A Close Look at Eagle Materials' Dividend Potential

By Maxx Chatsko Markets Fool.com

It may not be a household name or on the radar of income investors, but construction materials leader Eagle Materials (NYSE: EXP) is a stock that recently attracted my attention. Gaining 60% in a calendar year, as shares did in 2016, can certainly do that. But that's not the only reason. The cement, concrete, and gypsum wallboard manufacturer has an impressive history of growing both organically and through acquisitions.

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Since fiscal 2013 (the company's fiscal year ends each March), management has executed a strategy that achieved 78% revenue growth, 160% growth in operating profits, 150% growth in EPS, and 113% growth in operating cash flow. While cash generated from operations has historically been reinvested back into the business or to fund acquisitions, there seems to be plenty of room to increase the dividend in the near future. Here's a closer look at Eagle Materials' dividend potential.

Image source: Getty Images.

Room to grow, but how much?

The company is by no means a dividend powerhouse, paying investors just $0.40 per share annually, which amounts to a yield of 0.4%. Income investors would be forgiven for overlooking the stock.

But don't sleep on Eagle Materials. It recently pulled the trigger on a $400 million acquisition that will boost its annual cement capacity by 20%, which will close by the end of March, its fiscal fourth quarter 2017. The cement segment was responsible for 38.5% of total revenue and 45% of all operating income through the first nine months of fiscal 2016. That means investors will certainly see a windfall from the production boost. How can we quantify it?

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Let's use some simplified estimates to get a quick view of where operations might be headed. Consider that cement segment revenue for the first nine months of fiscal 2017 represented annualized revenue of $479 million, while operating income during the same period represented an annualized amount of $170 million. An increase of 20% would push the segment's annual revenue potential to $575 million and its annual operating income to $204 million -- and that's before accounting for growth potential from higher selling prices or increased utilization rates from existing operations.

EXP data by YCharts.

This oversimplified estimate shows that the company could see a roughly $34 million boost in operating income from the acquisition alone. By comparison, Eagle Materials currently spends about $20 million in dividend payouts annually. While the potential to roughly double the dividend is great, it still only gets investors to a yield of 0.8%.

The good news is that three of the company's four operating segments -- gypsum wallboard, cement, and concrete and aggregates -- are experiencing strong growth in both revenue and operating income. The fourth (and by far smallest) segment -- oil and gas proppants -- has been a sore spot for investors since management gambled on the long-term potential of throwing sand into fracked wells. However, if rising oil prices lead to increased drilling activity in the years ahead, then there's a strong case to be made for upside.

With or without significant contributions from oil and gas proppants, Eagle Materials is on pace for its best year in terms of operating cash flow. The company exceeded its annual record for operating cash flow in the first nine months of fiscal 2017 and achieved a net change in cash of $159 million during the period. To put that into perspective, the company hasn't recorded a net change in cash greater than $2.6 million in any year since 2013.

To be fair, those numbers exclude borrowing against the credit facility to fund the acquisition, which will be partially paid with cash on hand. Either way, the trend is the friend of investors: Eagle Materials recently set a new record for operating cash flow for any prior 12-month period in its history.

EXP data by YCharts.

Boosting production capacity will obviously help the upward trend continue, barring any headwinds in the broader market. It also bodes well for the stock's dividend potential. While there's no telling how management will decide to utilize its increasing cash generation, the company is well-positioned to greatly increase its dividend in the near future. Whether that's a doubling, tripling, or more (or less) depends on whether or not the company wants to continue its multiyear-long acquisition spree. But the takeaway is clear: Eagle Materials' dividend is likely to grow soon.

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Maxx Chatsko has no position in any stocks mentioned. The Motley Fool recommends Eagle Materials. The Motley Fool has a disclosure policy.