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Does PZ Cussons Plc (LON:PZC) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Today we'll take a closer look at PZ Cussons Plc (LON:PZC) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With PZ Cussons yielding 4.1% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying PZ Cussons for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on PZ Cussons!

LSE:PZC Historical Dividend Yield, August 19th 2019

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. PZ Cussons paid out 133% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. PZ Cussons paid out 67% 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 good to see that while PZ Cussons's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is PZ Cussons's Balance Sheet Risky?

As PZ Cussons'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. PZ Cussons has net debt of 1.61 times its EBITDA, which we think is not too troublesome.

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 13.84 times its interest expense, PZ Cussons's interest cover is quite strong - more than enough to cover the interest expense.

Consider getting our latest analysis on PZ Cussons'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 PZ Cussons's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was UK£0.048 in 2009, compared to UK£0.083 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.6% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. PZ Cussons's EPS have fallen by approximately 22% per year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and PZ Cussons's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that PZ Cussons'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 not keen on the fact that PZ Cussons paid out such a high percentage of its income, although its cashflow is in better shape. It hasn't demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. In summary, PZ Cussons 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.

Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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.