Investors love dividends. While dividends are widely cited in the media as creating one-third to half of total returns over time, some companies come with shockingly high dividend yields. Dividend investors have the right to wonder just how safe those dividends might be over time.
The 10-year Treasury yield now is close to 2.05% and the 30-year Treasury yield is near 2.55%. So having a yield of 5% or 6% has to imply some sort of risk. Throw in China trade war risks, Iran, an upcoming presidential election that is sure to be ugly, and a half-dozen other risks that create a louder voice for those predicting that a recession is around the corner.
If recession risks are really brewing, investors are likely to worry about Ford Motor Co. (NYSE: F) and its ability to maintain its 6% yield. What about that 4% dividend yield of rival General Motors Co. (NYSE: GM)? Is it safe? This will matter particularly when investors start considering the big layoffs that have come to light and that auto sales are expected to decline.
Many investors will be more critical when they begin wondering how safe their dividends are in the next recession. The bull market is now over 10 years old, and even if the odds are not strong for an immediate recession, it just seems logical to worry about one sooner rather than later. Ford and GM seem to have safe dividends if the downturn continues, but there are of course some risks.
So far in 2019, Ford shares have risen about 30% and GM shares are up 14%. These companies have operated under a period of “peak auto” for some time now. Investors seem to have entirely forgotten that Ford chose to do the right thing and not take a government bailout like rival GM did to bolster its finances before the Great Recession hit.
Ford’s second-quarter dividend that was announced in April was the same regular dividend that it has paid each quarter since 2016. It hasn’t had to raise its payout for a while because that $0.15 per share dividend now yields about 6.05%. In short, investors are being paid almost three times the yield of the 10-year Treasury to wait until the next auto boom comes.
Ford has lowered its long-term debt over the past couple of years, and in fiscal 2018 it had total cash flow from operations of $15 billion, which was a decline in the past two years, before backing out the negatives. Ford’s adjusted earnings per share of $1.30 from 2018 are expected to be $1.39 in 2019 and $1.41 in 2020. That easily covers a $0.60 annualized per share dividend.
At GM, the $1.52 per share annualized dividend compares with earnings of $6.54 per share in 2018. Refinitiv’s consensus earnings per share estimates are $6.65 in 2019 and $6.21 in 2020. Even if those estimates come down handily, GM should be able to maintain its dividend in a mild downturn.
There are of course some long-term risks for Ford and GM. As mentioned, the U.S. auto segment already has seen “peak auto” trends, and recessions do not mix well with car companies. The rise of Tesla and electric vehicles also has been a thorn in the side of the Big Three automakers. The rise of ride-hailing from the likes of Uber and Lyft haven’t exactly driven the younger generation to run out and buy a new car every few years either.
Before worrying too much about Ford’s 6% yield and GM’s 4% yield, note that Credit Suisse came out with a rather controversial analyst call on Thursday. The firm set new Outperform ratings on both Ford and GM with big upside targets, and it named Ford its highest conviction pick to outperform the auto sector despite some industry headwinds.
24/7 Wall St. doesn’t rely solely on analyst calls. That said, most analysts are not too eager to get clients into old, established companies just in time to hit a recession or catch a dividend cut.
As of Thursday’s closing bell, Ford shares were up nearly 3% at $10.20 and GM shares were marginally higher to $38.32. Ford barely traded an average day’s volume, and GM shares saw less than its daily average. Ford’s consensus target price from Refinitiv was $10.53 and GM’s consensus estimate was $46.68.
If a recession does come in 2020, what will matter is its severity. A big deep recession creates all sorts of negative surprises for companies. Many large-cap companies with lots of debt on their balance sheets currently are thought to be well set to withstand a so-called garden variety recession.