Today we'll take a closer look at Norfolk Southern Corporation (NYSE:NSC) 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.
While Norfolk Southern's 2.0% dividend yield is not the highest, we think its lengthy payment history is quite interesting. During the year, the company also conducted a buyback equivalent to around 4.1% of its market capitalisation. Some simple analysis can reduce the risk of holding Norfolk Southern for its dividend, and we'll focus on the most important aspects below.
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. Norfolk Southern paid out 33% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Norfolk Southern paid out 54% 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. It's positive to see that Norfolk Southern's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Norfolk Southern's Balance Sheet Risky?
As Norfolk Southern has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 2.20 times its EBITDA, Norfolk Southern has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Norfolk Southern has EBIT of 6.95 times its interest expense, which we think is adequate.
Remember, you can always get a snapshot of Norfolk Southern's latest financial position, by checking our visualisation of its financial health.
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. Norfolk Southern has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.36 in 2009, compared to US$3.76 last year. Dividends per share have grown at approximately 11% per year over this time.
It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Norfolk Southern has done it, which we really like.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Norfolk Southern has grown its earnings per share at 11% per annum over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Above all, we're glad to see that Norfolk Southern pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Overall we think Norfolk Southern scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 21 Norfolk Southern analysts we track are forecasting continued growth with our free report on 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%.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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