Since Avon Products used to be a bit of a DG investor darling with 22 consecutive years of rising dividends, I figured we should take a look at some of their operating results to see what could have tipped us off that a dividend cut was looming. Let's get into the numbers.
Take a look at the red columns on the following chart. They represent the earnings per share.
The EPS for the company offered decent growth between 2001 and FY 2005, however the FY 2006 saw a 41% drop in earnings. Considering this drop is just based off earnings per share numbers, this is pretty disheartening. There were 8.7% less shares outstanding at the end of FY 2006 than from the end of FY 2001 so the drop is even larger than the 41% mentioned. Maybe it was a one time issue, since the EPS increased over the next 2 fiscal years. Well, that was all good until the recession in late 2008/early 2009 came along to destroy the growth they had over the past 2 years. Since then earnings have been on a decline with each year bringing less to the bottom line.
If you notice the green columns, those are the FCF per share numbers. Everything was okay until 2006 closed and FCF no longer outpaced the dividends paid out. This meant that in order to pay the dividend management had to either start selling shares or take on debt to finance the payment. Management decided to take on more debt in order to cover the shortfall, and since they were already taking some also chose to continue their share buyback program. I could understand taking on a little bit of debt in order to payout the full dividend if you're pretty sure this is a one time issue that won't cause problems going forward. However taking on the extra debt to continue the share buyback program confuses me.
Starting in FY 2008 the share buyback program was essentially stalled, although without checking further I'm sure management continued buying back enough shares to counter those received in options to give the appearance that the shares outstanding weren't increasing. Unfortunately the bleeding in their operating results didn't stop along with the share buyback. EPS and FCF per share continued their decline while management continued to take on more debt to pay the increasing dividend. This only compounded the issue.
EPS grew 31% from 2001 through 2001 and the DPS grew by 142%. This alone gives reason to doubt the sustainability of their dividend since the payout ratio increased from 42% in 2001 up to 78% in 2011. The gap between FCF per share and DPS grew forcing management to continue taking on more debt. The LT debt per share increased 119% over that same time frame.
Revenue continued to increase most years since 2001, however their net income declined, due to the increased debt. This led to a decline in their net income margin from a high of 10.92% to a low of 4.19% for FY 2011.
If you wait for the dividend cut to be announced you've missed the boat because warnings signs are there in the operating results for a company. An increase in debt to pay out a dividend doesn't make sense. If you pay attention to the signs you could have gotten out much earlier in the decline and put that capital to work in another company.
It's not the amount of dividend growth that is truly important, it's the quality of the business and their operations that determines the future dividend growth.