I’m looking at some of your favourite FTSE 100 companies and examining how each will deliver their dividends. Today, I’m putting pharmaceuticals firm AstraZeneca (LSE: AZN) (NYSE: AZN.US) under the microscope.
Dividend policy
Let’s track AstraZeneca’s shifting dividend policy from 2008. During 2008 the board reaffirmed its existing policy:
“To grow dividends in line with reported earnings before restructuring and synergy costs, with an aim to maintain at least two times dividend cover”.
The following year, the policy was amended. Where previously the policy had been to “grow” the dividend, the board said it now intended to “maintain or grow” (my emphasis) the dividend.
The policy was amended again when AstraZeneca announced its first-half results for 2012. Where previously the policy had been to “maintain at least two times dividend cover”, the board said the dividend would no longer reflect the financial performance of “a single year taken in isolation”, and that the new target would be “an average dividend cover of 2 times” (my emphasis) over “the entirety of the investment cycle”.
To borrow a phrase from legendary investor Warren Buffett, it looks like a case of management “tempted to shoot the arrow of performance and then paint the bull’s-eye around wherever it lands”.
Implications
Bringing the dividend growth target down to as low as 0% gave the board the option of retaining as much cash as possible within the company without actually cutting the dividend. For 2012 the board held the dividend at the 2011 level, and this year’s first-half dividend, announced last week, has also been held flat. The consensus forecast among City analysts is for no growth in the payout this year or next.
Clearly, management decided that lowering the dividend-payout bar to a maintained dividend was not enough. A change was also needed to the dividend-cover policy in order for the board to be able to say of future dividends that they are in accordance with company policy. If AstraZeneca maintains its dividend at the current level, analyst earnings forecasts suggest dividend cover will fall to 1.9 for 2013 and 1.7 for 2014.
Behind the shifting dividend policy is the fact that the company is in transition between exclusivity losses on some of its bestselling drugs and new product launches.
Falling dividend cover means management is sailing closer to the wind with the dividend … but not so close that the payout is under any threat in the near term: forecasts suggest the company can cope with falling earnings for a few years yet. Furthermore, there’s an emergency generator in place as a result of AstraZeneca’s low net gearing of 10%. There’s scope for the company to borrow money to further support the dividend if necessary.
In summary, management would have to get things very wrong for quite a number of years before earnings and the balance sheet could no longer sustain the dividend.
Finally, I can tell you that one of the UK’s most successful investors has backed AstraZeneca to the hilt. City supremo Neil Woodford has made the company a top holding in his funds with a high-conviction weighting of 9%.
If you’re interested in discovering Woodford’s other big blue-chip bets and gaining a valuable insight into his enormously successful approach to investing, I recommend you download this free Motley Fool report.
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> G A Chester does not own any shares mentioned in this article.