Dividend Quality Analysis on Chesapeake Energy Corp. (NYSE:CHK)

While traditional dividend analysis focuses on dividend payout from net income, we focus on the cash flow coverage of dividends (paid to the common stock) in order to determine their quality and sustainability. We assess whether dividends are being paid from operating, investing and issuance cash flows or whether the beginning cash balance is needed to make this payment. We make the assumption that cash dividends are paid only after net debt repayments. We consider the cash outflow from share buybacks to be discretionary and thus ignore its impact on cash required to support the dividend policy.

Dividends that are fully covered from operating and investing cash flow net of any cash outflow from debt repayments and net of a decrease in deposits (for banks) are considered to be “high quality”. Those that require an additional net cash inflow from issuance are categorized as “medium quality”. If operating, investing and issuance cash flows are not sufficient to fund the dividend and the beginning cash balance is used, the dividend is referred to as “low quality”.

This last category is most at risk of a dividend cut though we recognize that companies that have a large cash balance could continue to pay dividends even with a “low quality” dividend profile. For all these definitions, we assume the cash outlay for share buybacks is discretionary and can instead be used to support dividends.

Over the last twelve months (prior to 2012-09-30), CHK-US’s dividend payout of -24.3% and the corresponding dividend yield of 2.1% (relative to the current price) compare to a peer median level of 15.1% and 0.9% respectively. Relative to its peers, the firm is generating a high dividend yield. However, its dividend payout is negative which suggests a likely downward pressure on the dividend based on this traditional analysis.