Commodity prices are inherently unpredictable. Surprises happen, and companies that depend on commodity prices are not always prepared.
As a result, cyclical industries that rely on commodities receive lower marks for dividend safety. Furthermore, we pay especially close attention to near-term trends for these sensitive businesses.
Since commodity prices are unpredictable, a small cut can quickly turn into a gaping wound. If business trends begin to deteriorate, a company’s Dividend Safety Score will quickly start to drop.
The chart below shows National Oilwell Varco’s quarterly sales growth. We can see that growth turned negative in the first quarter of 2015 and quickly plummeted from there. The company’s Dividend Safety Score began to fall quickly after the second quarter of 2015, and business trends only worsened from there.
Source: Simply Safe Dividends
On a somewhat related note, our Dividend Safety Scores take into consideration how a company performed during the last recession.
Companies with the safest dividend payments typically sell essential products and services that can power through periods of economic weakness. Many of these businesses held sales stable during the financial crisis.
As seen below, National Oilwell Varco’s diluted earnings per share fell by nearly 30% in fiscal year 2009. While its performance was better than many other energy companies, this is clearly a business that is sensitive to the broader economy. NOV’s stock also plunged by nearly 70% in 2008.
Energy is not one of the best stock sectors for dividend income.
Source: Simply Safe Dividends
Besides a company’s industry, near-term business trends, and recession performance, its balance sheet is incredibly important.
Businesses will always meet their debt obligations before they pay dividends. If times get tough and cash flows dry up, unprepared companies with too much debt can be forced to make very difficult decisions.
National Oilwell Varco’s balance sheet was actually in decent shape at the time of its dividend cut. The company had just over $2 billion in cash on hand compared to $3.9 billion of debt and $710 million in dividend payments made last year.
Source: Simply Safe Dividends
However, the company’s dependence on commodity markets once again compromised the safety of its dividend.
With fears that low oil prices could keep demand lower for longer, National Oilwell Varco made a reasonable decision to do whatever it takes to preserve cash flow and keep its balance sheet healthy.
Cutting the dividend by 90% will improve the company’s cash flow by over $600 million per year. Until there are clearer signs that the industry has bottomed, National Oilwell Varco will remain conservative.
Our Dividend Safety Score had also noted that the company had only been paying dividends since 2009. While National Oilwell Varco had increased its dividend for over five straight years, management had shown less of a commitment to the dividend than many other companies, such as those in the dividend aristocrats list.
While oil companies such as Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) have taken on more debt and sold off assets to keep their dividend growth streaks alive, this was presumably less of a concern for National Oilwell Varco.
