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What To Know Before Buying AltaGas Canada Inc. (TSE:ACI) For Its Dividend

Simply Wall St

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Could AltaGas Canada Inc. (TSE:ACI) 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.

AltaGas Canada has only been paying a dividend for a year or so, so investors might be curious about its 3.8% yield. That said, the recent jump in the share price will make AltaGas Canada's dividend yield look smaller, even though the company prospects could be improving. Some simple research can reduce the risk of buying AltaGas Canada for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

TSX:ACI Historical Dividend Yield, July 16th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. AltaGas Canada paid out 28% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. AltaGas Canada paid out 77% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It's positive to see that AltaGas Canada'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 AltaGas Canada's Balance Sheet Risky?

As AltaGas Canada 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. AltaGas Canada has net debt of 6.37 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 2.52 times its interest expense, AltaGas Canada's interest cover is starting to look a bit thin. 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.

Consider getting our latest analysis on AltaGas Canada's financial position here.

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. 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 CA$0.95 per share, effectively flat on its first payment one years ago.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

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. EPS have fallen -12% over the last 12 months. That's not great to see, but there could be a number of reasons for this. Should the decline continue, we would become concerned. Any one year of performance can be misleading for a variety of reasons, so we wouldn't like to form any strong conclusions based on these numbers alone.

We'd also point out that AltaGas Canada issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that AltaGas Canada's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that AltaGas Canada pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. Ultimately, AltaGas Canada comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 7 analysts are forecasting a turnaround in our free collection of analyst estimates here.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.