Is Babcock International Group PLC (LON:BAB) A Great Dividend Stock?
Is Babcock International Group PLC (LON:BAB) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A high yield and a long history of paying dividends is an appealing combination for Babcock International Group. We'd guess that plenty of investors have purchased it for the income. Remember though, given the recent drop in its share price, Babcock International Group's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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Payout ratios
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Babcock International Group paid out 56% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 178%, Babcock International Group's dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Babcock International Group's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Babcock International Group's ability to maintain its dividend.
Is Babcock International Group's Balance Sheet Risky?
As Babcock International Group 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 2.49 times its EBITDA, Babcock International Group has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 7.61 times its interest expense appears reasonable for Babcock International Group, although we're conscious that even high interest cover doesn't make a company bulletproof.
Consider getting our latest analysis on Babcock International Group's financial position here.
Dividend Volatility
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Babcock International Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was UK£0.14 in 2010, compared to UK£0.30 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.6% a year over that time.
Dividends have grown at a reasonable rate over this period, and without any major cuts in the payment over time, we think this is an attractive combination.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Earnings have grown at around 3.9% a year for the past five years, which is better than seeing them shrink! 3.9% per annum is not a particularly high rate of growth, which we find curious. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.
Conclusion
To summarise, shareholders should always check that Babcock International Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. In sum, we find it hard to get excited about Babcock International Group from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've identified 2 warning signs for Babcock International Group (1 is a bit unpleasant!) that you should be aware of before investing.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.
