U.S. Markets open in 7 hrs 32 mins

Investors In Melco Resorts & Entertainment Limited (NASDAQ:MLCO) Should Consider This, First

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Is Melco Resorts & Entertainment Limited (NASDAQ:MLCO) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With a 2.9% yield and a five-year payment history, investors probably think Melco Resorts & Entertainment looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock during the year, equivalent to approximately 6.5% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Melco Resorts & Entertainment for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

NasdaqGS:MLCO Historical Dividend Yield, July 1st 2019

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 92% of Melco Resorts & Entertainment's profits were paid out as dividends in the last 12 months. This is quite a high payout ratio that suggests the dividend is not well covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 61% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Melco Resorts & Entertainment has available to meet other needs. It's good to see that while Melco Resorts & Entertainment's dividends were not well covered by profits, at least they are affordable from a free cash flow perspective. Even so, if the company were to continue paying out almost all of its profits, we'd be concerned about whether the dividend is sustainable in a downturn.

Is Melco Resorts & Entertainment's Balance Sheet Risky?

As Melco Resorts & Entertainment 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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Melco Resorts & Entertainment has net debt of 2.51 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.16 times its interest expense is starting to become a concern for Melco Resorts & Entertainment, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Melco Resorts & Entertainment's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Melco Resorts & Entertainment has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.52 in 2014, compared to US$0.62 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.7% a year over that time.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. In the last five years, Melco Resorts & Entertainment's earnings per share have shrunk at approximately 11% per annum. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

To summarise, shareholders should always check that Melco Resorts & Entertainment'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 Melco Resorts & Entertainment paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share are down, and Melco Resorts & Entertainment's dividend has been cut at least once in the past, which is disappointing. In this analysis, Melco Resorts & Entertainment doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 19 analysts we track are forecasting for the future.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.