Free cash flow is another key metric that influences a company’s ability to pay a dividend. Free cash flow allows a company to invest and return capital to shareholders without needing the assistance of capital markets.
Home Depot has been nothing short of a free cash flow machine. As seen below, Home Depot’s free cash flow has increased from a peak of $2.06 per share at the housing bubble’s peak in fiscal year 2007 to a whopping $6.17 per share last fiscal year.
Home Depot’s stores generate excellent free cash flow because many of their expenses are fixed. As same-store sales increase, expenses do not rise as quickly. In fact, management estimates that the company’s expenses will grow at about 50% of Home Depot’s sales growth rate over the next few years.
As Home Depot continues to make its stores and supply chain more efficient and new store growth slows, free cash flow should continue rising to support a safe and growing dividend.
Source: Simply Safe Dividends
Financial leverage is another big factor impacting dividend safety. A company will always make its interest and debt payments before paying a dividend.
Home Depot has close to $21 billion in debt compared to $3.3 billion in cash on its balance sheet. However, the company’s excellent profit generation and valuable real estate reduce any debt-related fears.
Home Depot’s net debt / EBIT (earnings before interest and taxes) ratio is 1.4, which means its total book debt could be retired with cash on hand and just 1.4 years of EBIT. This seems pretty conservative to me given the slow-moving nature of the home improvement retail industry.
The company’s real estate portfolio is also very valuable and supports the debt load. At the company’s most recent investor day, management estimated the value of Home Depot’s real estate at $35 billion, easily backing the debt carried by the company.
Home Depot also maintains a strong long-term debt rating of single-A.
Source: Simply Safe Dividends
Overall, Home Depot’s current dividend payment is extremely safe and supported by the company’s reasonable payout ratio, excellent free cash flow generation, high returns on capital, business stability, and manageable balance sheet.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Home Depot’s Dividend Growth Score is 88, which suggests that the company has some of the strongest dividend growth potential in the market.
Home Depot has paid uninterrupted dividends since 1987 and increased its dividend every year since 2009.
Management last boosted the company’s dividend by 16% in February 2016, marking its seventh consecutive increase to its annual dividend.
Large home improvement retailers have proven to be very reliable dividend growers. For example, Lowe’s has raised its dividend for more than 50 straight years and is a member of the dividend aristocrats list.
As seen below, Home Depot has increased its dividend at an annual growth rate of 19% over its last 10 fiscal years, and annual dividend growth has exceeded 20% over more recent time periods.
Source: Simply Safe Dividends
Going forward, management targets a dividend payout ratio of 50%, which is about where the company’s payout ratio sits today.
In other words, unless management is willing to increase Home Depot’s targeted payout ratio, dividend growth will likely follow earnings growth over the coming years.
Under Home Depot’s new three-year plan through 2018, management’s targets imply annual earnings growth in the mid-teens. If I had to guess, Home Depot will continue growing its dividend by at least 10% per year over the next few years.
