International Business Machines (NYSE: IBM) has raised its dividend payment annually for 23 consecutive years, and it's paid a quarterly dividend without fail since 1916. With that kind of track record, another dividend hike later this month is close to a guarantee.
That dividend increase probably won't be all that big. IBM has already been slowing down its pace of dividend growth over the past few years as the company's transformation took a bite out of revenue and profit. With the mega-acquisition of Red Hat set to load the balance sheet with debt, IBM will likely play it safe and opt for a small dividend hike.
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A solid and growing dividend
IBM expects the $34 billion Red Hat acquisition to close in the second half of this year. The company will finance the deal with a combination of cash and debt, so the end result will be a more debt-laden balance sheet. At the end of 2018, IBM had $12.2 billion of cash and $14.6 billion of corporate debt unrelated to the global financing business.
The plan is to suspend share buybacks in 2020 and 2021 to help shore up the balance sheet. IBM has spent between $3 billion and $5 billion annually on share buybacks since 2015, so that will certainly help the cause.
While IBM will forego share buybacks for a while, it remains committed to growing its dividend. IBM expects the Red Hat deal to boost cash flow in the first year, and to boost adjusted earnings per share in the second year. That will help support continued dividend increases.
The current quarterly dividend of $1.57 per share represents just 45% of IBM's adjusted earnings guidance for this year on an annualized basis, so there's certainly room for IBM to grow its dividend. It's possible IBM will surprise investors with a larger-than-expected dividend increase -- a 10% increase would leave the payout ratio just shy of 50%. But a smaller increase would allow IBM to reduce its debt at a faster rate, which should be the priority.
Last year, IBM raised its dividend by just 5%. I would expect a similar mid-single-digit increase this year.
A bargain stock
While IBM isn't providing the same level of dividend growth compared to a few years ago, the stock remains a rare value in the tech sector. Shares trade for just about 10 times adjusted earnings guidance for this year, despite key competitive advantages that make IBM difficult to disrupt.
The Red Hat deal will strengthen IBM's hand in the hybrid cloud-computing market. IBM has long recognized that large companies with complex IT operations were unlikely to go all-in on the public cloud. While Amazon and Microsoft dominate the public cloud market, hybrid cloud appears to be where the industry is headed. That's good news for IBM.
IBM stock yields about 4.4%. That's down from nearly 6% during the stock market sell-off late last year, but it's still more than double the yield of the S&P 500. With such a high yield, even slow dividend growth makes IBM a great dividend stock.
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