Debt and Dividends Can Co-Exist. Here Are 5 Stocks That Shouldn’t Wilt.

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Although a heavy debt load can sometimes crimp or preclude a company’s dividend payout, the recent stretch of historically low borrowing costs should give equity income investors some comfort when considering a number of highly indebted companies.

That’s among the observations of a recent research report on dividends that examines how companies have been managing their balance sheets in recent years.

While interest rates have moved up recently as the Federal Reserve continues its tightening regimen, ratcheting up corporate borrowing costs, “many firms have improved their capital structure in the past two years, softening the blow of higher rates,” concludes the report written by Ian VanderHorn, principal research analyst at S&P Global Market Intelligence. The recent spike in rates notwithstanding, many companies took advantage of ultralow interest rates in recent years by refinancing their debt or even paying it down.

Take the energy sector. The average ratio of net debt to earnings before interest, taxes, depreciation, and amortization, or Ebitda, for S&P 500 energy companies dropped to 1.8 last year from 6.6 in 2020, he points out.

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“Rather than refinancing, energy producers are in the fortunate position of being able to pay down debt in large swaths,” the report says. And that has helped their dividends considerably—along with rising oil and gas prices.

Another positive development for dividends, at least for now, is that many companies have pushed out their principal debt payments, providing more breathing room, “since less cash is needed in the short term,” the report notes.

The report lists about 60 companies that have big debt loads but still pay a dividend. They include utility

Southern

(ticker: SO), which recently yielded 3.6%;

Ford Motor

(F), 2.9%;

Deere

(DE), 1.3%;

Domino’s Pizza

(DPZ), 1.1%; and

MetLife

(MET), 3%. All have net debt to Ebitda ratios of at least five, according to the report.

One thing that some of these companies have going for them, however, is relatively low dividend payout ratios—that is, the percentage of earnings paid out in dividends. “If you are paying out a low percentage of your earnings, you’re only consuming a low percentage of your cash,” VanderHorn tells Barron’s. “There’s more flexibility.”

Deere paid out $3.32 a share in dividends in its previous fiscal year, which ended in October, on earnings of $18.99 a share, for a payout ratio of under 20%. Ford reinstated its quarterly dividend last fall after a pandemic pause. But if its quarterly disbursement of 10 cents a share is annualized, that would be 40 cents on

FactSet
’s
projected 2022 earnings estimate of $1.93 on an adjusted basis, for a payout ratio of less than 10%.

For contrast, the S&P 500’s dividend payout ratio was 29% at the end of December, according to S&P Dow Jones Indices.

VanderHorn points out, however, that some sectors have much higher payout ratios by design. That includes utilities and real estate, whose payout ratios in the S&P 500 were 97.2% and 87.2%, respectively, as of Dec. 31. REITs are required to distribute at least 90% of their taxable income to shareholders. Utility stocks are often coveted more for their income than their capital appreciation, and investors typically expect reasonable dividend payouts.

In sum, a company’s debt load is something an investor should examine, but it’s not necessarily a deal breaker for the dividend, especially since many companies have lowered their borrowing costs.

“As long as they have enough cash flow to cover debt-servicing without overburdening other capital-allocation priorities,” says VanderHorn, “the dividend should be sustainable.”

Write to Lawrence C. Strauss at [email protected]