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 Banco Santander (LSE: BNC) (NYSE: SAN.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
For 2013, City analysts expect Banco Santander to provide a dividend of 59.7 euro cents per share, with earnings per share of 46.6 euro cents also predicted for this period. This results in dividend cover of 0.8 times prospective times, effectively a negative reading and well below the broadly classified safety mark 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
Banco Santander recorded free cash flow of €5.06bn in 2012, down from €8.71bn in the previous year. A meaty collapse in operating profit, to €3.17bn from €8.12bn, was the main driver behind the deterioration. However, a reduction in tax costs, to €291m from €1.49bn in 2011, helped to limit the fall.
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
The bank recorded a negative gearing ratio of 237.8% in 2012, an improvement from a negative reading of 205% in the previous year. The most notable factor was a rise in cash and cash equivalents, which increased to €210.8bn from €183.1bn. Meanwhile, shareholder funds edged higher during the period, to €81.8bn from €80.9bn.
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.
Under Basel III capital requirement rules, Banco Santander is in a particularly strong position compared with many of its rivals in the banking sector. Indeed, the bank announced in April’s interims that it expects core capital to come in at 12% under the new standard by the end of the year, comfortably within the legislative bracket due for introduction next year.
A yield too good to pass up?
Banco Santander currently boasts a dividend yield of 11.9% in 2013, a mammoth prospect when compared to the 3.3% FTSE 100 average and 4% projection for the wider banking sector. The company has kept the full-year dividend on hold since 2009, but analysts expect a mammoth earnings snapback this year to herald a rise in the payout.
The bank’s strong cash position and gearing situation makes it a great pick for income investors, in my opinion, even if dividend cover registers under par. The possibility of further economic turmoil in Europe, especially in Spain, could potentially dent earnings expectations in the medium term. But I believe that the firm’s operational improvements since the 2008/2009 banking crisis, allied to its heavy exposure to lucrative Latin America, should keep earnings moving steadily higher.
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> Royston does not own shares in Banco Santander.
