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 Unilever (LSE: ULVR) (NYSE: UL.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
Unilever is expected to provide a dividend of 88.8p per share in 2013, according to City numbers, with earnings per share predicted to register at 139.1p. The widely-regarded safety benchmark for dividend cover is set at 2 times prospective earnings, but Unilever falls short of this measure at 1.6 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
Free cash flow increased to €5.14bn in 2012, up from €3.69bn in 2011. This was mainly helped by an upswing in operating profit — this advanced to €7bn last year from ?6.43bn in 2011 — and a vast improvement in working capital.
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
Unilever’s gearing ratio for 2012 came in at 56.6%, down from 59.5% in the previous 12 months. The firm was helped by a decline in net debt, to €7.36bn from €8.78bn, even though pension liabilities edged higher. Even a large decline in cash and cash equivalents, to €2.47bn from €3.48bn, failed to derail the year-on-year improvement.
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.
Unilever does not currently operate a share repurchase programme, although it remains open to committing capital to expand its operations around the globe. Indeed, the company is attempting to ratchet onto excellent growth in developing regions as consumer spending in the West stagnates — the firm saw emerging market sales rise 10.4% in quarter one versus a 1.9% fall in developed regions.
The firm remains dogged in its attempts to acquire a 75% stake in India’s Hindustan Unilever, for example, and I expect further activity to materialise in the near future. Meanwhile, Unilever is looking to reduce its exposure to stagnating markets by divesting assets, exemplified by the recent sale of its US frozen foods business.
An appetising long-term pick
Unilever’s projected dividend yield for 2013 is bang in line with the FTSE 100 average of 3.3%. So for those seeking above-par dividend returns for the near-term, better prospects can be found elsewhere. Still, the above metrics suggest that the firm’s financial position is solid enough to support continued annual dividend growth.
And I believe that Unilever is in a strong position to grow earnings strongly, and with it shareholder payouts, further out. Galloping trade in developing markets, helped by the strength of its brands — the company currently boasts 14 ‘€1 billion brands‘ across the consumer goods and food sectors — should significantly bolster sales growth and thus dividend potential in my opinion.
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> Royston does not own shares in Unilever. The Motley Fool has recommended shares in Unilever.