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Should You Buy Spark New Zealand Limited (NZSE:SPK) For Its 5.7% Dividend?

Simply Wall St

Could Spark New Zealand Limited (NZSE:SPK) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, Spark New Zealand likely looks attractive to investors, given its 5.7% 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 analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

NZSE:SPK Historical Dividend Yield May 3rd 2020

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 102% of Spark New Zealand's profits were paid out as dividends in the last 12 months. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

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 134%, Spark New Zealand'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. Cash is slightly more important than profit from a dividend perspective, but given Spark New Zealand's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Is Spark New Zealand's Balance Sheet Risky?

As Spark New Zealand's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Spark New Zealand has net debt of 1.83 times its EBITDA, which is generally an okay level of debt for most companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 15.70 times its interest expense, Spark New Zealand's interest cover is quite strong - more than enough to cover the interest expense.

We update our data on Spark New Zealand every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of Spark New Zealand's dividend payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was NZ$0.24 in 2010, compared to NZ$0.25 last year. Dividend payments have grown at less than 1% a year over this period.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Earnings have grown at around 5.5% a year for the past five years, which is better than seeing them shrink! Although per-share earnings are growing at a credible rate, virtually all of the income is being paid out as dividends to shareholders. This is okay, but may limit growth in the company's future dividend payments.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Second, earnings growth has been ordinary, and its history of dividend payments is chequered - having cut its dividend at least once in the past. In this analysis, Spark New Zealand doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've identified 3 warning signs for Spark New Zealand (1 doesn't sit too well with us!) that you should be aware of before investing.

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.