Helmerich & Payne (HP), an oil and gas driller, is feeling the pressures of the bearish energy market. Like many energy companies, it is under pressure to maintain a responsible dividend payout policy.
Helmerich has something that few publicly traded companies have, however, and that is 42 consecutive years of dividend growth. That growth, combined with share price pressures, has created a dividend yield close to 5.5%.
Investors should look at multiple statistics to test the sustainability of a company's dividend. First, and the most obvious, is the payout ratio. Calculated by dividing the dividend per share into earnings per share, the payout ratio indicates the percentage of earnings paid out as dividends. Helmerich's earnings have eroded over the past few quarters, but the payout ratio on a trailing 12-month basis remains under 100%.
Unfortunately, for Helmerich's outlook, analysts have the company struggling to make a profit for all of 2016. Even with a modest recovery, the projections improve to 29 cents per share by the end of 2017. This is far from the current quarterly dividend of 69 cents per share.
The company's payout ratio on a trailing 12-month basis basically will shoot through the 100% threshold within the next couple of quarters and stay there until at least 2018. This places doubt on its ability to maintain its dividend.
An alternative measure of dividend sustainability is examining return on equity. In theory, a company must produce a return on equity equal to its price-to-book ratio multiplied by the dividend yield in order to sustain the dividend. Otherwise, companies would need to dip into equity, and consequently risk their credit ratings in order to support the dividend.
In Helmerich's case, the required return on equity is slightly over 6%. The company's return on equity now is 8.6%, which indicates sustainable return on equity. Based on the above earnings projections, however, return on equity will fall below that threshold over the next couple of quarters. It will then remain there for the next few years. Helmerich will need to determine how much to risk for dividend sustainability.
One area of dividend sustainability that could be classified as the "silver lining" is in Helmerich's free cash flow. After struggling in 2014, Helmerich's free cash flow on a trailing 12-month basis recovered to $294 million. Compared to the projected dividend of $297 million over the next 12 months, Helmerich appears to be close to sustaining its dividend through free cash flow.
Even Helmerich & Payne's 42-year history of dividend growth cannot protect it from the threat of a cut. The energy market is experiencing unbelievable duress and analysts are not comfortable with the company's ability to earn a profit in 2016. Investors should continue to monitor free cash flow as the sole indicator that may be able to keep this dividend juggernaut intact.