Today we'll take a closer look at Frontline Ltd. (NYSE:FRO) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Frontline is a new dividend aristocrat in the making. We'd agree the yield does look enticing. Remember though, due to the recent spike in its share price, Frontline's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Some simple research can reduce the risk of buying Frontline for its dividend - read on to learn more.
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Frontline paid out 30% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
Is Frontline's Balance Sheet Risky?
As Frontline 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). With net debt of 6.12 times its EBITDA, Frontline could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.75 times its interest expense is starting to become a concern for Frontline, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.
Remember, you can always get a snapshot of Frontline's latest financial position, by checking our visualisation of its financial health.
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. Looking at the data, we can see that Frontline has been paying a dividend for the past four years. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past four-year period, the first annual payment was US$1.00 in 2015, compared to US$0.40 last year. Dividend payments have fallen sharply, down 60% over that time.
We struggle to make a case for buying Frontline for its dividend, given that payments have shrunk over the past four years.
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. Frontline's EPS have fallen by approximately 11% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Frontline's earnings per share, which support the dividend, have been anything but stable.
We'd also point out that Frontline issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.
To summarise, shareholders should always check that Frontline'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 glad to see Frontline has a low payout ratio, as this suggests earnings are being reinvested in the business. Earnings per share are down, and Frontline's dividend has been cut at least once in the past, which is disappointing. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Frontline out there.
Given that earnings are not growing, the dividend does not look nearly so attractive. See if the 9 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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 firstname.lastname@example.org. 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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