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Could Micro Focus International plc (LON:MCRO) Have The Makings Of Another Dividend Aristocrat?

Simply Wall St

Could Micro Focus International plc (LON:MCRO) 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. 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.

A high yield and a long history of paying dividends is an appealing combination for Micro Focus International. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock equivalent to around 12% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Micro Focus International!

LSE:MCRO Historical Dividend Yield, August 14th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Although it reported a loss over the past 12 months, Micro Focus International currently pays a dividend. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

Micro Focus International paid out 60% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business.

Is Micro Focus International's Balance Sheet Risky?

Given Micro Focus International 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 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 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). Micro Focus International has net debt of 1.94 times its EBITDA, which is generally an okay level of debt for most companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 2.59 times its interest expense is starting to become a concern for Micro Focus International, and be aware that lenders may place additional restrictions on the company as well.

We update our data on Micro Focus International 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 Micro Focus International's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.26 in 2009, compared to US$1.41 last year. Dividends per share have grown at approximately 18% per year over this time.

With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.

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. Over the past five years, it looks as though Micro Focus International's EPS have declined at around 4.4% a year. 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.

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. We're not keen on the fact that Micro Focus International paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. It hasn't demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. In summary, Micro Focus International has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 9 analysts we track are forecasting for the future.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.