SunCoke Energy (NYSE: SXC) is the largest independent supplier of coke in North America. Before you start getting mental images from Scarface, remember, coke is a material that’s made from coal and used to make steel.
SunCoke Energy announced today that it will release earnings on November 1. I’ll be looking at the numbers carefully to see how they’ll affect the company’s Safety Net rating.
After rising steadily for a couple of years, SunCoke Energy’s free cash flow topped out in 2021. It dipped ever so slightly last year – from $134.5 million to $133.4 million. This year, however, free cash flow is projected to drop to $119 million.
The Safety Net model has a big problem with declining cash flow. Like most airplane seats, Safety Net allows no wiggle room. If free cash flow declines by a dollar, the stock gets downgraded.
However, SunCoke Energy has raised its dividend in each of the past two years, including a big 25% raise in August. The current quarterly dividend of $0.10 per share equates to an annual yield of 4.1%.
And fortunately, despite its declining cash flow, the company has plenty of cash to pay its dividend.
Its payout ratio (the percentage of free cash flow that is paid out in dividends) was a very low 18% last year, and that figure is forecast to remain the same this year.
I like to see a payout ratio of 75% or lower. That gives me confidence that the company can sustain its dividend going forward.
If free cash flow stays the same in 2024, the payout ratio would be a still-low 28% – even with the company paying the new $0.10 dividend for all four quarters rather than just two (as is the case this year).
Clearly, there is reason for both concern and optimism here.
But I haven’t mentioned another glaring mark on SunCoke Energy’s record that could be the kiss of death for its dividend safety: In 2016, it eliminated its dividend entirely, and it didn’t start it up again until 2019.
That’s not a good sign at all.
Now, SunCoke Energy does have a pretty good track record of beating analysts’ earnings expectations. It has reported better-than-expected earnings in 12 of the past 16 quarters, including each of the last four.
If earnings do come in stronger than anticipated, that could raise this year’s free cash flow estimate above last year’s total, which would result in an upgrade for the stock.
I’ll be watching closely in early November to see whether that’s the case. But until then, I have no choice but to remain skeptical.
The situation with SunCoke Energy is interesting because the company can easily afford its current dividend. But a company can’t have declining cash flow forever without it affecting the payout to shareholders. And that gaping three-year hole when the company did not pay a dividend shows that management won’t hesitate to cut the dividend again if it has to.
To be clear, I don’t expect SunCoke Energy to cut its dividend in the near future. But if things don’t improve, a reduction could certainly be on the horizon.
The earnings results and guidance that will be released in a few weeks will be very revealing.
Dividend Safety Rating: D
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