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Should Keurig Dr Pepper Inc. (NYSE:KDP) Be Part Of Your Dividend Portfolio?

Simply Wall St

Today we'll take a closer look at Keurig Dr Pepper Inc. (NYSE:KDP) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

Keurig Dr Pepper has only been paying a dividend for a year or so, so investors might be curious about its 2.2% yield. There are a few simple ways to reduce the risks of buying Keurig Dr Pepper for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

NYSE:KDP Historical Dividend Yield, January 15th 2020

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Keurig Dr Pepper paid out 76% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Keurig Dr Pepper's cash payout ratio in the last year was 41%, which suggests dividends were well covered by cash generated by the business. It's positive to see that Keurig Dr Pepper'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 Keurig Dr Pepper's Balance Sheet Risky?

As Keurig Dr Pepper 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). Keurig Dr Pepper has net debt of 4.26 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 4.12 times its interest expense, Keurig Dr Pepper's interest cover is starting to look a bit thin.

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

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. With a payment history of less than 2 years, we think it's a bit too soon to think about living on the income from its dividend. Its most recent annual dividend was US$0.60 per share.

Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn't want to rely on this dividend too much.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Over the past five years, it looks as though Keurig Dr Pepper's EPS have declined at around 25% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Keurig Dr Pepper's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Keurig Dr Pepper's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Keurig Dr Pepper has an acceptable payout ratio and its dividend is well covered by cashflow. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Keurig Dr Pepper out there.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

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