Is Doubling the Dividend Enough?

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Last week, Ford (NYSE: F) doubled its dividend. This comes from a company which, only a few years ago, was forced to suspend its dividend payments entirely. Facing declining revenue and unprecedented competition from foreign automakers, Ford had no other choice. Then the financial crisis hit, raising fears that Ford could very well face bankruptcy. But Ford survived, re-initiating its dividend in 2012 at $0.20 per share. This was a strong signal that Ford was back on its feat, a signal which was amplified by the 100% dividend increase last week. But is the dividend, now yielding 2.82%, enough to draw investors back to a company which came so dangerously close to failing?   

How Ford came back from the dead

Ford has the distinction of being the only US auto company to refuse a government bailout during the financial crisis. Detroit neighbor General Motors (NYSE: GM) was bailed out by the US and Canadian governments and reemerged as the "new GM," although detractors started calling it "Government Motors" instead. GM is now back on its feet, but has yet to start paying a dividend. The bailout created a stigma around GM, giving Ford a distinct advantage.

Foreign competitors like Toyota also suffered due to the financial crisis but not nearly to the same degree. The tsunami in Japan in 2011 greatly affected supply chains for Asian car manufacturers, thus allowing the US auto industry to recover with greatly reduced competition.

Ford took on a huge amount of debt before the crisis, resulting in enormous interest payments. This allowed the company the liquidity it needed to survive, but much of the profits went to servicing the debt. Ford has greatly improved its balance sheet since then, freeing money up for the dividend.

The big question now is: How fast can Ford grow the dividend? Ford has said that

"Ford's plan is to grow its dividend, consistent with earnings and liquidity growth, to a level that is sustainable through all business cycles."

This is a vague statement, but I expect it to mean that Ford won't be paying out 60%+ of earnings anytime soon.

Payout ratio

How much of Ford's free cash flow is being paid out in dividends? In 2011 Ford recorded $5.49 billion in FCF. The company is a little behind the pace through three quarters of 2012, but let's assume they do somewhere around $5.5 billion in FCF. The new dividend of $0.40 per share will result in a total annual payout of about $1.58 billion. This puts the payout ratio around 28.7%.

The good news is that this is a fairly low payout ratio. The bad news is that I don't think Ford will be increasing it very soon. The dividend will grow with earnings, and that'll be the main source of growth. The company, as can be seen from their quote above, wants to keep the dividend at a level which can be sustained through the good times and the bad. They want to avoid having to cut the dividend like they did in 2006. And given that interest expense still eats up about $4 billion per year, debt reduction should be their main concern.

Is it still a good dividend stock?

Even with the growth prospects at a minimum, a 2.82% yield is nothing to sneeze at. How fast does the dividend need to grow to justify the current share price? To answer this question I'll use the dividend discount model. This method values the company as the sum of all future dividend payments discounted back to today. I'll use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I'll assume that after ten years growth slows to 3% per year in perpetuity. By plugging in the current share price I arrive at a 10-year dividend growth rate of 9.55%.

I don't think that Ford will grow its dividend this quickly. The average analyst estimate for earnings growth going forward is 7.45%, meaning that some dividend growth would have to come by raising the payout ratio.

The bottom line

I'm not saying that Ford isn't a good investment. But it is not a good dividend stock, and is unlikely to be one for quite some time. If you're a dividend-focused investor I would stay away from Ford. The growth is just not there.

TheBargainBin has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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