Today we'll take a closer look at Melco Resorts & Entertainment Limited (NASDAQ:MLCO) 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. 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, Melco Resorts & Entertainment likely looks attractive to dividend investors, given its 4.6% dividend yield and six-year payment history. It sure looks interesting on these metrics - but there's always more to the story . Remember though, given the recent drop in its share price, Melco Resorts & Entertainment's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Melco Resorts & Entertainment paid out 83% 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. The company paid out 78% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's positive to see that Melco Resorts & Entertainment'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 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 2.10 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.
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 2.50 times its interest expense, Melco Resorts & Entertainment's interest cover is starting to look a bit thin.
We update our data on Melco Resorts & Entertainment every 24 hours, so you can always get our latest analysis of its financial health, here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Melco Resorts & Entertainment has been paying a dividend for the past six years. It's good to see that Melco Resorts & Entertainment has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past six-year period, the first annual payment was US$0.52 in 2014, compared to US$0.66 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.2% a year over that time. The dividends haven't grown at precisely 4.2% every year, but this is a useful way to average out the historical rate of growth.
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
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. In the last five years, Melco Resorts & Entertainment's earnings per share have shrunk at approximately 6.8% per annum. 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.
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. First, we think Melco Resorts & Entertainment is paying out an acceptable percentage of its cashflow and profit. Earnings per share are down, and Melco Resorts & Entertainment's dividend has been cut at least once in the past, which is disappointing. Overall, Melco Resorts & Entertainment falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Case in point: We've spotted 3 warning signs for Melco Resorts & Entertainment (of which 1 makes us a bit uncomfortable!) you should know about.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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