Does the consumer goods company's dividend pass the test?
In the dividend report card series, we analyse financial metrics to begin answering the following questions about a company's dividend:
1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?
For a full explanation of each category, click here for a tutorial.
Today's pupil is Reckitt Benckiser Group (LSE: RB) which has a prospective 3.4% yield, according to Company REFS.
Dividend history
Source: Capital IQ, as of September 7, 2010.
There's no doubt that Reckitt Benckiser's dividend growth rate has been impressive and its doubly encouraging that it's kept pace with earnings per share growth, which is exactly what you want to see. For those reasons, it scores at 5 of 5 in this category.
Sustainability
| Metric | Trailing
12 Months | Final Grade
Weighting | Report Card
Score
(out of 5) |
|---|
| Interest cover | 512 times | 10% | 5 |
| EPS payout ratio | 46.8% | 10% | 5 |
| FCFE payout ratio | 47.3% | 30% | 5 |
Source: Capital IQ, as of September 7. 2010.
That interest cover figure isn't a typo -- Reckitt Benckiser generates £512 in operating profit for every £1 it pays in interest expense and has no long-term debt on its books. Add its £653 million cash balance to the mix, and you have a high quality balance sheet that should help sustain the dividend.
The recent £2.5 billion acquisition offer for SSL International (LSE: SSL) will certainly cost a nice chunk of change, but if history is any guide, the company will quickly pay down any debt it may take on from the acquisition. Maynard Paton, Motley Fool Champion Shares PRO advisor, reminded investors of this corporate practice in a recent note: "Between 2006 and 2008, the group spent £3bn on two major acquisitions and all the associated borrowings were paid off by the end of 2009."
Considering the strong balance sheet and adequate earnings and free cash flow cover, Reckitt Benckiser's current dividend looks quite sustainable.
Growth
| Metric | Trailing
12 Months | Final Grade
Weighting | Report Card
Score
(out of 5) |
|---|
| EPS payout ratio | 46.8% | 10% | 4 |
| FCFE payout ratio | 47.3% | 20% | 4 |
| Sustainable growth rate | 21.2% | 10% | 5 |
Reckitt Benckiser has all the makings of a great dividend-growth share with payout ratios consistently below 50% and high returns on equity (the five year average is 39.5%).
But investors should also be mindful that the company is actually returning less overall value to shareholders today than in it did in 2008 because of the suspended share repurchase programme.
In 2008, for instance, Reckitt Benckiser repurchased a net £237 million worth of shares and paid £441 million in cash dividends, for a total £678 million returned to shareholders. In the past twelve months, however, the company has issued £154 million in shares (i.e. shareholder dilution) and paid out £718 million in cash dividends, resulting in a net return of just £564 million.
Sure, I'd prefer a dividend to share repurchases any day, but I also don't want to be concerned that the dividend growth is being fueled by a reduction in shareholder returns somewhere else along the line. At this point, that's not completely clear, so I'll be keeping my eye on this facet of Reckitt Benckiser's business in the coming quarters.
Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against its direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.
| Company | Dividend
Yield* |
|---|
| Procter & Gamble (US) | 3.2% |
| Colgate-Palmolive (US) | 2.8% |
| Unilever (LSE: ULVR) | 3.0% |
* All trailing yields
Reckitt Benckiser's 3.2% trailing yield is right in-line with its major global competitors, so there should be little internal or external pressure to change the company's approach to dividends.
Pencils down!
With all the numbers in, here's how Reckitt Benckiser's dividend scored:
| Weighting | Category | Final Grade |
|---|
| 10% | History | 5 |
| | Sustainability | |
| 10% | Interest Cover | 5 |
| 10% | EPS Payout Ratio | 5 |
| 30% | FCFE Payout Ratio | 5 |
| | Growth | |
| 10% | EPS Payout Ratio | 4 |
| 20% | FCFE Payout Ratio | 4 |
| 10% | Sustainable growth | 5 |
| 100% | Total Score (Out of 5) | 4.7 |
| | Final Grade | A |
There's a lot to like about Reckitt Benckiser's dividend -- it's well covered by profits and free cash flow and is backed by a nearly immaculate balance sheet. Its 3.2% trailing yield isn't much above the FTSE 100 average of 3%, but the potential payout growth is what makes Reckitt Benckiser's dividend attractive.
Read more dividend report cards:
> Todd owns shares of Procter & Gamble.
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