am looking at Wm. Morrison Supermarkets (LSE: MRW) to see whether the firm looks a safe bet to produce dependable payouts.
Forward dividend cover
Forward dividend cover is one of the most simple ways to evaluate future payouts, as the ratio reveals how many times the projected dividend per share is covered by earnings per share. It can be calculated using the following formula:
Forward earnings per share ÷ forward dividend per share
Morrisons is forecast to provide a dividend of 12.8p per share for the year ending January 2014, with earnings per share for this year estimated at 25.8p. This provides dividend cover bang on the security watermark of 2 times prospective earnings.
Free cash flow
Free cash flow is essentially how much cash has been generated after all costs and can often differ from reported profits. Theoretically, a company generating shedloads of cash is in a better position to reward stakeholders with plump dividends. The figure can be calculated by the following calculation:
Operating profit + depreciation & amortisation – tax – capital expenditure – working capital increase
Morrisons posted negative free cash flow of £52m last year, swinging from a positive reading of £220m in the prior 12 months. The company saw operating profit slip to £949m from £973m, while capex also rose to £1.02bn from £901m in 2012. Working capital movements exacerbated last year’s poor readout, too.
Financial gearing
This ratio is used to gauge the level debt a company carries. Simply put, the higher the amount, the more difficult it may be to generate lucrative dividends for shareholders. It can be calculated using the following calculation:
Short- and long-term debts + pension liabilities – cash & cash equivalents
___________________________________________________________ x 100
Shareholder funds
Morrisons saw gearing rise to 37.1% last year, leaping from 23.5% in 2012. The retailer saw net debt rocket to £2.18bn from £1.47bn the previous year due to capex hikes and an acceleration in the firm’s equity retirement programme. In addition, a reduction in shareholders’ funds, to £5.23bn from £5.4bn, worsened the fall.
Buybacks and other spare cash
Here, I’m looking at the amount of cash recently spent on share buybacks, repayments of debt and other activities that suggest the company may in future have more cash to spend on dividends.
Morrisons has pencilled in another annual rise in capital expenditure this year as it seeks to reclaim ground from its rivals. The firm has said that it plans to spend £1.1bn in 2014 for new store openings, development of its IT systems and improve its multi-channel approach.
Elsewhere, the company completed its £1bn multi-year share buyback scheme last year, but has ceased repurchase activity more recently.
Decent near-term prospects but future uncertain
Morrisons has a steady record of annual dividend increases in recent years, moving in line with decent earnings growth. And City analysts expect further payout growth this year despite a projected fall in earnings.
Decent coverage projections make Morrisons an attractive dividend pick for the immediate term. And Morrisons currently boasts a dividend yield of 4.7% for 2014, far in excess of the 3.3% FTSE 100 average
But the other metrics discussed in this article underline the difficulties the supermarket is facing as it continues to lose market share in the British grocery space, a phenomenon which I believe could pressure earnings — and thus dividend growth — further out. The company will have to keep spending big in its bid to catch its main UK rivals.
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> Royston does not own shares in Wm. Morrison Supermarkets. The Motley Fool has recommended shares in Wm. Morrison Supermarkets.
