Home Depot Dividend – Slowing Or Growing?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Home Depot (NYSE: HD) and its orange signs are nearly ubiquitous in the U.S. It's rare to go into any town that has a decent size population, and not see either a Home Depot or a Lowe's (NYSE: LOW). The company used to be a huge growth stock, but as it has matured, the company has been giving back more of their profits to shareholders in the form of dividends. For a long time Home Depot's dividend was a token payout that didn't add much to shareholder's income. Today the company's dividend yield is just over 2.4%, and can be considered as a decent payout in light of savings and CD rates. Can Home Depot afford these higher payouts of the last few years? What type of dividend growth can investors expect in the future? Let's get answers to these important questions.
When it comes to the company's current payout. It makes sense to look at what percentage of free cash flow the company is using to cover the dividend. Look at the last three years and you can see the company is covering the dividend very well.
In 2011 the payout ratio jumped, but so far the ratio has dropped in 2012 to the lowest in the last three years at just 30%. This is a positive for investors for two reasons. First, the company is easily able to pay its current dividend. Second, the company has plenty of room to increase its payout even if cash flow showed no growth at all.
How has the company grown dividends in the past? Look at the following and I think you can see the same pattern I do:
You can see from 2004 – 2007 the company increased their dividend by an average of almost 40% per year. However, when the Great Recession hit, Home Depot chose to not increase the dividend at all in 2008 or 2009. As the economy started to turn around, the company gingerly increased the dividend in 2010 and 2011 by over 5%. Then in 2012 the company returned to a more normalized increase by raising the payout 16%.
So what should investors expect in the future? I think looking at the company's competitor Lowe's is instructive. Lowe's only pays out about 25% of their free cash flow, and is expected to grow earnings by 15% going forward. Home Depot pays about 30% and is also expected to grow earnings by nearly 15%. I've said before that Lowe's should be able to increase their dividend by 12-18%. That is because Lowe's cash flow growth has been outpacing net income growth. With Home Depot, while their earnings increased on average 15.3% in the last three years, their operating cash flow increased by about 10%. If this trend were to continue, the company's near 15% EPS growth would produce a similar 10% operating cash flow growth. With 10% growth in cash flow, I would feel comfortable expecting 10-15% dividend increases by Home Depot going forward. The difference between the two companies is Lowe's carries about a 43% debt-to-equity ratio versus Home Depot's ratio is about 60%. This higher debt means more of Home Depot's cash has to go to interest payments. While Home Depot shoppers get “More Saving, More Doing”, investors get more income, more returns.
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