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How Does Endesa, S.A. (BME:ELE) Fare As A Dividend Stock?

Simply Wall St

Is Endesa, S.A. (BME:ELE) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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, Endesa likely looks attractive to investors, given its 5.9% 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.

Click the interactive chart for our full dividend analysis

BME:ELE Historical Dividend Yield, January 28th 2020

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Endesa paid out 378% of its profit as dividends. 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. Endesa paid out 111% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given Endesa's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Is Endesa's Balance Sheet Risky?

As Endesa's dividend was not well covered by earnings, 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 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. With net debt of 1.86 times its EBITDA, Endesa has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 16.07 times its interest expense, Endesa's interest cover is quite strong - more than enough to cover the interest expense.

Consider getting our latest analysis on Endesa's financial position here.

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. For the purpose of this article, we only scrutinise the last decade of Endesa's dividend payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was €5.90 in 2010, compared to €1.43 last year. The dividend has fallen 76% over that period.

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

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's good to see Endesa has been growing its earnings per share at 29% a year over the past five years. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet.

Conclusion

To summarise, shareholders should always check that Endesa'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 Endesa paying out a high percentage of both its cashflow and earnings. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Overall, Endesa falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 16 Endesa analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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