The dividend safety rating of Dow Chemical (NYSE: DOW) may be a victim of its time.
Let me explain… Dow Chemical was spun off from DowDuPont last year when the company split into three parts.
As a result, Dow Chemical as a stand-alone company has a very short dividend-paying track record.
That’s strike No. 1, as SafetyNet Pro is a “show me” model.
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In my dividend safety rating system, a company needs to have a solid history of paying dividends. Otherwise, it gets a penalty in its rating.
The most important issue for Dow Chemical is that this year, free cash flow is forecast to slip 5%.
Though the company has been on its own for only a year, it has broken out its financials for several years, and the numbers had been improving until 2020.
Last year, Dow Chemical paid out 53% of its free cash flow in dividends. This year, it is forecast to pay 57%.
Here’s where it falls victim to extenuating circumstances again…
Prior to the COVID-19 outbreak, if a company’s payout ratio was more than 75%, it received a penalty in its dividend safety rating. Any stock with a payout ratio less than 75% was considered safe.
If I had written up Dow Chemical in January, I would have said that with a 57% projected payout ratio, the company could easily afford the dividend.
However, as the economy tanked and many companies slashed their dividends, I took a much more conservative approach with SafetyNet Pro. I lowered the threshold for a ratings penalty to a 50% payout ratio instead of 75%.
I’d rather be too careful of a company cutting its dividend than rate a stock too high and have investors surprised by a reduction in the payout.
Dow pays a quarterly dividend of $0.70 per share, which comes out to a robust 6.7% yield. It could easily reduce the dividend and still have an attractive yield for shareholders.
But with a very short track record and a new conservative dividend safety model, Dow Chemical’s dividend can’t be considered safe.
Interestingly, if I had written this article in January, the rating would have been a “C.” But the new, stricter model takes it all the way down to an “F.”
Keep in mind, I’m not saying a cut is imminent – but if free cash flow comes in below expectations, it wouldn’t surprise me if the company did in fact reduce the dividend in 2021.