Are Dividend Investors Making A Mistake With AusNet Services Ltd (ASX:AST)?
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Today we'll take a closer look at AusNet Services Ltd (ASX:AST) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
In this case, AusNet Services likely looks attractive to investors, given its 5.4% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.
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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. So we need to be form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 139% of AusNet Services'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. Unfortunately, while AusNet Services pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective. It's good to see that while AusNet Services's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.
Is AusNet Services's Balance Sheet Risky?
As AusNet Services'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 measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). With net debt of more than 5x EBITDA, AusNet Services could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 2.52 times its interest expense, AusNet Services's interest cover is starting to look a bit thin. Low interest cover and high debt can create problems right when the investor least needs them. We're generally reluctant to rely on the dividend of companies with these traits.
Consider getting our latest analysis on AusNet Services's financial position here.
Dividend Volatility
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 AusNet Services's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was AU$0.099 in 2009, compared to AU$0.097 last year. The dividend has shrunk at a rate of less than 1% a year over this period.
When a company's per-share dividend falls we question if this reflects poorly on either the business or management. Either way, we find it hard to get excited about a company with a declining dividend.
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. AusNet Services has grown its earnings per share at 5.8% per annum over the past five years. 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
To summarise, shareholders should always check that AusNet Services'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 AusNet Services 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, AusNet Services looks quite suboptimal from a dividend investment perspective.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 10 AusNet Services analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
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 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.
