Today, Investment U’s Income Expert, Marc Lichtenfeld, takes a look at NetApp’s dividend safety.

NetApp (Nasdaq: NTAP) is a cloud storage and data management company based in Silicon Valley. But unlike most tech companies, this one has a robust 4.5% dividend yield.

Can tech investors expect to continue to receive their $0.48 per share quarterly dividend?

A big red flag is that NetApp’s free cash flow is headed in the wrong direction. In 2019, it declined slightly to $1.17 billion from $1.33 billion the year before.

This year, free cash flow is projected to drop to $936 million, and then it’s expected to drop all the way down to $714 million in 2021.

This year, NetApp is forecast to pay $439 million in dividends, or 60% of its free cash flow.

In normal, nonpandemic times, that would be perfectly okay. But during the pandemic, I’ve taken my threshold for an acceptable payout ratio down to 50%. (A company’s payout ratio is the percentage of free cash flow that it pays in dividends.)

The reason I lowered the threshold from 75% to 50% is because the pandemic has created havoc for many businesses. Across the board, management teams understandably feel the need to conserve cash.

NetApp Dividend Safety Rating Overview 

I want to make sure we are not caught by surprise, assuming a dividend is safe only to see it cut later.

A company that pays out 50% or less of its cash in dividends has a big enough buffer that it can afford to keep paying the dividend even if free cash flow dips.

NetApp has a solid but brief dividend-paying history. Since it began paying a dividend in 2013, it has raised the payout every year except 2020.

But that dividend track record isn’t enough for SafetyNet Pro. The falling free cash flow is a major problem, and the higher-than-acceptable payout ratio is also an issue.

NetApp’s dividend is attractive, especially for a tech company, but I don’t think you can consider it safe. The dividend cut may not come immediately, but if 2021’s numbers are weaker than expected, a reduction next year is very possible.

Dividend Safety Rating: D

While NetApp seems to have an interesting dividend, it’s at high risk of being cut, and its plummeting free cash flow is a major concern. However, only time will tell if the NetApp dividend safety can improve.

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