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In the income world, shipping companies are known for a couple of things: high yields and inconsistent dividends.

To be fair, some of them have variable dividends, but others simply don’t generate enough free cash flow.

DHT Holdings (NYSE: DHT) is a Bermuda-based oil tanker company with a fleet of 24 ships, not including four more that are being built.

Over the past four quarters, DHT has paid out a total of $1.05 per share in dividends, with the quarterly payouts ranging from $0.19 to $0.35. At the stock’s current share price of around $12, its dividend yield is above 8.6%.

The company’s policy is to pay out 100% of its net income to shareholders. As a result, its dividend is going to vary each quarter.

It’s nice to see a company paying out 100% of its net income – but net income is not the same as free cash flow, which is the more accurate representation of how much cash a company is bringing in.

Net income has all kinds of noncash items in it. For example, a company could make a sale, bill a client and mark the proceeds down as revenue, which makes its way down to the bottom line as net income. But if the customer hasn’t paid by the end of the quarter, their payment does not figure into the free cash flow number – though it does still count toward revenue and net income.

Since dividends are paid with cash rather than accounting tricks, I want to see that a company generates enough free cash flow to afford its dividend payout.

And last year, DHT did not.

It paid shareholders $186.7 million in dividends while generating $123 million in free cash flow. So that extra $63 million had to come from either the company’s cash in the bank, debt, or somewhere else.

This year, free cash flow is forecast to jump to $301 million, while the total amount paid in dividends is projected to rise to $251 million for a payout ratio of 83%. That’s still too high for me. I like to see a payout ratio of 75% or lower, because that ensures that even if the company’s cash flow dips, it can still pay its dividend.

DHT Holdings’ dividend payout and free cash flow are expected to rise. But given that its free cash flow doesn’t always cover the dividend and the dividend payout per share is all over the place, you shouldn’t expect DHT’s dividend to stay at these levels forever.

Dividend Safety Rating: F

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