Does the drinks giant's dividend pass the grade?
Last year, we began putting some of the FTSE's most popular dividend-paying stocks through the Dividend Report Card in an effort to better measure the health of a company's dividend.
Specifically, we wanted to answer three questions:
1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?
Some companies scored well, whilst others scored poorly. Today, we'll begin giving those companies a fresh look now that they've reported full-year earnings.
Today, we'll size up Diageo (LSE: DGE), which boasts a 3.0% yield. Here's a chart of its dividend per share and yield history over the past decade, ending March 2011.
*Used with permission of Bloomberg Finance LP
|Dividend per share||5.3%|
Data provided by Capital IQ, as of 11May 2011.
As the above chart shows, Diageo has an enviable track record of raising dividends, having boosted payouts each year for well over a decade, but the rolling five-year growth rate has declined from 6.9% in 2006 to 5.3% today.
Past returns don't guarantee future results, however, so dividend history is only 10% of the final grade. That said, for this category, Diageo scores a 3 of 5.
(out of 5)
|EPS payout ratio||52.5%||10%||4|
|FCFE payout ratio||94.6%||30%||2|
Data provided by Capital IQ, as of 11 May 2011.
Though dividend cover remains strong at 1.9 times, Diageo's free cash flow cover has slipped from two times in 2009 to just over one today.
Free cash flow can be volatile, but the main culprits behind the deterioration are higher acquisition outlays and increased working capital investment. Whilst free cash cover could certainly improve this year, it is something for Diageo investors to keep an eye on.
Some Dividend Report Card readers have civilly argued that it isn't right to deduct acquisitions when calculating free cash flow, and that's a fair argument when we're analysing a company doesn't make frequent acquisitions; however, it is a prudent deduction when we're talking about serial acquirers like Diageo, as it is essentially a reinvestment cost and should be counted.
Anyway, even if we didn't include acquisitions, Diageo's dividend cover would have been just 1.3 times.
The interest coverage ratio is still a little lower than I'd prefer, but Diageo has an "A-" credit rating from Standard & Poors and appears to have no problem paying its creditors.
(out of 5)
|EPS payout ratio||52.5%||10%||3|
|FCFE payout ratio||94.6%||20%||2|
|Sustainable growth rate||17.8%||10%||5|
According to Bloomberg, the consensus analyst estimate for Diageo's dividend for the fiscal year 2014 is 52.5p, which would be a 38% increase from fiscal year 2010's 38.1p.
Could that come to pass? Sure, but the combination of low free cash cover and the declining dividend growth trend makes me less-than-confident about Diageo's ability to grow the payout at an expected 8.3% annualised pace in the coming four years.
With all the numbers in, here's how Diageo's dividend scored:
|30%||Free cash flow||2|
|100%||Total Score (out of 5)||2.8|
| ||Final Grade||C|
Diageo's declining DRC score -- from "B+" last July to "B-" in January to "C" today -- leaves me with more questions than answers and more concern than comfort.
There's no question that Diageo has a portfolio of top-notch brand names and a wide economic moat, but a bet on the shares today seems to be a bet that the global economic recovery will continue and that consumers will trade-up to its premium-priced offerings. In my mind, at least, that's anything but a sure bet.
> Todd Wenning is advisor of Motley Fool Dividend Edge. You can follow him on Twitter.
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