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Investors In Farmland Partners Inc. (NYSE:FPI) Should Consider This, First

Simply Wall St

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Dividend paying stocks like Farmland Partners Inc. (NYSE:FPI) 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. 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.

With a five-year payment history and a 3.1% yield, many investors probably find Farmland Partners intriguing. We'd agree the yield does look enticing. The company also bought back stock during the year, equivalent to approximately 9.6% of the company's market capitalisation at the time. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Click the interactive chart for our full dividend analysis

NYSE:FPI Historical Dividend Yield, July 17th 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. Although it reported a loss over the past 12 months, Farmland Partners currently pays a dividend. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Farmland Partners paid out 131% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term.

It is worth considering that Farmland Partners is a Real Estate Investment Trust (REIT). REITs have different rules governing their payments, and are often required to pay out a high portion of their earnings to investors.

Is Farmland Partners's Balance Sheet Risky?

As Farmland Partners's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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). Farmland Partners has net debt of 13.26 times its EBITDA, which we think carries substantial risk if earnings aren't sustainable.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.52 times its interest expense is starting to become a concern for Farmland Partners, and be aware that lenders may place additional restrictions on the company as well. 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.

We update our data on Farmland Partners every 24 hours, so you can always get our latest analysis of its financial health, 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. Looking at the data, we can see that Farmland Partners has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.42 in 2014, compared to US$0.20 last year. Dividend payments have fallen sharply, down 52% over that time.

We struggle to make a case for buying Farmland Partners for its dividend, given that payments have shrunk over the past five 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. It's good to see Farmland Partners has been growing its earnings per share at 31% a year over the past 5 years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet.

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. It's a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. In summary, Farmland Partners has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Are management backing themselves to deliver performance? Check their shareholdings in Farmland Partners in our latest insider ownership analysis.

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