Agilent’s Dividend Is Credit Negative; the Latest Trend Among Cash-Rich Companies

Agilent’s Dividend Is Credit Negative; the Latest Trend Among Cash-Rich Companies

Last Wednesday, Agilent Technologies (Baa2 stable) announced that its board of directors had authorized a quarterly dividend of 10 cents per share, a first for the company. The initiation of a dividend program, whose annual distribution will approximate $139 million, is credit negative, but does not have an effect on the company’s rating or outlook.

Agilent joins the ranks of companies that have recently initiated dividends, including Zimmer Holdings (Baa1 stable), Amgen (Baa1 stable), and Cisco Systems (A1 stable). In addition, many companies have been significantly boosting their dividends. Although healthcare and technology are two of the most cash-rich industries paying dividends and have led the trend, we have seen dividend announcements in other industries. Below is a sampling of companies that have recently initiated dividends or announced a significant increase in them.

Examples of Companies with Significant Changes to Dividend Payouts

The proliferation of dividends comes amid high levels of cash held by US corporates, which we estimate at over $1 trillion. For many companies, the dividend moves reflect lower organic growth prospects and increased focus on investor returns rather than growth. For others, it is a signal of management’s confidence in the business and strong financial prospects.
For Agilent, which had approximately $3.5 billion of cash at 31 October 2011, we believe the move makes sense in the context of the company’s transformation over the years from a highly cyclical technology company to one with more steady cash flows and a focus on more stable end-markets. Agilent’s inaugural dividend roughly equates to a 13% payout ratio (as a percentage of free cash flow), which is somewhat lower than the typical technology company’s 20% payout and also below the median payout ratio of approximately 30% for investment-grade healthcare companies.

While any significant increase in shareholder returns is credit negative, we generally view dividends as a fixed obligation to shareholders versus share buybacks, which provide greater financial flexibility to a company. However, none of the dividend policy changes cited above have resulted in rating or outlook changes, except in the case of Amgen, which announced a significant increase in debt-funded share repurchases in conjunction with its dividend. For the others, we expect dividends to be funded with internal cash, resulting in only a moderate effect on free cash flow to debt metrics. For Agilent, we expect free cash flow to debt including the dividend to be in the 25%-30% range for fiscal 2012, versus an actual 37.5% for fiscal 2011 (these metrics include our standard accounting adjustments).
Despite the moderate effect on free cash flow to debt metrics and significant cash hoards, the vast majority of cash and cash flow at many companies, including Agilent, is off-shore and would therefore not be readily available without a tax penalty. As a result, significant future increases in dividends may need to be funded with additional debt for some companies, which may have more severe credit implications.