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Is Kennametal Inc. (NYSE:KMT) A Risky Dividend Stock?

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Simply Wall St
·4 min read
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Could Kennametal Inc. (NYSE:KMT) 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. 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.

In this case, Kennametal likely looks attractive to investors, given its 3.6% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Remember that the recent share price drop will make Kennametal's yield look higher, even though recent events might have impacted the company's prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

NYSE:KMT Historical Dividend Yield April 14th 2020
NYSE:KMT Historical Dividend Yield April 14th 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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Kennametal paid out 51% of its profit as dividends. 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 122%, Kennametal's dividend payments are poorly covered by cash flow. Kennametal paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Kennametal's ability to maintain its dividend.

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

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Kennametal's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.48 in 2010, compared to US$0.80 last year. Dividends per share have grown at approximately 5.2% per year over this time.

Dividends have grown at a reasonable rate over this period, and without any major cuts in the payment over time, we think this is an attractive combination.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Over the past five years, it looks as though Kennametal's EPS have declined at around 4.7% a year. A modest decline in earnings per share is not great to see, but it doesn't automatically make a dividend unsustainable. Still, we'd vastly prefer to see EPS growth when researching dividend stocks.

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 Kennametal has an acceptable payout ratio, although its dividend was not well covered by cashflow. Moreover, earnings have been shrinking. While the dividends have been fairly steady, we'd wonder for how much longer this will be sustainable if earnings continue to decline. In summary, Kennametal 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.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Taking the debate a bit further, we've identified 4 warning signs for Kennametal that investors need to be conscious of moving forward.

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.