This week’s Safety Net has me in a conundrum.
Typically, when I examine a stock for dividend safety, I look at the financials, take the company’s track record of paying dividends into account and assign a rating.
However, while today’s company’s financials suggest that the dividend is unsustainable, it has a fantastic track record of paying dividends and raising them.
The stock is Aqua America (NYSE: WTR), one of the largest publicly traded water utilities in the U.S. Thanks to B. Ohara for suggesting I look at it this week.
[ad#Google Adsense 336×280-IA]Aqua America serves 3 million people in eight states.
It currently pays a quarterly dividend of $0.165, which is a yield of 2.6%.
The Numbers Don’t Add Up
Aqua America doesn’t have a problem with profits. Net income has gone up each year for at least the past 10 years. It’s cash flow that’s the concern.
Utilities often generate lots of cash flow from operations, but have huge infrastructure costs.
For example, Aqua America generated $368 million in cash flow from operations in 2013, but spent $308 million on capital expenditures (capex). That left the company with just $60 million in free cash flow. During the year, it paid out $103 million in dividends.
In fact, capex have historically been so high that Aqua America’s free cash flow only turned positive in 2011, once cash flow from operations was finally greater than capex (free cash flow is calculated by subtracting capex from cash flow from operations).
Going forward, free cash flow is expected to rise, but still not cover the dividend.
A+ Track Record
On the other hand, Aqua America’s track record as a dividend payer/raiser is excellent.
It has paid a dividend for 69 years in a row and raised it in each of the past 23 years. Its most recent hike was over 8%.
And that’s been pretty consistent over the years. The average for the past three and five years has been an increase of 7.4%, while it’s been 7.9% over the past decade.
One other note about Aqua America’s dividend: If you’re a shareholder and enrolled in its dividend reinvestment plan (DRIP) directly through the company, you can reinvest your dividends at a 5% discount.
That is outstanding and fairly unusual. You’re buying shares at $0.95 on the dollar with your dividends. That means you can buy even more shares with your dividends. This furthers the notion that Aqua America is a shareholder-friendly company.
Believe it or not, it is fairly common for utilities’ free cash flows to not cover the dividend. Southern Company (NYSE: SO) and Consolidated Edison (NYSE: ED) are two more examples. Those companies have raised the dividend for 13 and 40 consecutive years, respectively.
You can see that, like Aqua America, other utilities find a way to keep the dividend intact even when free cash flow isn’t higher than the dividend payments.
I don’t believe there’s much of a risk of Aqua America cutting its dividend. Not with that track record and its commitment to shareholders.
However, I cannot give it my top rating if it does not generate enough free cash flow to pay the dividend.
Dividend Safety Rating: B
— Marc Lichtenfeld
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Source: Wealthy Retirement