National-Oilwell Varco, Inc. (NYSE:NOV) surprised many dividend investors with its decision to slash its dividend by 90% on April 11. Income investors could have avoided the cut by paying closer attention to the company’s main risk factors.
The dividend cut announcement came shortly after the company’s CEO gave an investor presentation on March 22.
In the slide deck, the company was noted to have a “strong balance sheet” and “resilient free cash flow generation,” perhaps giving dividend investors a false sense of security.
While business trends weren’t great (sales fell by 52% last quarter), the company still had over $5 billion in cash and undrawn credit capacity compared to $3.9 billion of debt and just $710 million in dividend payments made last year.
National Oilwell Varco’s free cash flow payout ratio over the last twelve months was also still somewhat reasonable at 81%.
Simply put, most companies that end up cutting their dividends are usually in far worse shape by the time they opt for a reduction.
Among hedge funds and other institutional investors tracked by Insider Monkey, National Oilwell Varco’s popularity remained basically unchanged with the number of funds long the stock falling by two to 26 during the fourth quarter. These funds amassed 10.10% of the company’s outstanding stock at the end of 2015, with notable shareholders including First Eagle Investment Management and Mason Hawkins’ Southeastern Asset Management, which held 20.77 million shares and 10.80 million shares, respectively.
How could conservative income investors have known to avoid buying National Oilwell Varco for its dividends?
At Simply Safe Dividends, we do our best to help dividend investors avoid companies that cut their dividends before the dividend is actually reduced.
Analyzing the main factors that support a company’s ability to pay a dividend allows us to assess the dividend’s safety and find safer dividend stocks.
We review a company’s debt levels, payout ratios, recession performance, cash flow generation, industry cyclicality, profitability trends, and more to generate Dividend Safety Scores.
Scores range from 0 to 100 with scores of 50 being average, 25 or lower considered weak, and 75 or higher considered excellent.
Using this process, Kinder Morgan Inc (NYSE:KMI), ConocoPhillips (NYSE:COP), BHP Billiton Limited (ADR) (NYSE:BHP), and other major dividend-payers were each flagged as being in the riskiest 10-20% of stocks out there for dividend safety well before they ultimately cut their dividends.
Let’s take a closer look at National Oilwell Varco, which scored in the bottom 10% for dividend safety prior to announcing its dividend cut.
One of the first safety factors we consider is the industry that the company is in. A company’s industry has a large influence on the stability of the cash flows a business generates.
For example, an industry selling construction equipment will experience a high level of cyclicality, whereas beverage companies enjoy steadier demand.
National-Oilwell Varco, Inc. (NYSE:NOV) operates in the oil field machinery industry and essentially supports oil wells across their entire lifecycle – from the time they are drilled through their production and maintenance.
When oil prices are high, oil producers have incentive to drill more wells and increase their production, driving demand higher for National Oilwell Varco’s products and services.
However, the opposite is also true – low oil prices cause producers to pull back on their investments, hurting demand for oil field machinery.