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Factors Income Investors Should Consider Before Adding Amcor plc (ASX:AMC) To Their Portfolio

Simply Wall St

Dividend paying stocks like Amcor plc (ASX:AMC) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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 Amcor yielding 5.6% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. The company also returned around 1.7% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple research can reduce the risk of buying Amcor for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Amcor!

ASX:AMC Historical Dividend Yield, March 11th 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. 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. Amcor paid out 147% of its profit as dividends, over the trailing twelve month period. 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. Amcor paid out 149% of its free cash flow last year, which we think is concerning if cash flows do not improve. 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. Cash is slightly more important than profit from a dividend perspective, but given Amcor's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Is Amcor's Balance Sheet Risky?

As Amcor'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 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). Amcor has net debt of 3.72 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.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Amcor has EBIT of 5.09 times its interest expense, which we think is adequate.

We update our data on Amcor every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

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. Amcor 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 declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.28 in 2010, compared to US$0.46 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.0% a year over that time. Amcor's dividend payments have fluctuated, so it hasn't grown 5.0% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Amcor might have put its house in order since then, but we remain cautious.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Over the past five years, it looks as though Amcor's EPS have declined at around 11% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Amcor's earnings per share, which support the dividend, have been anything but stable.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Amcor paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Earnings per share are down, and Amcor's dividend has been cut at least once in the past, which is disappointing. There are a few too many issues for us to get comfortable with Amcor from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Case in point: We've spotted 4 warning signs for Amcor (of which 1 is a bit concerning!) you should know about.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.