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Are Dividend Investors Making A Mistake With Exelon Corporation (NYSE:EXC)?

Simply Wall St

Could Exelon Corporation (NYSE:EXC) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While Exelon's 3.0% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple research can reduce the risk of buying Exelon for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Exelon!

NYSE:EXC Historical Dividend Yield, September 23rd 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. 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. Exelon paid out 60% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Exelon paid out 631% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Exelon's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Exelon's ability to maintain its dividend.

Is Exelon's Balance Sheet Risky?

As Exelon 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. Exelon has net debt of 3.89 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. Interest cover of 2.74 times its interest expense is starting to become a concern for Exelon, and be aware that lenders may place additional restrictions on the company as well.

We update our data on Exelon 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. Exelon has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 US$2.10 in 2009, compared to US$1.45 last year. This works out to be a decline of approximately 3.6% per year over that time. Exelon's dividend hasn't shrunk linearly at 3.6% per annum, but the CAGR is a useful estimate of the historical rate of change.

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

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Earnings have grown at around 3.2% a year for the past five years, which is better than seeing them shrink! 3.2% per annum is not a particularly high rate of growth, which we find curious. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.

Conclusion

To summarise, shareholders should always check that Exelon's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Exelon gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. In summary, Exelon 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.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 11 analysts we track are forecasting for Exelon for free with public analyst estimates for the company.

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.