Is Kraft Heinz's 6.4%-Yielding Dividend Safe?

A key reason many investors buy shares of Kraft Heinz (NASDAQ: KHC) is undoubtedly for the dividend. At around 6.4%, it's a fairly high yield. It's also considerably higher than the S&P 500 average of just 1.2%. That dividend can be particularly valuable, as it provides investors with recurring income and enhances their overall total returns.

The problem is that if that dividend isn't sustainable, the risk will be reflected in the share price. Kraft Heinz's stock has declined by more than 20% over the past 12 months. Even if you factor in its dividend, its total returns are still a negative 16%.

Investors aren't buying the stock, despite a seemingly impressive payout. It's a sign that there could be trouble with the business that's keeping them away.

The company has also recently announced that it will be splitting up its business, which may result in increased uncertainty for the stock in the future. Is Kraft Heinz's dividend safe, and can you rely on it? Or are you better off going with other dividend stocks instead?

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Are Kraft Heinz's earnings strong enough to support the dividend?

A key metric that income investors look at when evaluating a dividend stock is its payout ratio. This indicates the percentage of a company's earnings that are distributed as dividends. The higher the percentage, the less sustainable and safe the dividend might be. That isn't always the case, especially for companies that incur high amortization expenses, which are non-cash items that can weigh down the bottom line. However, it's still a good initial number for investors to focus on when first examining a dividend stock.

In its most recent quarter, which ended Sept. 27, Kraft Heinz's earnings per share totaled $0.52, which exceeded the rate of its quarterly dividend of $0.40. If the company were to maintain that pace, its payout ratio would be around 77% for a full year, which would appear to be manageable for the business.

Another way to evaluate the payout is to examine free cash flow, which can help eliminate the noise that sometimes accompanies earnings numbers. Kraft Heinz's free cash totaled $3.6 billion over the trailing 12 months, which is a fair amount higher than the $1.9 billion it paid in dividends over that timeframe. For now, all signs indicate that the dividend appears to be safe.

Will Kraft Heinz's dividend be safe in the long run?

In 2019, Kraft Heinz reduced its quarterly dividend from $0.625 to $0.40. It has remained at that level ever since. While it has proven to be sustainable, there are questions hovering over the business these days. The company is in the midst of breaking up its business into two entities, with one side focusing on sauces and spreads while another will focus on its core food brands, including Oscar Mayer, Lunchables, and Kraft Singles. It expects to complete the separation around the middle of 2026.

The company has struggled to generate growth in recent years, and Kraft Heinz hopes that this move can unlock greater value for shareholders and lead to better growth opportunities. Kraft Heinz's revenue totaled $25.8 billion last year, which was a decline of 3% from the previous year.

It states that despite the breakup, the current dividend will remain intact (in aggregate) and that it expects to maintain it going forward. But if the separation doesn't lead to better results and the businesses decide to invest more heavily into growth initiatives, pressure could mount to once again reduce dividend payments in order to free up cash.

Kraft Heinz's dividend may be safe today, but I wouldn't rely on it for the future

Things don't appear to be working well for Kraft Heinz lately, which is evident from its stagnant top line and the need for management to pursue a business breakup in order to stimulate growth. Currently, there is no compelling reason to invest in the food stock. In five years, Kraft Heinz's stock has declined by about 23%, and even with the dividend, the total return remains negative at -3%.

At the very least, you may want to hold off on investing until after the breakup takes place, and perhaps consider investing in the better-performing business at that stage. Although the dividend doesn't appear to be in imminent danger today, with so many questions surrounding Kraft Heinz's future, I wouldn't rely on its payout for the long haul.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Kraft Heinz. The Motley Fool has a disclosure policy.