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Dividend paying stocks like CenturyLink, Inc. (NYSE:CTL) 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. 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.
A high yield and a long history of paying dividends is an appealing combination for CenturyLink. It would not be a surprise to discover that many investors buy it for the dividends. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. Although CenturyLink pays a dividend, it was loss-making during the past year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.
The company paid out 71% of its free cash flow, which is not bad per se, but does start to limit the amount of cash CenturyLink has available to meet other needs.
Is CenturyLink's Balance Sheet Risky?
Given CenturyLink is paying a dividend but reported a loss over the past year, 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. With net debt of above 3x EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.90 times its interest expense, CenturyLink's interest cover is starting to look a bit thin.
We update our data on CenturyLink every 24 hours, so you can always get our latest analysis of its financial health, here.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of CenturyLink's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was US$2.80 in 2009, compared to US$1.00 last year. The dividend has shrunk at around 9.8% a year during that period. CenturyLink's dividend hasn't shrunk linearly at 9.8% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying CenturyLink 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. In the last five years, CenturyLink's earnings per share have shrunk at approximately 23% per annum. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
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. We're not keen on the fact that CenturyLink paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. There are a few too many issues for us to get comfortable with CenturyLink from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 14 analysts are forecasting a turnaround in our free collection of analyst estimates here.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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 firstname.lastname@example.org. 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.