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 Aviva (LSE: AV) (NYSE: AV.US) 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
Aviva is expected to provide a dividend of 16.1p per share in 2013, according to City boffins, with earnings per share of 41.4p anticipated for this period. This culminates in dividend cover of 2.6 times projected earnings, comfortably above the security threshold of 2 times.
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
Aviva recorded free cash flow of £1.3bn in 2012, down from £1.86bn in the previous year. A severe drop in operating profit was the main single contributor — down to £2.13bn from £2.5bn in 2011 — although an increase in capex costs, to £377m from £214m, also prompted the reduction.
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
Aviva holds reported a net negative gearing ratio of 213.9% in 2012. This compares with a negative reading of 154.7% in 2011. Total debt rose to £659m from £648m in the previous year, and although cash and cash equivalents remained substantial, this edged down to £22.9bn from £23.04bn. Instead, a change in shareholder equity, to £9.79bn from £13.83bn, helped the measure to improve on an annual basis.
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.
The company is undertaking a massive drive to cut costs and reduce debt, streamlining the business and disposing of underperforming assets to improve cashflows and underpin future growth. Clearly, therefore, expectations of share repurchases and massive capex programmes are firmly off the agenda.
An unattractive income pick for all but the brave
Despite decent dividend coverage, I believe that Aviva remains an exceptionally risky pick for investors seeking juicy income from their stocks portfolio. The company slashed the full-year payout to 19p last year from 26p in 2011, rebasing the payout to cut leverage and boost retained earnings.
City brokers expect the payout to fall again this year, and I believe that the company’s turnaround programme will require some time to bed in, a situation that could continue to pressure shareholder payouts beyond 2013.
A dividend of yield of 4.5% for this year versus the 3.3% prospective FTSE 100 average makes it a classic high-risk, high-reward play for income investors, although I do not think this divergence is currently meaty enough to warrant the risk.
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> Royston does not own shares in Aviva.
