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Here's Why We're Wary Of Buying K-Bro Linen Inc.'s (TSE:KBL) For Its Upcoming Dividend

Simply Wall St

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see K-Bro Linen Inc. (TSE:KBL) is about to trade ex-dividend in the next 4 days. You will need to purchase shares before the 29th of August to receive the dividend, which will be paid on the 13th of September.

K-Bro Linen's next dividend payment will be CA$0.10 per share, and in the last 12 months, the company paid a total of CA$1.20 per share. Last year's total dividend payments show that K-Bro Linen has a trailing yield of 3.1% on the current share price of CA$38.48. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether K-Bro Linen can afford its dividend, and if the dividend could grow.

View our latest analysis for K-Bro Linen

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. K-Bro Linen paid out 180% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. K-Bro Linen paid out more free cash flow than it generated - 117%, to be precise - last year, which we think is concerningly high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

Cash is slightly more important than profit from a dividend perspective, but given K-Bro Linen's payouts were not well covered by either earnings or cash flow, we would be concerned about the sustainability of this dividend.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

TSX:KBL Historical Dividend Yield, August 24th 2019

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. K-Bro Linen's earnings per share have fallen at approximately 15% a year over the previous 5 years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

We'd also point out that K-Bro Linen issued a meaningful number of new shares in the past year. It's hard to grow dividends per share when a company keeps creating new shares.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, K-Bro Linen has lifted its dividend by approximately 0.9% a year on average.

To Sum It Up

Should investors buy K-Bro Linen for the upcoming dividend? Not only are earnings per share declining, but K-Bro Linen is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders as dividends. This is a clearly suboptimal combination that usually suggests the dividend is at risk of being cut. If not now, then perhaps in the future. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of K-Bro Linen.

Curious what other investors think of K-Bro Linen? See what analysts are forecasting, with this visualisation of its historical and future estimated earnings and cash flow .

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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.