Today we'll take a closer look at FirstEnergy Corp. (NYSE:FE) 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. 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.
In this case, FirstEnergy likely looks attractive to investors, given its 3.2% dividend yield and a payment history of over ten years. 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 FirstEnergy for its dividend, and we'll go through these below.
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. Looking at the data, we can see that 66% of FirstEnergy's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while FirstEnergy 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 FirstEnergy's Balance Sheet Risky?
As FirstEnergy has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). FirstEnergy has net debt of 5.65 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
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 2.22 times its interest expense, FirstEnergy's interest cover is starting to look a bit thin. Low interest cover and high debt can create problems right when the investor least needs them, and we're reluctant to rely on the dividend of companies with these traits.
Consider getting our latest analysis on FirstEnergy's financial position here.
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 FirstEnergy's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was US$2.20 in 2009, compared to US$1.56 last year. This works out to be a decline of approximately 3.4% per year over that time. FirstEnergy's dividend has been cut sharply at least once, so it hasn't fallen by 3.4% every year, but this is a decent approximation of the long term change.
We struggle to make a case for buying FirstEnergy for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? It's good to see FirstEnergy has been growing its earnings per share at 20% a year over the past five years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that FirstEnergy's growth will be slower in the future.
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. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Ultimately, FirstEnergy comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 10 FirstEnergy 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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