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 Reckitt Benckiser Group (LSE: RB) (NASDAQOTH: RBGLY.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
Reckitt Benckiser is expected to provide a dividend of 139.2p per share in 2013, with earnings per share for this year forecast to come in at 269.5p. This results in dividend cover of 1.9 times, just below the widely-considered safety benchmark 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
Reckitt Benckiser saw free cash flow come in at £1.86bn in 2012, a chunky increase from £1.59bn in 2011. The company was helped by an increase in operating profit, to £2.57bn from £2.49bn. As well, lower capex and tax costs, and a smaller working capital increase — this rose £157m in 2012 versus £175m in 2011 — helped cash flows improve.
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
Reckitt Bensicker reported a gearing ratio of 32.8% in 2012, up from 28.7% the previous year. The business saw total debt increase to £2.43bn from £1.8bn in 2011, more than offsetting an improvement in pension liabilities and increased cash and cash equivalents — the latter increased to £887m from £639m.
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.
Reckitt Benckiser has been busy on the M&A front in recent times, and most recently announced a collaboration with Bristol-Myers Squibb in February. The deal encompasses several over-the-counter consumer health brands across Latin America, including Brazil and Mexico. The tie-up covers a three-year period and gives Reckitt Benckiser an option to purchase at the end.
Not the right prescription for plump dividends
The metrics above indicate that Reckitt Benckiser is, broadly speaking, in rude financial health which should give income investors peace of mind, at least over the medium term. It also has an excellent record of punching annual full-year dividend increases in recent times.
However, the company only carries a 3% dividend yield for 2013, below the 3.3% average across the rest of the FTSE 100. In my opinion there are a multitude of solid, blue-chip beauties with better dividend prospects that can be found elsewhere.
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> Royston does not own shares in Reckitt Benckiser.