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Would Fomento de Construcciones y Contratas, S.A. (BME:FCC) Be Valuable To Income Investors?

Simply Wall St

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Today we'll take a closer look at Fomento de Construcciones y Contratas, S.A. (BME:FCC) 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.

A high yield and a long history of paying dividends is an appealing combination for Fomento de Construcciones y Contratas. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding Fomento de Construcciones y Contratas for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

BME:FCC Historical Dividend Yield, June 25th 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. Looking at the data, we can see that 55% of Fomento de Construcciones y Contratas's profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

Is Fomento de Construcciones y Contratas's Balance Sheet Risky?

As Fomento de Construcciones y Contratas 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 a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). Fomento de Construcciones y Contratas has net debt of more than 3x 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.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of less than 5x its interest expense is starting to become a concern for Fomento de Construcciones y Contratas, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Fomento de Construcciones y Contratas'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 Fomento de Construcciones y Contratas's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was €1.43 in 2009, compared to €0.40 last year. This works out to a decline of approximately 72% over that time.

When a company's per-share dividend falls we question if this reflects poorly on either the business or management. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's good to see Fomento de Construcciones y Contratas has been growing its earnings per share at 78% a year over the past 5 years. With recent, rapid earnings per share growth and a payout ratio of 55%, this business looks like an interesting prospect if earnings are reinvested effectively.

We'd also point out that Fomento de Construcciones y Contratas issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.

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. Fomento de Construcciones y Contratas's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Fomento de Construcciones y Contratas has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 Fomento de Construcciones y Contratas 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%.

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.