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 AstraZeneca (LSE: AZN) (NYSE: AZN.US) to see whether the firm looks a safe bet to produce dependable payouts.
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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
City analysts expect AstraZeneca to produce a dividend of 181.3p in 2013, while earnings per share for this year are predicted to come in at 336.7p. This provides dividend cover of 1.9 times forward earnings, 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
The pharmaceutical giant saw free cash flow dip to $2.07bn in 2012, down substantially from $7.83bn in 2011. The company suffered from a large dip in operating profit — to $8.15bn from $12.8bn — as patent expiries whacked revenues. Additionally, a massive hike in capex outlay, to $5.85bn from $2.62bn, also weighed on cash flow. This still outweighed a near-halving in tax costs, to $2.04bn from $4bn.
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
AstraZeneca’s gearing ratio registered at 20.3% in 2012, up from 18.9% in 2011. The company saw debts rise to $10.31bn from $9.33bn in the prior 12-month period, although pension liabilities and cash and cash equivalents did improve — the latter increased to $7.7bn from $7.57bn. Still, an increase in shareholders’ equity, to $23.95bn from $23.47bn, helped stymie the gearing increase.
Buybacks and other spare cash
AstraZeneca has pledged to chuck vast amounts of capital into research and development in order to mitigate the rolling problem of patent expirations across its key products. The company announced in March its strategy to introduce innovation centres in the UK, Sweden and the US in order to bolster its product pipeline, although work is not expected to be completed until 2016.
In the meantime, the company remains hot in the M&A front, and last week announced that it had bought out New Jersey-based Omthera Pharmaceuticals, which develops therapies for abnormal lipid levels in the blood, for around $323m. This follows the purchase of Pearl Therapeutics late last month, which produces therapies for respiratory diseases. This deal could cost AstraZeneca as much as $1.15bn.
Big rewards but the risks are high…
AstraZeneca currently carries a dividend yield of 5.5% for 2013, far ahead of the prospective 3.3% FTSE 100 average. Although this clearly provides great opportunities to generate juicy dividend income, investors should be aware that the possibility of further earnings pressure could put the stops on future dividend growth.
Indeed, the pharma play kept last year’s full-year dividend on hold at 280 US cents as earnings took a 12% dive. I believe that the effect of eroding patent protection, coupled with the long wait times for its new R&D strategy to recharge its product pipeline, on the firm’s balance sheet could damage the dividend prospects moving forwards.
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> Royston does not own shares in AstraZeneca.