Deere & Co.’s (NYSE: DE) history is impressive. What started as a blacksmith shop in 1837 has grown into one of the world’s largest farm and construction equipment companies, generating more than $26 billion a year in sales.
The company began paying a dividend in 1972.[ad#Google Adsense 336×280-IA]The early dividend-paying days were rocky.
There were 14 raises and five drastic cuts between 1972 and 1988.
But since raising its payout in December 1988, the company has been consistent.
It’s boosted the dividend 18 times with no reductions.
While the company hasn’t raised its dividend every year, the compound annual growth rate over the past 28 years is an impressive 9.3%.
Its last dividend increase was in June 2014.
Is another increase coming, or is Deere’s first cut in nearly three decades more likely?
Will Cash Flow Cover the Dividend?
The company’s capital expenditures (“capex”) have been steadily rising since 2011.
Capex is the money spent to acquire or upgrade assets that increase the company’s long-term value and productivity. Oftentimes, they’re investments in things like land, buildings or expensive equipment.
When capex increases, it reduces the amount of free cash flow. That means there’s less money available to pay dividends, buy back shares, reinvest in the business or save for later.
This year, capex is expected to drop dramatically, to just $650 million, which will increase cash flow.
Over the past 12 months, the company generated $742 million in free cash flow, and it paid $771 million in dividends
That’s not good. It means the company is not generating enough cash to pay its dividend. It has to dip into cash on hand to pay shareholders the $0.60 per share quarterly dividend that they have come to expect.
For the past three years, the company’s cash flow covered the dividends, but not by much.
It used 90% of its free cash flow to pay dividends last year. That’s the same payout ratio we saw in 2014.
The payout ratio is the percentage of earnings or cash flow (I use cash flow) that’s paid out in dividends.
But a 90% payout ratio is too high. It doesn’t leave much room for error, as we’ve seen the past four quarters. Deere has had to use existing cash to pay its dividend.
I like to see a payout ratio of 75% or lower to feel comfortable that the dividend is safe even if the company hits a rough patch.
Next year shouldn’t be a problem, though. Its free cash flow is forecast to rise to $1.3 billion.
If dividends paid stay at around $750 million, that brings the 2017 payout ratio down to a reasonable 58%.
At that point, I wouldn’t be surprised to see a dividend raise – especially if management is confident that free cash flow will continue to climb in the coming years.
We’ll want to keep a close eye on Deere to make sure free cash flow is strong enough to comfortably pay the dividend.
If capex rises or free cash flow declines for some other reason, the dividend could be in jeopardy.
But as long as capex stays under $1 billion as forecast, the dividend should be safe.
Dividend Safety Rating: A
— Marc Lichtenfeld[ad#wyatt-income]
Source: Wealthy Retirement