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How Does Estia Health Limited (ASX:EHE) Fare As A Dividend Stock?

Simply Wall St

Is Estia Health Limited (ASX:EHE) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Estia Health is a new dividend aristocrat in the making. We'd agree the yield does look enticing. 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 Estia Health!

ASX:EHE Historical Dividend Yield, January 14th 2020

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Estia Health paid out 100% of its profit as dividends. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while Estia Health 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.

Is Estia Health's Balance Sheet Risky?

As Estia Health'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 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). Estia Health has net debt of 1.20 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. With EBIT of 13.52 times its interest expense, Estia Health's interest cover is quite strong - more than enough to cover the interest expense.

Remember, you can always get a snapshot of Estia Health's latest financial position, by checking our visualisation of its financial health.

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. Estia Health has been paying a dividend for the past four years. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past four-year period, the first annual payment was AU$0.14 in 2016, compared to AU$0.16 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.8% a year over that time. Estia Health's dividend payments have fluctuated, so it hasn't grown 3.8% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

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. It's good to see Estia Health has been growing its earnings per share at 58% a year over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in 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 Estia Health'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 Estia Health paying out a high percentage of both its cashflow and earnings. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall, Estia Health 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.

Are management backing themselves to deliver performance? Check their shareholdings in Estia Health in our latest insider ownership analysis.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.