Surging cash pile is set to boost this 5% yield

Shares of specialist chemical group Elementis (LSE: ELM) rose by 9% this morning, after management said that rising net cash would boost this year’s special dividend payment.

In this article I’ll ask how today’s news will affect this year’s dividend payout, and whether Elementis is still a buy after recent gains. I’ll also consider the group’s larger peer, Croda International (LSE: CRDA). Are further gains likely for this highly-valued FTSE 100 stock?

Show me the money!

In today’s third-quarter update, Elementis said that net cash is expected to be above last year’s level of $74m at the end of this year. The company has a policy of paying a special dividend equal to 50% of net cash each year, which means this year’s special payout should be more than 8 cents per share.

In addition to this, Elementis pays an ordinary dividend, based on one-third of adjusted earnings per share. This year’s interim payout was left unchanged at 2.7 cents, which suggests to me that the final dividend may also be unchanged.

My calculations suggest that this year’s total dividend will be a minimum of 16.5 cents. That’s equivalent to around 13.5p per share, which would give a yield of 5.8% after today’s 9% rise.

The company didn’t specify how much further net cash is expected to rise this year, so it’s hard to be too precise. But the firm’s strong cash generation is encouraging, given that earnings are expected to be broadly flat this year.

Elementis currently trades on a forecast P/E of 15.9. That seems reasonably full, but I think that the group’s solid profit margins and strong cash generation make the current price an acceptable entry point for long-term investors.

Could Croda smash growth forecasts?

Shares of Croda International have risen by 16% over the last year. A large part of this growth is the result of the devaluation of the pound that followed the referendum — only a small portion of Croda’s sales are in the UK.

Growth forecasts for Croda are slightly stronger than for Elementis. Its adjusted earnings per share are expected to rise by about 8% this year and by 7% in 2017. But in my view this more positive outlook is offset by Croda’s much steeper valuation.

The shares currently trade on a forecast P/E of 23 for 2016, falling to 21 in 2017. A yield of about 2.3% is expected in both years. Although Croda paid a special dividend of 100p per share in June this year, this was paid with spare debt capacity, not surplus cash.

Croda does generate plenty of cash, but believes it’s more efficient to maintain a moderate level of gearing. This gratuitous use of debt makes me slightly uneasy, but in fairness Croda’s high level of profitability should mean that the risks are fairly low.

The group’s operating margin has averaged almost 24% over the last five years, while return on capital employed has averaged 28%. These are impressive figures that few other companies can match.

Croda’s valuation may be justified by its strong performance, but I’m conscious that exchange rate fluctuations can rapidly reverse. I’d rather pay a little less for this stock, in order to enjoy more downside protection.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Elementis. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.