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Do Investors Have Good Reason To Be Wary Of WPP AUNZ Limited's (ASX:WPP) 8.6% Dividend Yield?

Simply Wall St

Could WPP AUNZ Limited (ASX:WPP) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the 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 high yield and a long history of paying dividends is an appealing combination for WPP AUNZ. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on WPP AUNZ!

ASX:WPP Historical Dividend Yield, February 26th 2020

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. While WPP AUNZ pays a dividend, it reported a loss over the last year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

WPP AUNZ paid out 71% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business.

Is WPP AUNZ's Balance Sheet Risky?

Given WPP AUNZ is paying a dividend but reported a loss over the past year, 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). WPP AUNZ has net debt of 0.99 times its EBITDA, which we think is not too troublesome.

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 5.71 times its interest expense appears reasonable for WPP AUNZ, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of WPP AUNZ's latest financial position, by checking our visualisation of its financial health.

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 WPP AUNZ's dividend payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was AU$0.047 in 2010, compared to AU$0.052 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.0% a year over that time. The dividends haven't grown at precisely 1.0% every year, but this is a useful way to average out the historical rate of growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Over the past five years, it looks as though WPP AUNZ's EPS have declined at around 28% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that WPP AUNZ'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 not keen on the fact that WPP AUNZ paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. Using these criteria, WPP AUNZ looks quite suboptimal from a dividend investment perspective.

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

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 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.