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Should You Buy Unique Fabricating, Inc. (NYSEMKT:UFAB) For Its 6.6% Dividend?

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Dividend paying stocks like Unique Fabricating, Inc. (NYSEMKT:UFAB) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With a four-year payment history and a 6.6% yield, many investors probably find Unique Fabricating intriguing. It sure looks interesting on these metrics - but there's always more to the story . Some simple analysis can reduce the risk of holding Unique Fabricating for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

AMEX:UFAB Historical Dividend Yield, July 3rd 2019
AMEX:UFAB Historical Dividend Yield, July 3rd 2019

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. 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, Unique Fabricating paid out 245% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Unique Fabricating paid out 99% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. As Unique Fabricating's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Is Unique Fabricating's Balance Sheet Risky?

As Unique Fabricating has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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. Unique Fabricating has net debt of 3.78 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.83 times its interest expense is starting to become a concern for Unique Fabricating, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Unique Fabricating's financial position here.

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. Looking at the data, we can see that Unique Fabricating has been paying a dividend for the past four years. During the past four-year period, the first annual payment was US$0.60 in 2015, compared to US$0.20 last year. The dividend has fallen 67% over that period.

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

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. While there may be fluctuations in the past , Unique Fabricating's earnings per share have basically not grown from where they were five years ago. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Still, the company has struggled to grow its EPS, and currently pays out 245% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

Conclusion

To summarise, shareholders should always check that Unique Fabricating's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with Unique Fabricating paying out a high percentage of both its cashflow and earnings. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Using these criteria, Unique Fabricating looks quite suboptimal from a dividend investment perspective.

See if management have their own wealth at stake, by checking insider shareholdings in Unique Fabricating stock.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.