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What To Know Before Buying Canadian Tire Corporation, Limited (TSE:CTC.A) For Its Dividend

Simply Wall St

Could Canadian Tire Corporation, Limited (TSE:CTC.A) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, Canadian Tire likely looks attractive to investors, given its 3.1% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 5.8% of the company's market capitalisation at the time. 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 Canadian Tire!

TSX:CTC.A Historical Dividend Yield, September 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. In the last year, Canadian Tire paid out 36% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Canadian Tire paid out 97% of its free cash flow last year, which we think is concerning if cash flows do not improve. Canadian Tire paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Canadian Tire to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Is Canadian Tire's Balance Sheet Risky?

As Canadian Tire 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 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. Canadian Tire is carrying net debt of 4.54 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 6.19 times its interest expense appears reasonable for Canadian Tire, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Canadian Tire'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. For the purpose of this article, we only scrutinise the last decade of Canadian Tire'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 CA$0.84 in 2009, compared to CA$4.15 last year. This works out to be a compound annual growth rate (CAGR) of approximately 17% a year over that time.

With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Canadian Tire has grown its earnings per share at 10.0% per annum over the past five years. It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like Canadian Tire's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Second, it has a limited history of earnings per share growth, but at least the dividends have been relatively stable. Overall we think Canadian Tire is an interesting dividend stock, although it could be better.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 9 analysts we track are forecasting for Canadian Tire for free with public analyst estimates for the company.

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.