This Chemical Company Offers a Great Dividend
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Dow Chemical (NYSE: DOW) paid its first dividend in 1900. Now, 112 years later, the company continues to pay its dividend year in and year out. Dow has become one of the world's largest chemical and materials companies, recording close to $60 billion in sales in 2011. After a dividend increase earlier this year Dow now sports a dividend yield of 4.24%, well above the S&P average. Let's take a closer look at the dividend and determine if Dow Chemical is a value.
Up until 2009 Dow Chemical had either raised or held steady its dividend payment every year since 1900. The financial crisis, however, caused Dow to dramatically cut its dividend as the stock price plummeted.
As the stock price dropped to under $10 per share the quarterly dividend was cut by 64%. Since then it has been increased twice, but is still less than the pre-recession levels. Here is the 10-year dividend history for Dow Chemical.
Since the dividend cuts the company has increased the dividend substantially, but it still sits well below the peak in 2008. Because of this we may see fairly high dividend growth for the next few years until it gets closer to pre-recession highs.
|Year||Free cash flow||Payout Ratio|
Being in a cyclical industry Dow's free cash flow is volatile. This leads to fluctuating payout ratios, so a single year doesn't tell you much. In 2011 the payout ratio was high at 79.72%, but the TTM free cash flow is $1,949 million resulting in a TTM payout ratio of 64%. Because of this I don't think that the payout ratio is too high, especially since demand is still recovering from the recession. The company also has $4.1 billion in cash on the books, further supporting the dividend.
Three companies which Dow Chemical competes with are DuPont (NYSE: DD), BASF, and Cabot (NYSE: CBT). All three pay dividends, but none are as impressive as Dow. Here is the dividend comparison for the four companies.
Comparing growth rates is difficult because of the volatility, but on yield Dow Chemical blows the competitors away. The closest dividend competitor, DuPont, has seen extremely slow dividend growth. Over the last decade DuPont's dividend has grown a total of 22%, from a quarterly payment of $0.35 to $0.43. So it's safe to say that Dow offers a superior dividend to DuPont on both yield and growth.
In order to estimate the fair value of Dow Chemical I will use the dividend discount model. This model assumes that the value of a stock is solely the value of all future dividend payments discounted back to today. This is a reasonable valuation method for a dividend investor who is interested mainly in building an income stream from dividends. I will use a discount rate of 8%, which is roughly the long term growth rate of the market as a whole. For Dow, since the dividend is still recovering from the massive cuts of the recession and the growth rate has been 30-40% in the last two years I will employ a three stage model. For the first three years I'll set dividend growth to 10%. This puts the dividend in three years still well short of the peak level of 2008. Then, for the next 7 years I'll set the dividend growth to 5%. After this 10 year period I'll set the perpetual growth rate to 3%. These seem like conservative values. Using these parameters I arrive at a fair value of $31.47.
The Bottom Line
Dow Chemical currently trades at $30.22, a little less than my fair value estimate. Obviously, predicting dividend growth rates is difficult given the fluctuations over the past few years, but the values I've chosen seem fairly conservative. Given the 4.24% yield Dow Chemical offers an attractive dividend for the dividend-focused investor.
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