Dow’s Cash Flow Increases The Safety Of Its Dividend Yield

On a price return basis, the Safest Dividend Yields Model Portfolio (+4.4%) outperformed the S&P 500 (+3.8%) by 0.6% from June 23, 2022 through July 19, 2022. On a total return basis, the Model Portfolio (+4.8%) outperformed the S&P 500 (+3.8%) by 1.0% over the same time. The best performing large cap stock was up 12% and the best performing small cap stock was up 14%. Overall, nine out of the 20 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from June 23, 2022 through July 19, 2022.

This Model Portfolio only includes stocks that earn an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a uniquely well-screened group of stocks that can help clients outperform.

Since its spin-off from Dupont De Nemours Inc. (DD) in 2019, Dow has grown revenue by 13% compounded annually and net operating profit after-tax (NOPAT) by 65% compounded annually. Dow’s NOPAT margin rose from 6% in 2019 to 13% over the trailing twelve months (TTM), while invested capital turns improved from 0.7 to 1.1 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 4% in 2019 to 14% TTM.

Figure 1: Dow’s Revenue and NOPAT Since 2019

Dow has increased its regular dividend from $2.10/share in 2019 to $2.80/share in 2021. The current quarterly dividend, when annualized, provides a 5.5% dividend yield.

Dow’s free cash flow (FCF) comfortably exceeds its regular dividend payments. From 2019 to 2021, Dow generated $16.0 billion (43% of current market cap) in FCF while paying $5.7 billion in dividends. Over the TTM, Dow has generated $6 billion in FCF and paid $2 billion in dividends. See Figure 2.

Figure 2: Dow’s FCF vs. Regular Dividends Since 2019

Companies with strong FCF provide higher quality dividend yields because the firm has the cash to support its dividend. Dividends from companies with low or negative FCF cannot be trusted as much because the company may not be able to sustain paying dividends.

DOW Is Undervalued

At its current price of $52/share, DOW has a price-to-economic book value (PEBV) ratio of 0.3. This ratio means the market expects Dow’s NOPAT to permanently decline by 70%. This expectation seems overly pessimistic given that Dow grew NOPAT by 65% compounded annually since 2019.

Even if Dow’s NOPAT margin falls to 9% (vs. 13% over the TTM) and the company’s NOPAT falls 5% compounded annually over the next decade, the stock would be worth $75+/share today – a 44% upside. See the math behind this reverse DCF scenario. Should the company’s NOPAT not fall at such a steep rate, or even grow from current levels, the stock has even more upside.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Dow’s 10-K and 10-Qs:

Income Statement: I made $3.1 billion in adjustments with a net effect of removing $930 million in non-operating expenses (2% of revenue).

Balance Sheet: I made $16.6 billion in adjustments to calculate invested capital with a net increase of $11.3 billion. The most notable adjustment was $9.0 billion (18% of reported net assets) in other comprehensive income.

Valuation: I made $24.1 billion in adjustments with a net effect of decreasing shareholder value by $19.8 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $6.1 billion in underfunded pensions. This adjustment represents 16% of Dow’s market value.

Disclosure: David Trainer, Kyle Guske II, Matt Shuler, and Brian Pellegrini receive no compensation to write about any specific stock, style, or theme.

David Trainer

New Constructs leverages reliable fundamental data to provide unconflicted insights into the fundamentals and valuation of private and public businesses.

Source: Dow’s Cash Flow Increases The Safety Of Its Dividend Yield

Critics by Macrotrends

Dow annual/quarterly free cash flow history and growth rate from 2017 to 2022. Free cash flow can be defined as a measure of financial performance calculated as operating cash flow minus capital expenditures.

Dow free cash flow for the quarter ending June 30, 2022 was 2,607.00, a year-over-year.
Dow free cash flow for the twelve months ending June 30, 2022 was , a year-over-year.
Dow annual free cash flow for 2021 was $4.79B, a 18.72% decline from 2020.
Dow annual free cash flow for 2020 was $5.893B, a 48.51% increase from 2019.
Dow annual free cash flow for 2019 was $3.968B, a 91.69% increase from 2018.

Dow annual/quarterly revenue history and growth rate from 2017 to 2022. Revenue can be defined as the amount of money a company receives from its customers in exchange for the sales of goods or services. Revenue is the top line item on an income statement from which all costs and expenses are subtracted to arrive at net income.

Dow revenue for the quarter ending June 30, 2022 was $15.664B, a 12.81% increase year-over-year.
Dow revenue for the twelve months ending June 30, 2022 was $60.129B, a 30.19% increase year-over-year.
Dow annual revenue for 2021 was $54.968B, a 42.62% increase from 2020.
Dow annual revenue for 2020 was $38.542B, a 10.27% decline from 2019.
Dow annual revenue for 2019 was $42.951B, a 13.41% decline from 2018.

Current and historical gross margin, operating margin and net profit margin for Dow (DOW) over the last 10 years. Profit margin can be defined as the percentage of revenue that a company retains as income after the deduction of expenses. Dow net profit margin as of June 30, 2022 is 11.06%.

Current and historical p/e ratio for Dow (DOW) from 2017 to 2022. The price to earnings ratio is calculated by taking the latest closing price and dividing it by the most recent earnings per share (EPS) number. The PE ratio is a simple way to assess whether a stock is over or under valued and is the most widely used valuation measure. Dow PE ratio as of August 03, 2022 is 5.40.

Current and historical current ratio for Dow (DOW) from 2017 to 2022. Current ratio can be defined as a liquidity ratio that measures a company’s ability to pay short-term obligations. Dow current ratio for the three months ending June 30, 2022 was 1.64.

Historical dividend payout and yield for Dow (DOW) since 2021. The current TTM dividend payout for Dow (DOW) as of August 03, 2022 is $2.80. The current dividend yield for Dow as of August 03, 2022 is 5.43%.