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Is AltaGas Ltd. (TSE:ALA) The Right Choice For A Smart Dividend Investor?

Simply Wall St

Today we'll take a closer look at AltaGas Ltd. (TSE:ALA) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

In this case, AltaGas likely looks attractive to investors, given its 4.8% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Some simple research can reduce the risk of buying AltaGas for its dividend - read on to learn more.

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TSX:ALA Historical Dividend Yield, December 10th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. AltaGas paid out 31% of its profit as dividends, over the trailing twelve month period. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while AltaGas pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Is AltaGas's Balance Sheet Risky?

As AltaGas has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 6.92 times its EBITDA, AltaGas could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.72 times its interest expense is starting to become a concern for AltaGas, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

Remember, you can always get a snapshot of AltaGas's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. AltaGas has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was CA$2.16 in 2009, compared to CA$0.96 last year. This works out to be a decline of approximately 7.8% per year over that time. AltaGas's dividend hasn't shrunk linearly at 7.8% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying AltaGas for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. It's good to see AltaGas has been growing its earnings per share at 19% a year over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

We'd also point out that AltaGas issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that AltaGas's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we like AltaGas's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Ultimately, AltaGas comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 AltaGas analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.