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The Case For Humana AB (publ) (STO:HUM): Could It Be A Nice Addition To Your Dividend Portfolio?

Simply Wall St

Today we'll take a closer look at Humana AB (publ) (STO:HUM) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With only a three-year payment history, and a 1.1% yield, investors probably think Humana is not much of a dividend stock. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. 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

OM:HUM Historical Dividend Yield, January 15th 2020

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. 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. Humana paid out 17% of its profit as dividends, over the trailing twelve month period. We'd say its dividends are thoroughly covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Humana's cash payout ratio last year was 11%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Humana's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Humana's Balance Sheet Risky?

As Humana 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 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. Humana has net debt of 3.50 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.

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 5.30 times its interest expense appears reasonable for Humana, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of Humana'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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was kr0.50 in 2017, compared to kr0.70 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Humana has grown its earnings per share at 11% per annum over the past five years. Earnings per share are growing at a solid clip, and the payout ratio is low. We think this is an ideal combination in a dividend stock.

Conclusion

To summarise, shareholders should always check that Humana's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Humana is paying out a low percentage of its earnings and cash flow. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. Overall we think Humana scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Humana stock.

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.