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InterContinental Hotels Group PLC (LON:IHG) Is Yielding 1.8% - But Is It A Buy?

Simply Wall St

Dividend paying stocks like InterContinental Hotels Group PLC (LON:IHG) 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. 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 1.8% yield is nothing to get excited about, but investors probably think the long payment history suggests InterContinental Hotels Group has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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LSE:IHG Historical Dividend Yield, December 22nd 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. InterContinental Hotels Group paid out 52% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 54% of its free cash flow, which is not bad per se, but does start to limit the amount of cash InterContinental Hotels Group has available to meet other needs. It's positive to see that InterContinental Hotels Group's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is InterContinental Hotels Group's Balance Sheet Risky?

As InterContinental Hotels Group has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). With net debt of 2.74 times its EBITDA, InterContinental Hotels Group's debt burden is within a normal range for most listed companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 8.56 times its interest expense appears reasonable for InterContinental Hotels Group, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on InterContinental Hotels Group'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. InterContinental Hotels Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was US$0.56 in 2009, compared to US$1.20 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.9% a year over that time. InterContinental Hotels Group's dividend payments have fluctuated, so it hasn't grown 7.9% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

A reasonable rate of dividend growth is good to see, but we're wary that the dividend history is not as solid as we'd like, having been cut at least once.

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? Earnings have grown at around 3.0% a year for the past five years, which is better than seeing them shrink! Growth of 3.0% is relatively anaemic growth, which we wonder about. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.

Conclusion

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, we think InterContinental Hotels Group is paying out an acceptable percentage of its cashflow and profit. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than InterContinental Hotels Group out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 19 InterContinental Hotels Group analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.